Even though oil has been depressed in the recent past, I am bullish on oil for the long term. I therefore see this period as excellent for buying good stocks in the energy sector. Today, I will discuss one oil and gas drilling services company that looks interesting at current levels. Throughout the crisis, Diamond Offshore (DO, Financial) has been managing its debt and liquidity well. The company also has sufficient contract backlog for sustained cash inflow.
Diamond Offshore is a contract drilling service provider to the energy industry worldwide. The company currently has a fleet of 28 offshore drilling rigs, of which 19 are semi-submersibles, four are drillships and five are jack-ups.Ă‚
Modernization of fleet
With the current downturn in the oil and gas industry, most of the offshore drilling companies have either cold stacked or scrapped their non-functional rigs to cut down on costs. However, the number of idle rigs continues to grow due to rigs going off-contract or new rigs being delivered.
Diamond Offshore has added 17 new rigs since 2014, but what is important to note here is that their rigs have a competitive advantage over their peers since the average age of the rigs is lower and the fleet is modern.
Decent contract backlog
One of the key reasons Diamond Offshore is a good stock to own is because the company has a decent contract backlog of $4.1 billion. This makes me positive for the fourth quarter of 2016 and fiscal 2017 as Diamond Offshore can deliver decent revenue and EBITDA numbers.
The company is likely to report revenue of $368 million in the fourth quarter and $1.52 billion in fiscal 2017.
Considering an EBITDA margin of 41% (same as the third quarter of 2016), EBITDA for the fourth quarter of 2016 and fiscal 2017 are likely to be $150 million and $623 million respectively. Moreover, if we look at the management’s objectives, the company is focusing on cutting down on costs. If the results are positive, we can expect a better EBITDA level next year.
Furthermore, Diamond Offshore has secured two new contracts in the third quarter of 2016. The Ocean Valiant has secured a 12-month contract with Maersk in the North Sea and the jack-up Ocean Sceptor has entered an eight-month contract with Fieldwood in Mexico. As oil prices move higher, there could be more contracts coming, which will help improve the company’s order backlog for 2017.
Strong liquidity position
As of Sept. 30, Diamond Offshore has total debt of $2.2 billion with debt maturity in 2019. Therefore, there is no immediate debt repayment pressure for the company, which will help preserve current liquidity and incoming cash flows.
On the cash outflow front, third-quarter capital expenditure was $625 million, resulting in a negative free cash flow. However, there are no significant capital expenditure plans for the company in 2017 apart from maintenance costs of $125 million. Thus, assuming a conservative operating cash flow of around $500 million and with no debt due, the company will have sufficient liquidity coming in as free cash flow.
Another aspect of looking into the company’s liquidity is its current ratio. Diamond Offshore has a current ratio of 0.99, which suggests the company has sufficient current assets to cover its short-term liabilities. An added advantage of revolving credit of $1.3 billion is also available to the company. Overall, liquidity is sufficient for the next year and should help Diamond Offshore maintain strong fundamentals.
Key takeaways
Expected positive free cash flow with a well-managed liquidity leads me to believe in the upside potential of Diamond Offshore. Moreover, the current fall in price makes it a good entry point. Diamond Offshore has the potential to survive the storm and give good returns to its shareholders.
Disclosure: No positions in the stock.
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