Diamond Offshore Drilling: Brazil, Pre-Salt And Growth

| About: Diamond Offshore (DO)
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Over the next 10 to 15 years, Brazil is looking to evolve itself from energy importer to energy exporter. This evolution will make Brazil the largest producer of crude oil in Latin America. As Brazil will become the largest producer of crude in Latin America, it will surpass both Mexico and Venezuela to take top spot. One company focusing on Brazil and currently working with Petrobras - Petroleo Brasileiro S.A. (OTC:PBRQF) and OGX Petroleo e Gas (OTCPK:OGXPY) to benefit from the growth in Brazilian crude is Diamond Offshore Drilling (NYSE:DO).

As the Brazilian government is looking to increase oil production over the next twenty years, they will be looking to access the Pre-Salt region off the coast. According to the EIA website, there is a vast amount of oil in the pre-salt region. The site states "analysts place total extent of pre-salt recoverable oil and natural gas reserves at more than 50 billion barrels of oil equivalent (BOE)." Not only does this region have vast amounts of oil but it is also of quality as the Brazilian Government states "Most of the oil is light grade, which has greater value and is easier to process. Light oil has a greater value since it produces a greater volume of products such as gasoline and diesel." The exploration of this region will transform Brazil into one of the ten largest oil producers in the world.

Petrobras and OGX Petroleo e Gas are two companies that are invested in the exploration and production of the pre-salt fields. Petrobras alone expects to invest US$53.4 billion in the Pre-salt reserves by 2015 but assures its shareholders that the company will not need to issue shares to help fund the project. According to the Brazilian Government website, the fields are viable over the long term as they estimate that the price of a barrel of oil on the international market will be between US$120 and US$134 by 2020.

Picture from (Petrobras Website)

As the depth of the oil field is very deep (between 5,000 and 7,000 meters), is challenging to access and is located under the ocean, this will present opportunities for many offshore drilling companies. One company that has been working with Petrobras and OGX Petroleo e Gas to access these reserves is Diamond Offshore Drilling.

Currently, Diamond Offshore Drilling generates 46.1% of its revenues from Brazil. According to its 10-K, the largest customer that Diamond Offshore has is Petrobras. The relationship with Pertobras has yielded 33.3% of the company's total revenues in 2012. The relationship with OGX Petroleo e Gas has 12.5% of the company's revenues. As these two companies have accounted for 45.8% of the company's total revenues and are situated well to capitalize on the Brazilian pre-salt reserves, this bodes well for future of Diamond Offshore Drilling.

In the section below, I will analyze the past three year performance of the company. I will look at Diamond Offshore's past profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

All numbers sourced from Company Webpage and Morningstar


Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money, and gauge the quality of the reported profits.

  • Net income 2010 = $955.46 million.
  • Net income 2011 = $962.54 million.
  • Net income 2012 = $720.48 million.

Over the past three years, Diamond Offshore Drilling's net profits have decreased from $955.46 million in 2010 to $720.48 million in 2012. One of the reasons for the decline in net income in 2012 was the "impairment of assets." This counts for a decline of $62.437 million off the company's earnings. According to the company's 10-K, Diamond Offshore Drilling's "impairment of assets" is due to "the management adopted a plan to actively market for sale three of our mid-water semi-submersibles, consisting of two previously cold-stacked rigs (the Ocean Epoch and Ocean New Era) and the Ocean Whittington, which was idled in 2012 upon its return from Brazil prior to being cold stacked, and the Ocean Spartan, a previously cold-stacked jack-up rig. As a result of this decision, we recognized an impairment loss of $62.4 million in the fourth quarter of 2012 to write down the aggregate net book value of these rigs to their estimated recoverable amounts, aggregating $11.6 million."

  • Operating cash flow 2010 = $1.425 billion.
  • Operating cash flow 2011 = $1.255 billion.
  • Operating cash flow 2012 = $962 million.

Operating cash flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years, the company's operating cash flow has also decreased. Diamond Offshore Drilling's operating cash has decreased by 51.43%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $955.46 million.
    • Net income 2011 = $962.54 million.
    • Net income 2012 = $720.48 million.
  • Total asset growth

    • Total assets 2010 = $6.726 billion.
    • Total assets 2011 = $6.964 billion.
    • Total assets 2012 = $7.235 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 14.21%.
    • Return on assets 2011 = 13.82%.
    • Return on assets 2012 = 9.96%.

Over the past three years, Diamond Offshore's ROA has decreased from 14.21%% in 2010 to 9.96% in 2012. This indicates that the company is making less money on its assets than it did in 2010.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.


  • Operating cash flow 2010 = $1.425 billion.
  • Net income 2010 = $955.46 million.


  • Operating cash flow 2011 = $1.255 billion.
  • Net income 2011 = $962.54 million.


  • Operating cash flow 2012 = $962 million.
  • Net income 2012 = $720.48 million.

Over the past three years, the operating cash flow has been higher than the net income. This indicates that the company is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $6.726 billion.
    • Total assets 2011 = $6.964 billion.
    • Total assets 2012 = $7.235 billion.
    • Equals an increase of $509 million
  • Total liabilities

    • Total liabilities 2010 = $2.865 billion.
    • Total liabilities 2011 = $2.631 billion.
    • Total liabilities 2012 = $2.658 billion.
    • Equals a decrease of $207 million

Over the past three years, Diamond Offshore Drilling has acquired more total assets than total liabilities. This indicates that the company has not been financing its assets through debt. Over the past three years, the company's total assets increased by $509 million, while the total liabilities decreased by $207 million.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $1.863 billion.
    • Current assets 2011 = $1.992 billion.
    • Current assets 2012 = $2.133 billion.
  • Current liabilities

    • Current liabilities 2010 = $626.29 million.
    • Current liabilities 2011 = $427.29 million.
    • Current liabilities 2012 = $485.55 million.
  • Current ratio 2010 = 2.97.
  • Current ratio 2011 = 4.66.
  • Current ratio 2012 = 4.39.

Over the past three years, Diamond Offshore Drilling's current ratio has increased from 2.97 in 2010 to 4.39 in 2012. As the ratio has increased over the past 3 years, this signifies strength and indicates that the company would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 139.03 million.
  • 2011 shares outstanding = 139.03 million.
  • 2013 current shares outstanding = 139.03 million.

Over the past three years, the number of company shares has remained the same. The amount of common shares has been consistent at 139.03 million.

Operating Efficiency

Operating efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $1.840 billion / $3.322 billion = 55.39%.
  • Gross margin 2011 = $1.707 billion / $3.322 billion = 51.38%.
  • Gross margin 2012 = $1.400 billion / $2.986 billion = 46.88%.

Over the past three years, the gross margin has decreased. The ratio has decreased from 55.39% in 2010 to 46.88% in 2012. As the margin has decreased, this indicates the company has been slightly less efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $3.322 billion.
    • Revenue 2011 = $3.322 billion.
    • Revenue 2012 = $2.986 billion.
    • Equals a decrease of 10.11%.
  • Total Asset growth

    • Total assets 2010 = $6.726 billion.
    • Total assets 2011 = $6.964 billion.
    • Total assets 2012 = $7.235 billion.
    • Equals an increase of 7.57%.

As the revenue growth has increased less than the assets on a percentage basis, this indicates that the company is not making as much money on its assets as it did in previous years.

Based on the fundamentals above, Diamond Offshore Drilling is showing mixed results. Over the past 3 years, the profitability of the company has decreased. This is indicated in the gross margin, ROA, operating cash flow and net income. The analysis also reveals that the company's debt side has also decreased thus showing strength. This is revealed in the company's current ratio and TL/A ratio. Based on the above fundamentals, Diamond Offshore Drilling is showing mixed results over the past 3 years.

Analysts' Estimates

As the Brazil story is expected to take some time to develop and has many variables, I believe there will be some time to wait and see if the company's fundamentals improve. Analysts at MSN Money are estimating a slow year for 2013 but growth picking up in 2014. EPS estimates for FY 2013 are $4.69 while growth is expected to pick up in 2014 as EPS estimates increase to $7.48. Bloomberg Businessweek supports this idea as they expect revenues to be approximately $3.0 billion for FY 2013 and increase to $3.9 billion for FY 2014. Bloomberg also expects the company's EPS to be around $4.50 for FY 2013 and increase to $7.38 for FY 2014.

Price Targets

  • Finviz has a price target for Diamond Offshore $75.84
  • Recently analysts at JPMorgan Chase increased their price target to $84.00.
  • In January, Howard Weil upgraded its outlook on the company with a rating of "Market Outperform" and a price target of $83.00.

Since 2008, the average P/E ratio for Diamond Offshore Drilling has been 10.58. As the company has averaged a P/E of 10.58 and is expected to have an EPS in 2014 of approximately $7.40, this would give the stock a price target of around $78.29. This is a 12.96% upside from the current price of $69.31.

Based on the above analysis, there are many variables that could come into effect for Diamond Offshore Drilling. The positives include a very positive outlook for the pre-salt region off the coast of Brazil. As Diamond Offshore has assets in the region, has many contracts tied up in Brazil until late 2015 and early 2016 with two of the major companies in the region, this bodes well for the company. Having stated this, a negative for Diamond Offshore is the recent decline in profitability. Analysts are predicting an average year in 2013 but are predicting growth to pick up in 2014. To support analysts, I believe there will be some time to further assess the profitability for Diamond Offshore before making an investment decision, but the story looks attractive and Diamond Offshore Drilling is a company to keep an eye on moving forward.

Disclosure: I 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.