Drillers, Dividends and the 6% Rule

 | Jun 05, 2014 | 12:00 PM EDT
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I'm not an energy analyst, and quite a few people on Real Money know a lot more about drillers than I do, but I believe I have a unique perspective as a macro guy who looks at all sectors and all asset classes. Drillers, at this particular point in history, really stand out. 

It all started when I was looking for ways to get smart leverage on Brazil (I already own the iShares MSCI Brazil ETF (EWZ)). A few people suggested Transocean (RIG). They said it had a 7% dividend. Unpossible, I said. I looked, and what do you know? It has a 7% dividend! Then I pulled up the five-year chart. It's a disaster. It's a relentless bear market in drillers.

So I did some more investigation. Turns out there was some serious overbuilding and overcapacity. Day rates have declined by as much as 40% or 50% for deep-water rigs.

Back to the dividend: 7%.

One of my investing rules of thumb is that if a stock, especially a broad market index, has a dividend yield of 6% or more, you have to do some due diligence. If something has a 6% dividend yield, chances are the stock or sector or index is being left for dead. Now, sometimes, that is for good reason. Sometimes dividends really get high on the way to bankruptcy. Sometimes a company will raise dividends on the way down to fend off short-sellers. So not every 6% dividend is a good dividend.

Do your due diligence and decide whether there is going concern risk. If there isn't, and if it's a good dividend, then party on, Wayne. I should point out that the Eurostoxx 50 had a 6% dividend on the lows. Transocean is not in much danger of going bankrupt. It's levered, and the industry is in decline, but it's not distressed.

Then some people told me that I should check out SeaDrill (SDRL). They told me SeaDrill has a 10% yield. Too good to be true, right?

It's the real deal. SeaDrill has also seen better days, but just recently a subsidiary just signed a major deal to drill in the Arctic for Rosneft, an integrated oil company that is majority-owned by the Russian government. SeaDrill is more levered and less stable than Transocean, but unless the industry declines further, that 10% dividend also looks safe.

I'm going to put on my Warren Buffett hat for a moment and think about some businesses that are being given away for cheap that have big cash flows and big dividends and wide moats, like the drillers. I have less than zero interest in tech right now, after what happened in April and May. Some serious technical damage has been done. I'm not interested in retail, either. Retail is a bubble. I'm short retail. I believe the whole market is grossly overbought, so I am dumpster-diving for cheap names with big dividends. As I've written here before, I believe this market is very susceptible to a substantial correction, and I want no part of having any net exposure.

Two takeaways here: Be contrarian, and the 6% rule is your friend.

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