Diamond Offshore: Here Comes The Real Test For The Balance Sheet
- Diamond Offshore shares drop hard, pressured by low oil prices and coronavirus fears.
- Moody's downgrades the company's debt as it expects increased cash flow problems.
- The good news is that the company does not need additional access to capital markets in the next few years.
- While risks have certainly increased, Diamond Offshore's position looks more favorable than those of its peers.
Just like other offshore drilling stocks, shares of Diamond Offshore (NYSE:DO) got absolutely crashed this year and are down nearly 80% year-to-date. As my loyal readers know, I've always noted that the company had one of the most comfortable balance sheet situations in the industry. Apparently, the company's balance sheet will now be put to test by a mix of coronavirus-related problems and the collapse of the OPEC deal.
Moody's has recently downgraded Diamond Offshore's corporate family rating from B2 to Caa1 and its senior unsecured notes from B3 to Caa2 with a negative rating outlook. Moody's commented:
The downgrade of Diamond's ratings reflects lower earnings and higher negative free cash flow in 2020 than we previously expected, combined with few signs that offshore drilling fundamentals are going to greatly improve anytime soon. Without a much more robust improvement in dayrates, Diamond's debt burden will become untenable".
Source: Diamond Offshore 2019 annual report
Diamond Offshore finished the year 2019 with $156.3 million of cash on the balance sheet and $1.98 billion of debt. The company's nearest maturity comes on November 1, 2023, so Diamond Offshore has a lot of time before the first senior note debt comes due. The problem is that the company will have to use its revolving credit facility this year because of negative cash flow in 2020 (this view was reiterated during the most recent earnings call). The credit facility has a capacity of $950 million and matures in October 2023. So, the company will have to deal with maturities from the credit facility and the senior notes in late 2023, roughly three and a half years from now.
In these circumstances, Diamond Offshore's main goal is to limit cash bleed in 2020. To do this, the company must ensure that its active fleet is working. Diamond Offshore's main contract strength is the contract coverage for its drillships, with contracts ending in 2022-2023. There's a problem though with drillship Ocean BlackRhino, which has a contract gap between late May 2020 and the second quarter of 2021. Recent developments on the oil price front will make it harder for Ocean BlackRhino to find a job.
The other problem is the modern semi-sub Ocean GreatWhite which failed to find a contract due to unexpected deterioration of the market environment in the UK. Initially, most market observers including myself expected that the rig will be able to contribute to Diamond Offshore's cash flow in 2020, but it looks like this will be a challenging task. Moody's also notes this:
[…] utilization for the GreatWhite semisubmersible rig looks to be much lower than Moody's previously expected".
In addition to Ocean GreatWhite, Diamond Offshore will have to deal with semi-subs Ocean Courage and Ocean Valor that currently work in Brazil for Petrobras (PBR). Their contracts end in late July 2020 and mid-November 2020, respectively. Current dayrates are $380,000 for Ocean Courage and 289,000 for Ocean Valor, while dayrate expectations for modern semi-subs are $185,000 (Bassoe Offshore). Also, drillships enjoy greater demand than semi-subs, but Brazil is a place where a semi-sub can win a job by bidding low. Thus, even if Diamond Offshore succeeds in getting follow-up contracts for these two semi-subs, investors and traders should expect a meaningful cash flow hit since dayrates will be much lower.
Just like others, Diamond Offshore is in a survival mode right now. However, the company maintains access to the credit facility and does not have to deal with any maturities before late 2023 - this is its key strength. Last year was a heavy capex year for the company - Diamond Offshore spent $326 million on capex while generating just $9 million of operating cash flows. For 2020, the company expects cash capital spending of $190-210 million. While this spending will force the company to use the credit facility, it will not bring it to the edge neither in 2020 nor in 2021. The prospect of "lower oil for longer" is certainly bad for all offshore drilling stocks, but Diamond Offshore is a rare company that does not need to enter any preemptive negotiations with its lenders in the foreseeable future.
From a practical point of view, Diamond Offshore's stock will mostly continue to follow its peer group based on oil price developments since individual company differences are not important for the market right now. Fundamentally, the company is equipped to weather additional storm, although the risks have certainly increased.
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