Diamond Offshore Drilling Is a Good Oil Play

Oil has fallen quite a bit from its July highs and so have practically all the companies in the black crack sector. Despite the large money flows out of the Texas Tea space, one oil company in particular has been catching my eye lately, Diamond Offshore (DO) drilling. Diamond Offshore drilling is the second largest renter of offshore rigs, with 30 semisubmersible rigs, 15 jackup rigs and one drillship (currently working off the coast of Brazil).

I know what you are probably thinking, “Aren’t oil companies cutting back on exploration and drilling?” While oil companies are less eager to find oil with prices at 50 dollars a barrel then they were when prices were 150 dollars per barrel, Diamond Offshore drilling has managed to tie up most of their fleet for the next few years. As of September 2008, DO had 97% of its fleet booked for 2009 and 77% of its fleet booked for 2010. The company has 11.5 billion dollars in backlog which contract dates spanning until 2013.

In addition to that, I want you to look at an event that happened last December. A customer of DO’s canceled their rig contract (which was slated for 500k per day). It only took two weeks for DO to find new customers to take the rig, and the contract was signed at 520k per day, a rate higher than that of their canceled customers. To me, that is a very positive signal.

Diamond Offshore Drilling operates in a very high economic moat business, with operating margins of 54% and a profit margin of 37%. Moreover, DO pays a nice dividend which works out to be about a 10% yield, depending on the special dividends, and I see no reason why they would stop paying that yield anytime soon given their newbuild program is nearing completion and they have very strong free cash flow. Furthermore, DO has 740 million in cash on hand with a paltry 503 million in debt. The stock also sports an earnings multiple of 7.5 and a very nice Return on Equity of 42%.

With oil in contago mode (futures prices sloping upward), and high utilization rates coupled with a healthy backlog, I think Diamond Offshore Drilling is worth taking a look at.

Disclosure: Author is long DO options

Comments

[Spicer:]

"It's all the same."

No it isn't. Deepwater drilling is an entirely different ball game within the oil service sector. With the exception of Middle East and Brazil there hasn't been any major onshore or shallow water oil discoveries in the recent years( though plenty of natural gas discoveries), deepwater however has provided number of significant oil discoveries in the GOM, West Africa and Brazil.

Thanks to the credit crunch "the economic moat"( a new deepwater semi-submersible costs at least $500 million) that surrounds the deepwater drilling sector, has become much deeper and wider and should ensure high margins for the drillers in the near and midterm.

Apr 24 03:32 AM

[Dustinian:]

Any oil related company which has a large presence in deep water drilling is appealing to me. Incidentally, Diamond had better than expected first quarter earnings.

seekingalpha.com/artic...

This seems to be a very good long play as the price of oil increases and demand follows suit. Also, the future of oil is in deep waters, IMHO.

Apr 24 01:56 PM

[$OMALIA:]

Good to sell.

Apr 25 07:26 AM