Diamond Offshore Drilling: Fleet Analysis For A Well-Balanced Company

May. 5.14 | About: Diamond Offshore (DO)

Summary

Diamond Offshore delivered again a surprising quarter with higher day rates and stronger revenue than was expected.

The analysis of the company's fleet is showing a notable aging in midwater and jackup rigs. This condition may become a clear disadvantage in this actual softening rate environment.

The company offers a safe 6.7% in dividend and a strong balance sheet. Despite a recent spike in stock price, I see value long term.

Diamond Offshore drilling, Inc. (NYSE:DO)

Picture from Diamond Offshore Drilling website

Diamond Offshore provides drilling services to global energy industries, particularly oil companies. The current company was founded in 1989, but can be traced to 1953, when Odeco's Alden Laborde developed the first semi-submersible rig. Odeco, founded in New Orleans, Louisiana, was purchased by Diamond Drilling. It specializes in offshore drilling in regions such as the North Sea and Gulf of Alaska. The company employs around 5,500 employees worldwide, and has three regional offices in Australia, Brazil and Scotland.

It has a fleet of 45 drilling rigs, including 5 rigs under construction. Its fleet consists of 33 semi-submersibles, two of which are under construction, five dynamically positioned drillships, three of which are under construction, and seven jackups. The midwater Ocean New Era, Ocean Epoch and Ocean Whittington are for sale. The jackup Ocean Spartan is also for sale. Actual backlog is $6.8 billion.

Former CEO, Lawrence R. Dickerson just retired after more than 30 years of service with the company, and has been replaced by Marc G. R. Edwards. Mr. Edwards has spent most of his career with Halliburton (NYSE:HAL).

The company was founded in 1989, and is headquartered in Houston, Texas. Diamond Offshore Drilling, Inc. is a subsidiary of Loews Corporation.

Complete fleet analysis. April 23, 2014.

More information has been added after the conference call on April 24, 2014.

1 - Semi-submersibles, Deepwaters and Midwater

# Name Year Built Specification Contract End

Current day rate

K $

Location
1 Ocean Baroness 2001 Ultra-deepwater >7,500' 9/15 277 Brazil- South America
2 Ocean Black Hawk 2014 Ultra-deepwater >7,500' 6/19 495 GOM-US
3 Ocean Black Hornet 2014 Ultra-deepwater >7,500' Q3/14-Q3/19 495 GOM-US
4 Ocean Black Lion 2015 Ultra-deepwater >7,500' Q2 2015 - -
5 Ocean Black Rhino 2014 Ultra-deepwater >7,500' Q4 2014 *To be rented soon at probably over 450 est. -
6 Ocean Clipper 1997 Ultra-deepwater >7,500' 12/15 313 Brazil- South America
7 Ocean Confidence 2001 Ultra-deepwater >7,500'

Maintenance 04/15

4/15-1/16

550 N.Sea/Med/W.Africa
8 Ocean Courage 2009 Ultra-deepwater >7,500' 2/15 407 Brazil- South America
9 Ocean Endeavor 2007 Ultra-deepwater >7,500' 01/16 521.7 N.Sea/Med/W.Africa
10 Ocean Monarch 2008 Ultra-deepwater >7,500'

Available

6/14(60d to 150d)

-

420

Australia (Indonesia/Total)
11 Ocean Great White 2016 Ultra-deepwater >7,500' H2/16-H2/19 585 (NYSE:BP)?
12 Ocean Rover 2003 Ultra-deepwater >7,500' 03/16 464 Australia
13 Ocean Valor 2009 Ultra-deepwater >7,500' 10/15 440 Brazil- South America
1 Ocean Alliance 1988 Deepwater 5,000' to 7,500' 6/16 367 Brazil- South America
2 Ocean America 1988 Deepwater 5,000' to 7,500' 5/15 475 Australia
3 Ocean Apex 2014 Deepwater 5,000' to 7,500' Q4/14 485 Vietnam
4 Ocean Onyx 2013 Deepwater 5,000' to 7,500' 01/15 490 GOM-US
5

Ocean Star

1997 Deepwater 5,000' to 7,500' 5/14 301 Brazil- South America
6 Ocean Valiant 1988 Deepwater 5,000' to 7,500'

Available/idle

Going to N.Sea

- N.Sea/Med/W.Africa
7 Ocean Victory 1997 Deepwater 5,000' to 7,500'

Available 4/14-4/15

4/15-4/17

398

GOM-US

Trinidad

1 Ocean Ambassador 1975 Midwater 450' to 5,000' 03/16 211.5 GOM-Mexico
2 Ocean Concord 1975 Midwater 450' to 5,000' 6/15 248 Brazil- South America
3 Ocean General 1976 Midwater 450' to 5,000' 6/14 255 Australia
4 Ocean Guardian 1985 Midwater 450' to 5,000'

07/14

07/14-07/15

265

350

N.Sea/Med/W.Africa
5 Ocean Lexington 1976 Midwater 450' to 5,000' 6/14 300 Brazil- South America
6 Ocean Nomad 1975 Midwater 450' to 5,000' 8/15 330 N.Sea/Med/W.Africa
7 Ocean Patriot 1983 Midwater 450' to 5,000'

10/14 maintenance

10/14/10/17

-

400.5

Australia
8 Ocean Princess 1975 Midwater 450' to 5,000'

5/14

07/14

230

300

N.Sea/Med/W.Africa
9 Ocean Quest 1973 Midwater 450' to 5,000' 04/14-12/14 199 Australia
10 Ocean Saratoga 1976 Midwater 450' to 5,000' 05/14 250 GOM-US
11 Ocean Vanguard 1982 Midwater 450' to 5,000' 02/15 454 N.Sea/Med/W.Africa
12 Ocean Winner 1976 Midwater 450' to 5,000' 3/15 283.5 Brazil- South America
13 Ocean Worker 1982 Midwater 450' to 5,000' 2/15 283.5 Brazil- South America
14 Ocean Yatzy 1989 Midwater 450' to 5,000' 10/14 257 Brazil- South America
15 Ocean Yorktown 1976 Midwater 450' to 5,000' 07/14 184 GOM-Mexico
1 Ocean Epoch 1977 Midwater 450' to 5,000' For sale - Stacked
2 Ocean New Era 1974 Midwater 450' to 5,000' For sale - Stacked
3 Ocean New Whittington 1974 Midwater 450' to 5,000' For sale - Stacked
Click to enlarge

2 - Jackups

# Name Year Built Specification Contract End

Current day rate

K $

Previous day rate
1 Ocean King 1996 Jackup 0' to 450' 06/14 130 GOM-Mexico
2 Ocean Nugget 1976 Jackup 0' to 450' 08/16 97 GOM-Mexico
3 Ocean Scepter 2008 Jackup 0' to 450' 4/14 135 GOM-Mexico
4 Ocean Spur 1981 Jackup 0' to 450' 8/14 30 Brazil- South America
5 Ocean Summit 1972 Jackup 0' to 450' 05/15 86 GOM-Mexico
6 Ocean Titan 1974 Jackup 0' to 450' Q2 2014 ? GOM-Mexico
7 Ocean Spartan 1980 For sale - - Stacked
Click to enlarge

But suffice to say, we will get the Rhino contracted at a rate that will be higher than the rumor that was suggested at $400,000 a day.

Comment about Diamond Drilling's aging fleet.

In this competitive offshore drilling sector, it is often important to look at the fleet age component to evaluate how efficient the company will be for the next five years compared with its peers. An aging fleet will hamper the company in the need to rent its rigs at a good day rate and weaken its position at the bargaining table, thus affecting the company's future growth.

The company cannot escape the analysts' scrutiny and the fact that a few rigs must be replaced on a regular and seasonable basis. This situation has been tackled already with the semi-submersibles, which shows strength, but other sectors such as the midwaters and jackups are lagging far behind.

The fleet can be divided into four groups, and I will use the numbers above to calculate the age of each sector on average:

Semi-subs Deepwaters Midwaters Jackups
*Number of active rigs 13 7 15 6
Average age in year 6 16 36 29.5
Click to enlarge

* Including the rigs in construction and excluding the rigs for sale.

There is often a direct relation between the debt level and the fleet age. Diamond Drilling debt level of $2.49 billion is much more manageable than Seadrill Ltd. (NYSE:SDRL) with its $13.9 billion, Transocean Ltd. (NYSE:RIG), Ensco Plc. (NYSE:ESV), or Noble Corp. (NYSE:NE) now.

DO ESV NE RIG SDRL
Long-term Debt in $ billion 2.5 4.8 5.6 10.7 13.9
Click to enlarge

Consequently, however, it shows that the company has an aging fleet, particularly with its midwaters and jackups, and despite what M. Edwards has said on the conference call.

So I do take some umbrance with the issue that our fleet is very old. It needs to be looked at, is it fit for purpose, how well is it maintained, how well is it operated? And I think, if you look at it from that perspective, I think, it will alleviate many of the concerns or even the suggestions that we are encumbered by the age of our fleet.

The midwater fleet (15) is the one that presents an immediate problem with its 36-year old average rigs, followed not far behind by jackups (6) that are almost 30 years old. The jackups group is quite small, and seems not really a priority for management. However, the midwaters group is important and will have a more sensitive influence on revenue and earnings, attributable to the day rate softness that the offshore drillers are facing in general now. The company may be in position again to acquire some midwater rigs at a distress price, as it did in 2010, using the strength of its balance sheet.

In 2010, we bought 2 new ultra-deepwater semis at distressed prices, and we'll continue to grow the fleet.

Unfortunately, this is a hypothetical solution that cannot mitigate totally the necessary need for concrete actions toward a fleet rejuvenation, even so, well-maintained.

However, the company will have to take some important decisions regarding these two segments during 2014 or 2015, otherwise its competitiveness and earnings going forward will be adversely affected, in my opinion. Diamond Drilling started to take the problem seriously and aggressively by rejuvenating its semi-submersibles, with an actual 6-year old average now.

Marc Gerard Rex Edwards, the new CEO and president (two months), said:

I don't think it will come as a surprise, but I will be focusing on 3 main value drivers. These being, investment excellence to include asset optimization and capital efficiency allocation. Commercial excellence, centered around customer relationships, pricing, utilization and fleet positioning and operational excellence, whereby we minimize downtime and maintain discipline in operating expense and SG&A.

Comment regarding the stock price.

It is not a secret that the offshore drilling sector is experiencing a slowdown that I have covered extensively in my precedent articles. The question is the significance on revenue and future earnings, and if the stock price has already factored in this new market paradigm.

The company surprised positively with its Q1 2014 earnings. It posted a net income of $146 million, or 1.05 per share, and revenue totaling $685 million. Day rates for ultra-deep rigs increased about 11% to $387k quarter to quarter, and 4% for deepwater to $418k. Marc Gerard Rex Edwards, CEO, commented on the softness of the market at the CC:

After several years of strength in the offshore market, where demand for deepwater drilling rigs exceeded supply, today we find ourselves with a somewhat uncertain outlook ahead. There is a consensus view developing suggesting that it's going to get worse before it gets better ... that 2014 and 2015 could be a tough environment to the offshore drillers.

He added a bit later that this period of uncertainty is not going to last too long, and already, the company could visualize an increase in inquires owing to the normalization of the day rates, changing the investment metrics in favor of an increase of new projects that were disregarded attributable to their uneconomical cost or to the desire of getting a better rate potential. Nonetheless, it appears that a possible "bottleneck situation" will be forming for the next several quarters or until the end of 2014. This honest comment was quite encouraging, and shows a management aware of the challenges lying ahead.

Conclusion and recommendation.

Diamond Drilling is a well-balanced company with a strong balance sheet and a small debt level. The last earnings were another indication that the analyst world is underestimating the sector. The company delivered better day rates than anticipated, and again confirmed without hesitation that the dividends are solid and will stay at this level, even if the company is considering some share buybacks, and that I am not in favor of.

After analyzing the fleet, it is important to notice that there is a need of improvement that necessitates the rapid fleet-aging in the midwater sector with an average of the 36-year old fleet. The company balance sheet is strong enough to take care of this situation, especially in this softness environment that will offer eventually some distress-buying opportunities. I see Diamond's balance sheet as a clear advantage to take this opportunity, if it arises.

I was a bit afraid of the downturn regarding Brazil's market, but the comment on the conference call regarding this geographic sector and its prospects was reassuring. Marc Gerard Rex Edwards indicated that the company had contracted coverage well in 2015 and is optimistic about this opportunity.

Diamond got a nice boost after the earnings release, because the numbers and rates were much better than was expected. If we look at the stock price, we can see that the value per share is now at a better valuation:

Click to enlarge

DO data by YCharts

I believe the company presents many good sides, despite some clear weakness, and can still be considered as a value play, despite more than 20% improvement from early April. I will be monitoring the stock, and will eventually start a new position on any weakness.

Disclosure: I am long SDRL, RIG. 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.