Image: Semi-submersible Ocean Onyx Source: ALP Maritime service.
While Diamond Offshore (DO) is considered one of the best offshore drillers still standing upright, primarily, when it comes to its clean balance sheet, low net debt, and potential for growth assuming a full-blown recovery in the offshore drilling sector next year; it still presents definitive weaknesses when it comes to its rig fleet. I find Diamond Offshore's fleet unbalanced when it comes to quality, variety, and competitiveness. The company doesn't own a jack-up fleet anymore.
On the one hand, Diamond Offshore owns state-of-the-art drillships but, on the other hand, struggles with aging floater rigs as well. For the company to correct this pressing issue, management said that it would invest in its rig fleet rather than acquire new rigs at a discount, but will it be enough?
Furthermore, the company is still not inclined to recognize this situation entirely and refuses to follow the same path as its main competitors like Transocean (RIG) and Ensco (ESV) who have been quick to recognize the need to grow through acquisition and merger.
However, Diamond Offshore is owned 53% by Loews Corp. (L), which complicates the situation significantly and may explain why the company is not interested in a merger or acquisition.
However, I believe that Diamond Offshore presents a great opportunity now, and I recommend buying and accumulating at around $9, which is a multi-year record low.
Diamond Offshore - 4Q'18 and Balance Sheet History - The Raw Numbers
|Total Revenues in $ Million||388.8||349.2||391.9||374.2||399.3||366.0||346.2||295.5||268.9||286.3||232.52|
|Net Income in $ Million||−589.9||13.9||116.1||23.5||16.0||10.8||−31.9||19.3||-69.2||-51.1||-72.2|
|EBITDA $ Million||−536.9||140.3||187.1||145.3||106.2||108.0||217.5||85.0||32.1||60.3||59.0|
|Profit margin % (0 if loss)||0||4.0%||29.6%||6.3%||4.0%||3.0%||0||6.5%||0||0||0|
|EPS diluted in $/share||−4.30||0.10||0.84||0.17||0.12||0.08||−0.23||0.14||-0.50||-0.37||-0.58|
|Cash from operations in $ Million||64.1||186.5||154.6||98.7||78.2||189.8||127.2||83.8||47.0||58.0||43.3|
|Capital Expenditure in $ Million||475.3||64.8||54.4||29.5||42.4||28.8||38.9||31.5||59.0||69.3||62.66|
|Free Cash Flow in $ Million||−411.2||121.7||100.1||69.2||35.8||161.0||88.3||52.3||-12.0||-11.3||-19.4|
|Cash and short-term investments $ Million||103||81||156||123||161||277||376||430||419||477||453.9|
|Long-term Debt in $ Million||2,308||2,163||2,085||1,981||1,981||1,972||1,972||1,973||1,973||1,973||1,974|
|Shares outstanding (diluted) in Million||137.17||137.25||137.17||137.25||137.23||137.24||137.23||137.50||137.43||137.43||137.44|
Note: Most of the data indicated above come from Morningstar and company filings.
Trends and Charts: Revenues, Earnings Details, Free Cash Flow, and Backlog discussion
1 - Quarterly revenues
Diamond Offshore reported a loss for the fourth quarter of 2018 of $0.58 per share or $79.207 million, compared to a loss of $0.23 the same quarter a year ago.
Excluding one-time items, Diamond Offshore had an adjusted net loss of $35 million or negative $0.26 per share.
Contract drilling revenues were $226.0 million during the quarter, down 19.5% sequentially. Contract drilling expenses were down to $160.37 million.
Revenues for the fourth quarter were $232.5 million down 32.8% from the same quarter a year ago and down 17.8% sequentially. The market did not like it.
Scott Kornblau, the CFO, said in the conference call:
Net loss of $79 million or negative $0.58 per share for the fourth quarter of 2018, which includes unfavorable tax adjustments related to tax reform and further restructuring costs. Excluding these adjustments, our adjusted net loss for the fourth quarter was $58 million or negative $0.42 per share. This compares to our third quarter 2018 adjusted net loss of $35 million or negative $0.26 per share. The quarter-over-quarter decline was primarily driven by lower revenue across a number of rigs partially offset by decreased contract drilling costs.
2 - Free cash flow
Diamond Offshore generated $9.6 million in 2018 with minus $19.4 million this quarter. Free cash flow is a significant value that I always use to evaluate the long-term financial strength of the company. The takeaway here is that the business model is slowly degrading, and it will not improve in 2019.
Nonetheless, DO passes the FCF test but barely, despite having the three last consecutive quarters of negative free cash flow.
Marc Edwards, the CEO, noted in the conference call:
However, pricing in 2019 remains depressed as much of the work being tendered today is for 2020 and beyond. Despite recent volatility in the spot price of oil and U.S. onshore production that has surprised to the upside, we remain firm in our belief that future demand growth cannot be met entirely by onshore production alone and that deepwater will remain an important and growing component of the supply mix.
3 - Quarterly backlog history and discussion
Diamond Offshore released its fleet status on February 11, 2019.
For the details, I recommend you to read this article.
We can see that the contract backlog has been going down regularly since 2015, and it is still problematical to predict a bottom for the company despite a better oil prices environment. We can see the same trend throughout the whole offshore drilling industry.
Below is the backlog repartition per rig types:
And, below is the contract backlog repartition per year:
The backlog is now $2 billion as of February 11, 2019, with about $873 million remaining in 2019.
However, with a few contracts in the drillship segment, the company managed to slow the backlog erosion. One positive move is that the Ocean Onyx has been contracted.
Marc Edwards said in the conference call:
Also announced this morning is the further upgrade and reactivation of the moored semi, the Ocean Onyx. This rig is a victory-class rig and original design that has successfully been upgraded many times across our fleet.
The fleet status indicates a situation of continued weakness, in my opinion, that may last longer than previously expected unless the company decides to act firmly and move towards a merger to revamp the company's weak fleet. Marc Edwards is not convinced that a merger is a way to go, unfortunately.
Marc Edwards said in the conference call:
Well, I am not going to specifically comment on our M&A focus today other than suggest that as always we keenly look at what opportunities are in the marketplace. But as it relates to our current focus, the best allocation of capital that we see when we compare it with alternatives today is indeed keeping our fleet running.
4 - Net debt (the strength of the company)
Net debt is now $1.520 billion with a net debt-to-EBITDA ratio of 6.4, which is satisfactory and means that the company can repay its net debt in about six and one-half years based on its EBITDA for 2018.
It remains still one of the best ratios in the offshore drilling industry and a sign of financial strength, especially after establishing recently a new credit facility which matures in 2023 and amended the company's existing credit facility.
finally during 2018, we increased our cash and cash equivalent position to over $450 million with nothing borrowed against our $1.275 billion credit facility.
Conclusion and Technical Analysis
Diamond Offshore's recent results were received negatively by the market, and the stock sold off abruptly. It is true that the revenues and net income were meager and below expectation. They disappointed the market which expected more. However, I believe the market over-reacted today, as it often does, and consequently offered an excellent opportunity for savvy investors to accumulate this company at a significant discount. A look at the financials is enough to understand why.
However, the outlook is uncertain, as we speak, and the company hinted that 2019 would not be a stellar year when it comes to contracts and full recovery. Investors who are willing to invest in this industry must be patient and use the volatility of the oil sector to profit by trading a good part of their portfolio. The offshore drilling industry is susceptible to oil prices fluctuation, and we should all pay attention to it.
DO is forming a descending triangle pattern which is not indicated in the graph from Finwiz. My thinking is that the lows of December are a bottom (support), and I expect the company stock to re-test this level successfully (I recommend buying at $9.15 and accumulating if the stock drops lower) to bounce back again around $11.50.
It is important to trade DO in correlation with oil prices.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DO over 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.