Diamond Offshore Is A Hold – Seeking Alpha

Last week Diamond Offshore (NYSE:DO) delivered Q4 revenue of $391.9 million and eps of $0.40. The company beat on revenue by over $32 million. The stock is up about 2% since the report. I had the following takeaways:

Revenue Fell Y/Y, But Bounced Sequentially.

Diamond's total revenue fell 29% Y/Y. Ultra-deepwater floaters still make up 60% of total contract revenue. This segment fell 41% Y/Y as drilling for ultra-deepwater remains prohibitively expensive. Deepwater was off 30%, while Mid-water nearly doubled.

On a positive note, revenue was up about 13% on a sequential basis; Ultra-deepwater and Mid-water led the way with gains of 7% and 91%, respectively. The OPEC supply cut has sent oil prices in the mid-$50 range, and breathed new life into certain segments of the offshore market. The higher prices have also enticed North American shale drillers to increase supply. I expect oil prices to range from $50 - $60, which could help the Mid-water segment to remain a catalyst for several quarters.

Market For Offshore Drilling Remains Oversupplied

The general market for offshore contractors remains oversupplied. Industry participants have suffered from revenue declines due to waning demand for contract drilling services. Revenue earning days and average daily revenue have both been in decline. Diamond's biggest selling point is that it did not succumb to unbridled optimism that befell Seadrill (NYSE:SDRL) and others; it did not take on excessive debt or commit to capital expenditures that only made financial sense with oil prices in the $75 - $100 range.

On the earnings call management was keen to point out that it does not have any assets delayed in shipyards yet to be delivered or any sixth-generation assets uncontracted. The company has also been able to sustain its EBITDA margins during the downturn. Q4 EBITDA margin was 50%; this was higher than the 46% margin achieved in the year earlier period, despite lower revenue. These factors should allow the company to at least tread water if oil prices remain range bound.

Pristine Balance Sheet

Energy-related names seem to be bifurcated between those with strong balance sheets and those without them. Diamond's balance sheet is pristine. At Q4 it had working capital of $165 million. With $220 million in annual free cash flow, the company's liquidity should grow over time. As importantly, Diamond's $2.1 billion debt load is only 2.7x run-rate EBITDA.

That is in stark contrast to the balance sheets of competitors like Seadrill whose debt is over 5x EBITDA; Seadrill also has upside down working capital, and $1 billion in near term principal payments it might not be able to meet. Diamond's low debt load is probably why its liquidity and cash flow is so strong. If it had billions in near term principal payments then its cash flow and business prospects would be a lot more dismal. There is a scenario where Seadrill or another competitor could fold and potentially remove some supply from the market.

Conclusion

DO trades at 5.5x run-rate EBITDA. The low multiple is most likely due the dismal prospects of the offshore market with oil prices sub-$60. I believe oil prices will remain range bound due to land drillers increasing supply at higher prices. If financial markets endure a major correction or if a major competitor goes belly-up, removing supply from the offshore market, DO could become a buy. For now I rate the stock a hold.

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. I have no business relationship with any company whose stock is mentioned in this article.

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Diamond Offshore Is A Hold - Seeking Alpha