Real Client Managed Portfolio Memorandum
TO: Real Client Managed Portfolio, Spring 2011 Class
FROM: Rajwardhan Dhwale, Pratik Kamdar, Jinglin Pan
SUBJECT: Diamond Offshore Investment Recommendation
DATE: March 1st 2011
RECOMMENDATION: Place Limit Sell Order at $80 for 50 Shares
Company Overview
Diamond Offshore Drilling, Inc. is a leading drilling contractor whose niche lies in deepwater exploration and drilling, and has been providing services to oil and gas companies for four decades. The company’s headquarters are located in Houston, TX, and has significant presence globally, such as Australia, Africa and South America. Diamond Offshore offers various forms of oil exploration and drilling to their clients. Their fleet of rigs includes semisubmersibles, jack-ups, and a drillship. The current key drilling locations are Brazil and Asia Pacific, in lieu of the BP oil spill incident that occurred in April 2010.
Portfolio Position
The portfolio currently holds 150 shares of Diamond Offshore Drilling, Inc. (DO), which were purchased in two transactions – firstly in November 2008 for 50 shares at $72.96 per share for a total cost of $3,648, and secondly in Oct 2010 for 100 shares at $ 68.10 per share for a total cost of $6810. After exercising a short call at $76.22 on 100 shares, and realizing loss of $4,665 on an initial position entered in Feb 2008 at $122.90 per share, as of Feb 28th 2011, the security is yielding an unrealized gain of 12.20%.
Recent Performance
The entire oil and gas industry plummeted after April 2010 due to the BP oil spill incident in the Gulf of Mexico. As a result, operators and contractors had to terminate drilling operations in Gulf of Mexico. The moratorium resulted in mobilization of rigs and lawsuits over contract terms, which both lead to lower revenues for DO, and fellow contractors. Amongst the competitors, DO was the most affected firm due to its narrow niche in deepwater drilling previously in Gulf of Mexico. However, DO has managed its costs by cold stacking some rigs, while shift others into Brazil, contracting with Brazil Petroleum and into Asia Pacific, where potential new oil fields are.
Recommendation
The discounted cash flow estimation returns a fair value estimate of $76.89, while the multiples valuation returns an estimate of $84.75, which coincidence with DO’s underperformance comparative to its peers. Due to the fact that DO does not have any long term customers other than Brazil Petroleum, DO’s largest customer, which is expecting 7 rigs to be delivered in 2015, the year in which DO’s contract with them ends, we recommend placing a limit sell order at $80 for the 50 shares bought in November 2011. Despite the favorable and stable prospects for the oil and gas industry, the team finds that DO’s stock price will not be able to reflect that in the short term, and hence would like to cash out at a profitable price level in light of the recent spike in price levels due to the first issuance of permit for deepwater drilling in Gulf of Mexico since the oil spill incident.