Diamond Offshore (DO, Financial), very similar to other offshore drillers, plunged from 2014 highs of $56.92 to $29.37 on November 28, 2014. Since then, the stock has gradually moved higher and is currently trading at $39.28. Even after this recovery rally, I remain bearish on Diamond Offshore for 2015, and my view is that investors should not consider exposure to the stock at current levels.
The first reason to be bearish on Diamond Offshore is related to oil prices. OPEC has reiterated that it will not cut production in 2015. Further, the global economy continues to slowdown with the exception of the U.S. and India. In such a scenario, it is unlikely that oil prices will recover strongly in 2015. This will keep the offshore drilling market challenging, and it would be best to avoid certain offshore drillers.
I mentioned “certain offshore drillers” above and I will discuss why Diamond Offshore is not the best investment choice in the industry. Diamond Offshore’s current rig composition is the first reason to avoid the stock on a relative basis. Pacific Drilling (PACD, Financial) and Ocean Rig (ORIG, Financial) have high-specification rigs as a percentage of total rig at 100% and 84% respectively.
Diamond Offshore’s high specification rig as a percentage of total rig stands at only 11%. While the company’s deep-water and ultra-deepwater rigs are expected to increase in proportion by 2016, the current fleet composition does not look very attractive.
Another big reason to avoid Diamond Offshore is the company’s contract coverage for 2015. Ocean Rig has a 87% contract coverage in 2015, Pacific Drilling has a 73% contract coverage, Seadrill (SDRL, Financial) has a 74% contract coverage while Diamond Offshore has a contract coverage of just 57% for 2015.
Further, a significant number of fleet that are going off contract in 2015 are old rigs and I believe that re-contracting the fleet will be a big challenge for Diamond Offshore. Therefore, the company’s cash flow numbers for the coming year remain highly uncertain and lower cash flow can negative impact the stock price.
I must also mention here that Diamond Offshore is currently trading at an EV/EBITDA of 5.2. This might seem low as Pacific Drilling is trading at an EV/EBITDA of 7.5, Ocean Rig is trading at an EV/EBITDA of 6.0 and Seadrill is trading at an EV/EBITDA of 7.8. However, the above reasons explain why Diamond Offshore will continue to trade at a discount to peers when it comes to EV/EBITDA valuation. An older fleet and lower contract coverage for 2015 are the critical reasons for this discount.
I am certainly not suggesting that Diamond Offshore’s key growth metrics will not change in the future. When the oil prices recover along with recovery in the offshore market, Diamond Offshore will look attractive.
This is especially true as the company will have a higher percentage of DW and UDW fleet by 2016. However, for 2015, the stock does not look attractive and I believe that the stock is likely to correct again over the next few quarters.
Even in terms of dividend, Diamond Offshore offers a dividend of $0.5 per share and a current dividend yield of 1.5%. If investors are looking for a dividend stock in the industry with relatively better fundamentals and fleet, I would suggest exposure to Ensco (ESV, Financial). The company offers a dividend of $3 per share and a current dividend yield of 10.7%, which is likely to sustain in the coming year.
In conclusion, from a fleet perspective, contract coverage perspective and dividend perspective, there are better options to consider in the coming year than Diamond Offshore. The stock can be avoided even when it looks attractive from a valuation perspective.
