Amidst the negatives in the energy sector, Diamond Offshore (DO, Financial) reported a strong set of numbers on Nov. 2. Besides positives in the results, the company has also reported few other contract additions that strengthen the company’s order backlog. Here are the key points in the results that indicate Diamond Offshore has further upside from these levels.
I am still bearish on oil and gas prices. However, with winter approaching, there is likely to be short-term firmness in energy prices and I believe that this will translate into some rally for the energy sector. Investors can therefore consider some exposure to the sector for the next few months. However, caution should be exercised and highly leveraged stocks should be avoided.
Coming to the order backlog addition, Diamond Offshore confirmed that Ocean Guardian was awarded a contract for a one-year term in the U.K. North Sea beginning in March 2016 at a rate of $220,000 per day. This translates into order backlog addition of $80 million. Further, the contract for rig Ocean Courage is for $333 million for a period of 875 days. In challenging market conditions, the backlog addition/revision has been robust.
Looking at the performance for the first nine months, there are several positives. First, Diamond Offshore has reported EBITDA of $795 million for the first nine months of 2015 on the back of robust order backlog for the year. The current EBITDA run-rate implies an annualized EBITDA of $1.1 billion and Diamond Offshore is therefore well placed from a debt servicing perspective. In my view, this is the most critical analysis for offshore drilling companies as almost all offshore drillers have significant debt.
The second bullish point related to Diamond Offshore is that the company still has a total order backlog of $5.7 billion with 2016 order backlog of approximately $1.7 billion. The order backlog would imply EBITDA in the range of $700 to $750 million considering the EBITDA margin to be the same as 2015. Therefore, Diamond Offshore is well positioned from a debt servicing perspective for 2016. Importantly, the company has shown the ability to acquire new orders even in challenging market conditions, and I expect further improvement in order backlog for 2016.
From a valuation perspective, Diamond Offshore is trading at trailing 12-month EV/EBITDA of 4.78 and I believe that these are attractive valuations considering the fact that Seadrill (SDRL, Financial) still trades at a TTM EV/EBITDA of 5.8. It is also important to mention here that, in the last few years, Diamond Offshore has revamped its fleet, and the valuations will move significantly higher on first indication of sustained industry recovery. While that is not coming any time soon, Diamond Offshore is interesting for near-term trade but also interesting for long-term investing for investors who have the patience to hold with an investment horizon of three to five years.
However, avoid a big plunge in the broad energy sector. For Diamond Offshore, the rally from undervalued levels on the back of strong results can be used for some short-term gains.
