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Diamond: High Margins, Growth This Year

March 13, 2012 | About:
With tensions rising in the Middle East once more, where Syria and Iran are posing problems, the oil price is once more rising. With the rising price, further exploration becomes financially viable and drilling for oil in once off-limits fields will be a growth area. For investors this creates opportunity, and buying into companies that contract out offshore oil and gas drilling rigs could produce good returns.

Transocean (RIG) is one of the companies that is best known in the market, but with lawsuits over its part in the Mexico Gulf disaster still rumbling on, and likely to do so for some time, there is too much uncertainty surrounding the company to consider. This is particularly true now that BP (BP) has taken the first step and made a settlement of $7.8 billion over the weekend. Whilst drawing something of a line in the sand, this settlement may set a precedent going forward for other settlements in the pipeline.

Transocean took a write off of $1 billion in its fourth quarter report in relation to the disaster at the Macondo Well. The BP settlement may point to a further substantial write-offs on their way, and this will come on top of a write down on the value of its contract drilling unit of over $5 billion. Some good news from the company came with the announcement that day rates on its deepwater drilling units have moved above $600,000.

Transocean has also had a put option exercised against it, which will ultimately mean the company parting with cash or shares. Though the value of this is not yet known, it relates to a 50% share in Transocean Pacific Drilling Inc, a joint venture that was formed to work two ultra deep-water drillships. It seems that Quantum Pacific Management want out of the agreement, and is voting with its feet.

For me, with the Mexico disaster still hanging over it, and a possible near $500 million US tax bill looming, there is still too much fog over Transocean to invest.

Searching further, Noble Corp (NE) pays a good dividend. At 1.30%, its yield is one of the highest in the sector, and last year’s $0.52 dividend was covered nearly three times by its earnings. It last quarter revenue growth came in at 18.5%, and in line with market consensus. However, this was the first quarter in four that the company had not failed to match market expectations on its earnings. This said, earnings per share are expected to rise to $2.98 this year, which places the shares on a forward price to earnings ratio of 9.6.

Noble has recently reported new contracts for three of its drillships in Brazil, averaging at around a $430,000 day rate and for between 3 months and 3 years duration. It has over 60 off shore drilling units, and is building another 11 (five ultra deepwater rigs and six jackup rigs).

Whilst Noble is a better play than Transocean, investors may find better value elsewhere.

For those investors looking at exposure to the offshore drilling sector, then Diamond Offshore Drilling Inc (DO) looks a good investment.

Its recently announced fourth quarter numbers beat market expectations, the fourth quarter in a row that it has beaten consensus. Though revenue fell by 11%, analysts had been expecting a larger decline. Earnings of $1.36 per share whipped market consensus of $0.99 per share by a huge margin. Earnings per share for 2011 of $5.82 are expected to rise to $6.48 through 2012, though the first quarter may be a little weaker due to higher rig operating expense as five yearly examinations begin.

The dividend, at $0.50 yielding 0.70%, is covered 14 times and the company may decide to begin increasing again.

Operating margins of over 38% depend upon rig usage, and the company is bullish about prospects going forward. It has three new drillships coming online, and two have already received long term contracts. The Ocean BlackHawk will begin drilling in the fourth quarter of 2013, and the Ocean BlackHornet in the second quarter of the following year. While these are some way out, they demonstrate the company’s ability to win such contracts and plan for the future. Diamond also expect to secure significant contracts with market opportunity existing for a third drillship, the Ocean BlackRhino, and deepwater units (they have recently announced the addition of Ocean Onyx). Remember that day rates are moving up. At $600,000 per day, Diamond will be adding sizeable revenue to its income stream soon.

Looking at the 12-month chart, the shares, after hitting a low around $53 at the end of October and then again mid-December, have recovered well. With the MACD looking bullish, there is every chance that shares could move back toward 52-week highs around $80.

Margins being achieved on revenues are better at Diamond than both Transocean and Noble, and the company already has long term contracts in place for two of its new fleet. This shows an ability to work with its clients, and to profit from those relationships on a long-term basis. Though licensing costs this year may hamper profits, these will not be repeated for a further five years.

With demand for oil increasing worldwide, and political tension adding to upward pressure on price, demand for offshore drilling facilities is likely to grow. Diamond Offshore is well placed to capitalize from this growth through the coming years. BUY.

About the author:

Dividend King
I am primarily an investor interested in creating passive income streams through dividends. I focus on finding and analyzing dividend paying stocks, MLPs and REITs that are a good fit for income investors.

I practice Judaism and my faith is very important to me. I visit family in Israel once a year, but I am educated and work in the United States where I hold an MBA and a bachelor’s in English. I am a patient man, enjoy wine but am not a connoisseur, and I listen more than I speak.

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Rating: 4.0/5 (10 votes)

Comments

ry.zamora
Ry.zamora - 2 years ago
Hey DK! I got a few questions for you.

Its recently announced fourth quarter numbers beat market expectations, the fourth quarter in a row that it has beaten consensus. Though revenue fell by 11%, analysts had been expecting a larger decline. Earnings of $1.36 per share whipped market consensus of $0.99 per share by a huge margin. Earnings per share for 2011 of $5.82 are expected to rise to $6.48 through 2012, though the first quarter may be a little weaker due to higher rig operating expense as five yearly examinations begin.

The dividend, at $0.50 yielding 0.70%, is covered 14 times and the company may decide to begin increasing again.


Do you think revenue will keep on falling in the next two to three quarters of 2012?

And I doubt dividends will be increasing within the next few years. DO's got a ton of debt maturing through 2015 (including purchase obligations!) and the damage their FCF's will receive from that might just dissuade them from raising their dividends from the current 5% yield (2011 distribution ÷ prevailing market price as of writing).

Operating margins of over 38% depend upon rig usage, and the company is bullish about prospects going forward. It has three new drillships coming online, and two have already received long term contracts. The Ocean BlackHawk will begin drilling in the fourth quarter of 2013, and the Ocean BlackHornet in the second quarter of the following year. While these are some way out, they demonstrate the company’s ability to win such contracts and plan for the future. Diamond also expect to secure significant contracts with market opportunity existing for a third drillship, the Ocean BlackRhino, and deepwater units (they have recently announced the addition of Ocean Onyx). Remember that day rates are moving up. At $600,000 per day, Diamond will be adding sizeable revenue to its income stream soon.

Noted emphasized statement. THANK YOU for giving me another good thing to like about DO.

Margins being achieved on revenues are better at Diamond than both Transocean and Noble

I agree with you. Did you know DO's RNOA has increasingly exceeded Transocean's, Noble's, and Ensco's in the past six years? :D

and the company already has long term contracts in place for two of its new fleet. This shows an ability to work with its clients, and to profit from those relationships on a long-term basis. Though licensing costs this year may hamper profits, these will not be repeated for a further five years.

How strong do you think the damage would be here? Would it be enough to cause a severe drop in the stock price?

With demand for oil increasing worldwide, and political tension adding to upward pressure on price, demand for offshore drilling facilities is likely to grow. Diamond Offshore is well placed to capitalize from this growth through the coming years. BUY.

Do you have sources on the info re: "political tension"?

Were you able to estimate an intrinsic value for the company, btw? Out of curiosity. :)

---

And just to be clear, I'm bullish on Diamond Offshore myself. I'm just wondering when is the best time to buy DO as I want to maximize my margin of safety AND the dividend yield. I can't exactly rely on the macro events happening in the US (recovery) and the EU (crisis).
LwC
LwC - 2 years ago
Another reason to consider DO, and maybe best of all, James Tisch runs the company.

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