Article Overview

In one of the most challenging times for the energy industry, the focus of companies is not on growth, but on survival.

If we look at the broad energy industry, Whiting Petroleum Corporation (WLL) is the first major casualty with the company filing for bankruptcy. In my personal opinion, Chesapeake Energy (CHK) is not far behind.

Therefore, the sentiment related to the industry is bearish and this has translated into several stocks being oversold. This creates some trading opportunities, but investors need to be cautious.

Among stocks that have witnessed a sharp decline, Diamond Offshore (DO) has plummeted by 87% from 52-week highs of $12.64 and currently trades at $1.64. The stock can witness some trading bounce back. However, I remain bearish on Diamond Offshore.

This article will discuss the concerns that translate into a negative view on the stock even after the big decline.

Talking about survival, I would first look at the company's balance sheet and cash flow. Starting from the EBITDA level, Diamond Offshore reported an EBITDA of $247 million in 2018 and the company's EBITDA declined to $74 million in 2019.

Diamond Offshore has further mentioned in their annual report that cash flow for 2020 is likely to be negative. In all probability, the company will report operating level loss for 2020. The concern here is that the company has $2.0 billion in long-term debt. With losses at operating level, the company is likely to service debt through additional debt.

The positive point is that Diamond Offshore has $250 million in debt maturity in 2023 and $500 million in debt maturity in 2025. The remaining debt maturity comes on or after 2039. Therefore, the company faces no immediate debt refinancing pressure.

Another positive is that the company has $1.2 billion in undrawn credit facility. Even if we leave out the $250 million credit facility maturing in October 2020, the company still has $950 million in undrawn facility. In addition, balance sheet cash as of December 2019 was at $156 million. This will provide liquidity for debt servicing and maintenance capital expenditure through 2020.

However, this is not enough to boost investor confidence. The factor that will boost investor confidence is a relatively strong growth in order backlog. I don't see that coming through 2020 and potentially in 2021.

To put things into perspective, Diamond Offshore reported an order backlog of $1.6 billion as of December 2019. The backlog is front end loaded with $802 million of order executing in 2020 and $486 million in backlog for 2021.

Even with $802 million in backlog for the year, the company is expecting negative cash flows. Therefore, if Diamond Offshore has to return to operating level profit and positive cash flows in 2021, the backlog growth has to be significant.

With oil & gas companies scaling down on their investment plans, it seems unlikely that backlog growth will be strong through the year. My point is underscored by the fact that for 2019, Diamond Offshore reported order backlog growth of $620 million.

With significantly more challenging conditions, it would be optimistic to expect a backlog growth of even $600 million. Therefore, in all probability, Diamond Offshore will burn cash even in 2021. This concern will keep the stock subdued.

One factor that can take Diamond Offshore higher is a significant rise in oil prices in the next 12-18 months. I believe that there is a case for higher oil prices considering the following factors:

First, oil at $30 or $40 per barrel will hurt Russia, Saudi Arabia and the United States, among several other countries. With the COVID-19 already wreaking havoc, it's likely that oil producers will soon agree on production cut. This can take oil above $40 per barrel and potentially near $50 per barrel.

Second, China is already crawling back to normalcy after COVID-19. The same will hold true for other economies in the world. Once there is renewed economic growth and demand for oil, prices will trend higher. However, I don't expect strong economic recovery in 2020. It's only likely into 2021.

I also want to mention here that there is a significant amount of proven reserves in offshore deep-water and offshore.

This, coupled with the fact that offshore break-even price is on a decline, makes the outlook relatively positive for Diamond Offshore in the long term.

Of course, EBITDA margin is unlikely to be robust as it was few years before. However, orders will flow for companies like Transocean (RIG) and Diamond Offshore. The key factor for now is to reduce cost and battle for survival.

There is no doubt that Diamond Offshore has a high quality fleet. However, the company's liquidity and order backlog are a concern for the foreseeable future.

The backlog needs to grow and the company needs to show profit at operating level for the stock to witness any sustained rally.

For now, there can be strong bounce backs from oversold levels followed by renewed correction. Long-term investors can therefore avoid the stock even after the deep correction in 2020.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Avoid Diamond Offshore Even After A Big Correction - Seeking Alpha