We have maintained our Neutral recommendation on Diamond Offshore Drilling Inc. (DO), a major contract driller providing comprehensive offshore drilling services to the global energy industry.
The company recently announced upbeat first quarter results, which beat the Zacks Consensus Estimate mainly on higher day rates for its deepwater rigs.
We believe Diamond Offshore has solid fundamentals with significant free cash flow potential and a clean balance sheet that enhance the possibility of further share buybacks and/or special dividends in the years ahead.
Diamond is aiming to increase its footprint in emerging markets (such as Brazil and West Africa) to reap benefits from the recent deepwater discoveries. The company’s Brazilian backlog saw solid growth with extensions on Ocean Valient at increased dayrates. Another 15 rigs are already working for Petrobras (PZE). These are expected to enhance revenues for Diamond in view of the increased demand in Brazil and the inability of the region to develop a local offshore rig construction industry.
Again, the gradual improvement in the drilling market in the Gulf of Mexico (especially after the deepwater drilling ban was lifted), along with better bidding activity, will prove beneficial for a contract drilling company like Diamond Offshore.
Moreover, Diamond has signed a new contract for Ocean Victory at a dayrate of $419,500, up from the prior rate of $325,000. Further, Ocean Saratoga is also moving to the GoM for a single well job. These are expected to receive follow-on contracts, as the markets offer immense growth potential.
Diamond is expanding its ultra deepwater leverage through the construction of three drillships. The increasing demand in some regions of West Africa and GoM is likely to benefit the existing fleet along with the newbuilds –– Ocean Onyx scheduled for delivery in the third quarter of 2013 — as they may be contracted at higher dayrates.
However, Diamond Offshore remains leveraged to lower-spec deepwater and midwater floater markets where we believe utilization and dayrates could dampen over the next couple of years. Again, we remain cautious due to the anticipated increase in newbuilds entering the market over the next few years. Additionally, foreign currency fluctuation is also a threat to the company’s profitability.
Diamond holds a Zacks #3 Rank, which is equivalent to a Hold rating for a period of one to three months. It faces competition from Noble Corporation (NE).
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