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Diamond Offshore: Strong Fundamentals Will Take Stock Higher

- By Faisal Humayun

The offshore drilling industry continues to face sustained challenges and difficult times for the industry is likely to continue even through 2017. However, amid challenges, there are opportunities.

Diamond Offshore (DO) has been resilient year to date with the stock declining by 4.4%, and the first stock movement is an indication that fundamentals remain strong.


Diamond Offshore reported revenue of $859 million and EBITDA of $371 million in the first half, translating into an EBITDA margin of 43% for the period. Further, Diamond Offshore also reported operating cash flow of $305 million, and this implies an EBITDA cash conversion ratio of 82%. These numbers will help in projecting the likely revenue and cash flow potential for the next 12 to 18 months.

Diamond Offshore has a front-end loaded order backlog, and that ensures decent revenue and EBITDA even in challenging times for the industry.

The second important point to note is that Diamond Offshore's annualized EBITDA comes to $740 million and annualized cash interest payment comes to $105 million. This implies EBITDA interest coverage of 7.0 and indicates that Diamond Offshore is unlikely to face any trouble in debt servicing.

From a forward-looking perspective, Diamond Offshore has an order backlog of $754 million for the remainder of 2016 and an order backlog of $1.487 billion for 2017. This implies a total order backlog of $2.2 billion for the next 18 months. Considering an EBITDA margin of 43% (same as the first half of this year), the company's EBITDA for the next 18 months is likely to be $960 million. Further, considering EBITDA cash conversion ratio of 82%, the operating cash flow for the next 18 months is likely to be $790 million.

Clearly, even if there is no backlog addition in the next 18 months, Diamond Offshore still has a robust backlog to report strong EBITDA and cash flow.

Further, debt servicing is not a concern for the next 12 to 18 months. Even beyond 2017, it is important to note that Diamond Offshore has a healthy backlog of $1.2 billion for 2018.

One of the big advantages with Diamond Offshore is that the company has no speculative new rig deliveries, and this implies minimal capital expenditure expenses in the next 12 to 24 months. I expect excess cash from operations to be allocated toward reducing debt as it will ensure credit metrics remain healthy.

In the midst of all these positives, the concern that I see from an industry perspective is a prolonged period of depression in the industry coupled with meaningful EBITDA margin compression. The markets have largely discounted the point that industry conditions will remain challenging through 2017. However, EBITDA margin compression can act as a negative trigger going forward as it impacts credit metrics. In line with this view, I would consider only small exposure to Diamond Offshore or any other offshore drilling stock. The best time for a bigger exposure will be when there is more clarity on the extent of EBITDA margin compression.

However, in the medium term, Diamond Offshore will continue to report decent numbers and that is likely to keep the stock resilient. If oil trends higher from current levels, that will serve as a potential upside trigger for the stock. I must emphasize here that in challenging times for the industry, credit health is critical; from that perspective, Diamond Offshore scores over the likes of Seadrill (SDRL) and Ensco (ESV).

Disclosure: No positions in the stocks.

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This article first appeared on GuruFocus.


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