The oil and gas industry has witnessed some recovery on the back of oil remaining above $45 per barrel. However, challenges are far from over for the industry and that has resulted in several stocks still trading at appealing valuations.
I have been very selective in terms of stock selection for the broad industry, but there are opportunities for the medium term and for the long term that need to be considered. This article will discuss one such medium-term opportunity.
In early September 2016, Diamond Offshore (DO, Financial) was trading at $14.8; the stock currently is trading at around the same levels. This is a good accumulation opportunity.
Oil recently priced below $50 per barrel makes it a good time for exposure to Diamond Offshore. With consensus on production cuts, I don’t see oil moving significantly lower, and the correction presents a good buying opportunity in the sector.
Decent numbers for first quarter
Diamond Offshore reported first-quarter results on May 1, and the company’s results beat analyst expectations on the bottom line. I will address some of the key positives in the results before moving to the outlook for the remainder of the fiscal year.
I will not be discussing the headline numbers of revenue and EBITDA. Rather, I will focus on key points in the results that show healthy fundamentals even in challenging industry conditions.
First, Diamond Offshore reported operating cash flow of $99 million for the first quarter; for the same period, the company’s capital expenditure was $30 million. Even with declining backlog, the company has positive free cash flows that improve overall fundamentals.
Second, Diamond Offshore had short-term debt of $104 million as of December 2016, which was repaid in March. The company’s long-term debt remained at $1.980 billion for the period in discussion. Therefore, the company has pursued deleveraging, and I see further deleveraging in the coming quarters.
Backlog to support fundamentals
The current backlog is one of the key factors that is likely to keep sentiments positive for Diamond Offshore. For March, the company had total backlog of $3.2 billion and for fiscal 2017, the company’s total order backlog was $1.5 billion.
Considering the remaining backlog of $1.1 billion for the fiscal year, Diamond Offshore is positioned to report revenue in the range of $375 million to $400 million for the remaining quarters. This is a conservative assumption with no backlog addition assumed.
Revenue of $1.1 billion to $1.2 billion would also imply operating cash flow of $300 million to $350 million for the remainder of the fiscal year (based on first-quarter numbers). Therefore, with minimal investments, Diamond Offshore is positioned to repay debt through the year and improve fundamentals. This factor is likely to take the stock higher.
It is also worth mentioning here that Diamond Offshore has an order backlog of $1.1 billion for fiscal 2018, and that is likely to support fundamentals beyond the current financial year. Industry conditions will start improving in fiscal 2018 and beyond. This is likely to translate into higher order backlog for fiscal 2018 and healthy cash flows.
Conclusion
When good times are back for the offshore drilling industry, there will be few players who will be fundamentally strong to grab the opportunity and see renewed growth. Diamond Offshore is one of the companies in the industry that is likely to come out of the crisis maintaining healthy fundamentals.
The stock has been sideways and for medium- to long-term investors, current levels are attractive for exposure. I must caution that broad markets are trading at rich valuations and investors can consider small exposure and gradual accumulation instead of a big plunge in the stock. However, when sentiments are depressed for a stock or industry, the best bargins are available.
Disclosure: No positions in the stock.
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