Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 4Q17 Earnings Update
Prev. Ed.: Nov 29, 2017; 3Q17 Earnings Update (brokers’ material considered till Nov 28, 2017)
Brokers’ Recommendations: Neutral: 47.1% (8 firms); Negative: 47% (8); Positive: 5.9% (1) Prev. Ed.: 11; 5; 2
Brokers’ Target Price: $13.88 (↓$0.38 from the last edition, 15 firms) Brokers’ Avg. Expected Return: -13.9%
*NOTE: Though dated Mar 22, 2018, brokers’ materials and share price are as of Mar 21, 2018.
Note: A flash update was done on Feb 12, 2018; 4Q17 Earnings Update
Portfolio Manager Executive Summary
Diamond Offshore Drilling Inc. (DO) operates as an offshore oil and gas drilling contractor worldwide. It offers a range of services in deepwater, harsh environment, conventional semi-submersible and jackup markets.
Of the 17 firms in the Digest group covering Diamond Offshore Drilling, one rated it positive, eight rated it neutral and eight rendered negative ratings. Target price ranges from a low of $9.00 (44.2% downside from the current price) to a high of $19.00 (17.8% upside from the current price), with the average price being $13.88.
The following is a summarized opinion of the diverse brokerage viewpoints:
Positive or equivalent (5.9%; 1/17 firms): The bullish firms believe that Diamond Offshore Drilling has solid fundamentals with significant free cash flow potential and a clean balance sheet. Moreover, the company intends to increase its footprint in emerging markets (like Australia, Brazil and West Africa) to reap benefits from the recently discovered deepwater fields. This should work well for the company in the long term.
Neutral or equivalent (47.1%; 8/17 firms): The firms are of the opinion that Diamond Offshore’s strong financial foothold and lower debt levels should allow it to better withstand the weakness in the industry. Moreover, the company has undertaken several cost-containment measures that should work well for it. The firms expect the scenario to be more positive in 2018 as the oil prices show recovery.
However, near-term oversupply and weak demand could pose problems for the company’s aging fleet. The firms expect an increase in downtime.
Negative or equivalent (47.0%; 8/17 firms): The bearish firms are concerned about the marketability and outlook for both the company’s mid-water and deepwater floaters. Lack of new contracts and delay in existing ones are likely to hamper its cash flow.
With new supply entering the market, some of Diamond Offshore Drilling’s aging fleet could experience rate pressures. Moreover, consistently weak commodity prices and the possibility of cost overruns on new projects pose challenges for the company.
March 22, 2018
Overview
Diamond Offshore Drilling is a deepwater drilling contractor that owns and operates one of the largest fleets of offshore drilling units in the world. The company's diverse fleet consists of 17 offshore drilling rigs. The company owns four drillships and 13 semisubmersibles, as of Feb 15, 2018. The Ocean Spur was sold in Apr 2017. Diamond Offshore Drilling owns one of the largest middle water semi-submersible fleets. The company operates in the waters of six of the world's seven continents, supplying comprehensive drilling services to the global energy industry. Diamond Offshore Drilling has significantly expanded its deepwater capabilities over the past few years through program upgrades and acquisitions.
The company is headquartered in Houston, TX. More information on Diamond Offshore Drilling is available at its website: www.diamondoffshore.com. Diamond Offshore Drilling’s fiscal year coincides with the calendar year.
The firms identified the following factors for evaluating the investment merits of Diamond Offshore Drilling:
Key Positive Arguments / Key Negative ArgumentsFundamentals
· Strong leverage to offshore deepwater drilling market.
· Improving economic environment supporting increased drilling programs.
· Significant free cash flow generating capability.
· The U.S. land rig market remains bullish as the market is close to another inflection point on day rates on the back of high oil prices and expansion of activity in several oil shale plays.
Growth Opportunities
· Long-term contracts for semi-submersibles.
· Significant amount of contracts on backlog.
· Growing global supply constraints, especially midwater assets will push day rates up.
· Increasing demand for deepwater drilling rigs or an unforeseen tightness in supply would be positive for the stock. / Fundamentals
· Idle rig time and rising contract drilling costs.
· Higher operating costs associated with mandatory surveys, shipyard times, and mooring upgrades.
· The earnings growth of Diamond Offshore Drilling is dependent on the U.S. Gulf floater market, which is sensitive to oil and gas prices.
· Increased speculative floater supply coming to the market.
Macro Issues
· Volatile oil and gas prices.
· Geopolitical risks with international operations.
· Construction delays and cost overruns on new buildings.
· Currency fluctuations.
· As offshore drilling sector is cyclical, seasonal and susceptible to external shocks, it may lead to volatility.
Competition
· Diamond Offshore Drilling competes in the worldwide drilling market against major public and national drilling companies, which is a considerable challenge.
March 22, 2018
Long-Term Growth
Diamond Offshore Drilling is the largest deepwater operator in the GoM and is poised for consistent growth from the strengthening ultradeep and deepwater markets as rigs are pulled out to deeper water. The company has a strong leverage position in the current cyclical upturn in demand for drilling services. This high demand comes from oil and natural gas producers’ impressive balance sheets, which in turn, are attributed to high commodity prices. It includes their intention to ramp up exploration outlays following years of underinvestment in the industry’s productive capacity. Drilling contractors and other service providers stand to benefit from these positive trends. As one of the few premium offshore drilling contractors, Diamond Offshore Drilling enjoys above-average leverage in this cycle, particularly in the deepwater drilling markets.
March 22, 2018
Target Price/Valuation
Provided below is the summary of valuation and ratings as compiled by the Zacks Digest:
Rating DistributionPositive / 5.9%↓
Neutral / 47.1%↓
Negative / 47.0%↑
Average Target Price / $13.88 ↓
Digest High / $19.00
Digest Low / $9.00
No. of Firms with Target Price/Total / 15/17
Major impediments to the target price include a host of quantitative and qualitative factors such as price volatility, fluctuations in the level of oil and natural gas exploration and production activity. It includes a high degree of leverage to mid-water depth floating rig demand, sensitivity to rig demand and day rates and delays or cost overruns on the company’s various newly build and upgraded projects.
Recent Events
On Feb 12, 2018, Diamond Offshore reported 4Q17 financial results. The highlights are as follow:
· Total revenue was $346.2 million as against $391.9 million in 4Q16.
· Adjusted net income was $7.3 million compared with $116.1 million in 4Q16.
· Diluted earnings per share (EPS) was (5 cents) in 2Q17 versus 85 cents in 4Q16.
Revenue
Per the company, total revenues in 4Q17 were $346.2 million, down 11.7% year over year (y-o-y) from $391.9 million.
Utilization and Day rates – In 4Q17, rig utilization for Ultra-Deepwater floaters increased to 65% from 49% in the year-ago quarter. Utilization of Deepwater floaters was 37% compared with 39% a year ago. Mid-water category rig utilization was 17% compared with 35% in the comparable quarter last year.
Segment Details per the Company
Ultra-Deepwater– Revenues in 4Q17 were $424 million, down 7% y-o-y but up 4% sequentially.
Deepwater– Revenues were $195 million, down 39% y-o-y and 10.2% sequentially.
Mid-water– Revenues were $266 million, down 44.3% y-o-y and 17.4% sequentially.
Outlook
Diamond Offshore Drilling’s ageing fleet has been contracted at lower dayrates, which would negatively impact revenues. Lack of new contracts is likely to add to the woes. Firms believe that the rigs that have been successful in winning contracts so far will see uneven operations ahead, due to lack of work in the market. The firms expect Diamond Offshore’s cold stacked rigs not to become operational before 2019 as rig utilization is expected to remain poor.
However, the bullish firms expect the top line to benefit from the company’s steadfast focus on upgrade of several midwater rigs and the ongoing newbuild program. The firms think that contract wins on its core niche floater fleet for the medium-term in a shrinking market bode well for the company.
Margins
Per the company, contract drilling expenses in 4Q17 were $204.2 million, up 3.1% y-o-y.
The company’s operating loss was $6.4 million compared with operating income of $104.1 million in 4Q16. General and administrative expenses (G&A) of $20.2 million in 4Q17 increased 36.6% y-o-y. As a percentage of revenues, G&A expenses were 6%.
Outlook
Some firms remain upbeat about the company’s significant efforts to improve its costs and operational improvements. The firms believe that Diamond Offshore is conservative when it comes to maintaining cash flow. They believe its efforts would partially reduce the effect of increased downtime going forward.
Earnings per Share
The company reported 4Q17 loss per share of 5 cents compared with EPS of 85 cents in the year-ago quarter.
Net income totaled $7.3 million in 4Q17 compared with a net income of $116.1 million in 4Q16.
Average shares outstanding during the quarter were 137.2 million compared with 137.3 million in the year-ago quarter.
Outlook
Most of the firms have lowered EPS estimates for 2018. This is because of the bearish outlook of the overall industry, thanks to an oversupply in the rig market and weak commodity pricing. The firms expect greater downtime and lower utilization.
Some firms have raised EPS estimates for 2018 on expectations of rig market recovery in view of the contracts received by the company throughout the year.
However, some firms are of the view that the company’s financial stability, cost-containment measures and operational improvements should somewhat offset these negatives. The firms are also impressed by the company’s way of achieving maximum rig efficiency and rig utilization across its active fleet.
Analyst / Richa PansariCopy Editor / Saswata Sinha
Content Ed. / Nilanjan Banerjee
Lead Analyst / Nilanjan Banerjee
QCA / Nilanjan Choudhury
No. of brokers reported/Total brokers / 17/17
Reason for Update / 4Q17 Earnings Update
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