Diamond Offshore (DO, Financial), which provides contract drilling services globally, is not the best investment option among the exploration services companies. This article discusses the reasons for considering Diamond Offshore as avoid at current levels.
One of the most important trends in the drilling industry in the last few years has been the amount of oil discovered deep-water and ultra-deepwater. With some of the biggest discoveries being at greater water depth, there is an increasing demand for these rigs and these rigs command significantly higher day rate than mid-water rigs.
Among the industry players having the first mover advantage, Seadrill (SDRL, Financial), Pacific Drilling (PACD, Financial), Vantage Drilling (VTG) and Ocean Rig (ORIG) deserve a mention. These companies have the highest proportion of deepwater and ultra-deepwater rigs as a percentage of their total rig composition.
Diamond Offshore has been a laggard in this attractive market and ranks among the lowest in terms of the average water depth capability of the fleet. The company is changing its fleet composition to include more capable fleet, but the peers are already ahead. Therefore, Diamond Offshore does not seem very appealing to me considering its current assets.
Another important trend in the industry is the increasing regulations and oil & gas companies are increasingly going for new rigs than old rigs. The new rigs are more advanced and have a higher safety standard. Diamond Offshore is significantly behind peers in this comparison.
Diamond Offshore had an average fleet age of 17.4 years as of April 2014 and this is much higher than peers. Seadrill has an average fleet age of 3.4, Ensco (ESV, Financial) has an average fleet age of 4.0 and Transocean (RIG, Financial) has an average fleet age of 9.0. Therefore Diamond Offshore has the oldest fleet in the industry among close peers and this is a big negative for the company.
Another negative point, from a shareholders perspective, is the company’s dividend. At a current stock price of $49, the company has a dividend yield of 1%. It would be hard to understand why someone would invest in Diamond Offshore when Seadrill, with a young fleet, offers a dividend yield of 10% and Ensco, another player with a young fleet, offers a dividend yield of 5.4%. Even a young player in the industry, Ocean Rig, offers a dividend yield of 3.8%.
Diamond Offshore having a leverage of just 35% can be considered to be a positive factor when Seadrill has a leverage of 65% and Transocean has a leverage of 39%. The counter point is that leverage is not an evil if the company has robust cash flows. Seadrill does have a high leverage, but it can service its interest payments comfortably and using leverage to expand has benefited the company.
Diamond Offshore has four new rigs for delivery in 2014 and the company’s leverage is likely to increase. My key concern is how much of a laggard Diamond Offshore is as compared to industry peers and the differentiating gap is significant.
In conclusion, Diamond Offshore is trading at an EV/EBITDA valuation of 6.7. This might seem attractive on a standalone basis, but is certainly not attractive when compared to peers and when compared to peer company assets. Considering the factors discussed in the article, I would avoid Diamond Offshore with significantly better players in the industry.
