As oil prices have recovered from the lows of January, there are several offshore drilling stocks that have witnessed stock upside.
In particular, I have been impressed with the upside shown by Diamond Offshore (DO, Financial). On Jan. 20, the stock touched a low of $15.55, and the stock is currently higher by 54% at $23.98. After this big rally, there is likely to be some profit booking, but I remain bullish on Diamond Offshore for more upside in the medium term.
Coming to the first quarter results, Diamond Offshore reported revenue of $471 million and EBITDA of $215 million, representing an EBITDA margin of 45%. Considering the fact that the company has an order backlog of $1.16 billion for the remainder of 2016, the annual EBITDA is likely to be $750 million, and operating cash flow can be expected to be in the range of $600 million to $650 million. Diamond Offshore is likely to report decent numbers through 2016, and this will support the stock even when industry sentiments remain relatively challenging.
Further, it is also important to mention that Diamond Offshore has an order backlog of $1.5 billion for 2017, and this is likely to make 2017 as good as 2016 considering the current industry scenario. It is certain that in the coming quarters there is likely to be continued cold stacking of rigs coupled with new contracts with lower EBITDA margin. However, in the next 18 months, Diamond Offshore will be generating sufficient liquidity to survive the difficult times with relative ease.
The next reason to be bullish on Diamond Offshore is the capital expenditure profile for 2016. Diamond Offshore expects investment of $620 million for the remainder of 2016, and this will be largely in line with the company’s operating cash flow and cash buffer. I don’t see the need for leveraging in 2016 and 2017. This is a big positive as compared to companies like Seadrill (SDRL, Financial) that are struggling to defer capital expenditure for the next one to two years.
From a balance sheet perspective as well, investors can be confident of Diamond Offshore considering the fact that the company has no near-term debt maturity and the company’s long-term debt of $2.0 billion can be serviced smoothly in the next 24 months considering the EBITDA visibility during this period.
The EBITDA interest coverage ratio for Diamond Offshore is likely to remain healthy for 2016 and 2017. Beyond these two years, the credit profile for Diamond Offshore and other offshore drillers will depend on the extent of industry recovery and the level of EBITDA compression.
Besides the fact that Diamond Offshore generated operating cash flow of $241 million for the first quarter, the company also received proceeds of $113 million from asset sales. This adds to the company’s cash buffer, and asset sales are likely to continue in the coming quarters.
As a result of strong OCF and proceeds from asset sales, Diamond Offshore was successful in repaying debt of $287 million in the first quarter. In the next few quarters the cash buffer is likely to support deleveraging. This is another reason for the stock remaining in bullish momentum.
Diamond Offshore is among the stocks in the offshore drilling industry that have strong credit profiles, healthy order backlogs and quality fleets. It is not surprising to see the stock surge since Jan. 20. I expect the positive momentum for the stock to continue in the coming quarters and if there is some profit booking from current levels, it’s an opportunity to consider fresh exposure to the stock.
Disclosure: No positions in the stock.
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