Diamond Offshore Drilling - A Gutsy Trade

| About: Diamond Offshore (DO)

Summary

DO has been lagging the oil and gas subindustry since August 2016, primarily due to the cancellation of the Ocean Valor contract with Petrobras and offshore drilling market saturation.

DO has an ongoing legal battle with Petrobras, with the court recently upholding an injunction regarding the Ocean Valor contract.

Apart from the fact that DO is losing money, the company has some good fundamentals relative to the industry including price/book and operating margin.

DO regularly beats analysts’ estimates for sales and EPS which is a sign of conservative forward guidance. Analysts’ recommendation of 3.3 is poor.

High level of short interest and a declining stock price that is approaching long-term support make for a gutsy long speculative position.

Diamond Offshore Drilling Inc. (NYSE:DO) provides contract drilling services worldwide to independent oil and gas companies, and government-owned oil companies for the floater market, including ultra-deepwater, deepwater, and mid-water.

DO has been lagging the Oil & Gas subindustry since August 2016, primarily due to the cancellation of the Ocean Valor contract with Petrobras - Petroleo Brasileiro S.A. (NYSE:PBR), and also because the market for offshore drilling is oversupplied.

(Source:Portfolio123)

It should be noted that DO has an ongoing legal battle with Petrobras, with the court recently upholding an injunction regarding the Ocean Valor contract. But Petrobras still can appeal the ruling in the Superior Court of Justice.

Fundamentals

Despite the declining stock price and negative earnings, DO has some positive attributes that may make for an interesting investment. The figure below highlights how DO compares to the GICS Energy Equipment & Services industry. Note that the industry includes companies that supply oil and gas equipment and services other than drilling.

(Source:Portfolio123)

DO has a Price/Book of 0.57, half that of the industry at 1.16. The company's gross margin is far higher than the industry average with a figure of 46.9% versus 27.4%. DO's operating margin of 18.5% is double that of the industry operating margin of 9%.

Analyst Estimates

DO has been regularly beating analysts' estimates for both EPS and Sales. This generally means that the company provides conservative guidance and there are not usually surprises that will negatively impact the stock price when quarterly reports are released.

(Source:Portfolio123)

The average recommendation for DO is 3.3 on a scale of 1 to 5 with 1 being a 'Buy' and 5 being a 'Sell'. 3.3 is not a good score but I don't find that there is a good correlation between analysts' average recommendation and future stock performance.

The poor analysts' recommendation is reflected in the stock short interest, with a whopping 36.9% of float currently being shorted. A short squeeze could occur if the stock price spikes for any reason.

Technicals

The stock price has been in a downward trend since early December and recently experienced resistance at $16. DO recently traded at $15.56 and could conceivably drop to the support level of ~$14.50.

The Gutsy Trade

This trade is not for those with weak stomachs. In general, it is not a good idea to trade against the prevailing trend. But for speculative traders, there is an opportunity to initiate a long position if the stock price goes below $15. A stop loss should be put in place below the support level of $14.50. The success of this trade will likely be determined by the future direction of crude oil prices. In the long run I expect the price of crude to decline.

Wrap-Up

DO has been lagging the Oil & Gas subindustry since August 2016, primarily due to the cancellation of the Ocean Valor contract with Petrobras and offshore drilling market saturation. DO has an ongoing legal battle with Petrobras, with the court recently upholding an injunction regarding the Ocean Valor contract.

Apart from the fact that DO is losing money, the company has some good fundamentals relative to the industry including price/book and operating margin. DO regularly beats analysts' estimates for sales and EPS, which is a sign of conservative forward guidance. Analysts' recommendation of 3.3 is poor. A high level of short interest and a declining stock price that is approaching long-term support make for a gutsy long speculative position.

Disclosure: I/we 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.

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Tagged: , Oil & Gas Drilling & Exploration
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