A New Rig in Diamond's Kitty - Analyst Blog

A subsidiary of Diamond Offshore Drilling Inc. (DO) has signed a contract valued at $590 million with Korea's Hyundai Heavy Industries Co. to construct a new ultra-deepwater drillship, representing the company's increased focus for further deepwater venture.

The new drilling rig, capable of operating in 12,000 feet of water, is slated for delivery by the end of second quarter 2013. The company will utilize its available cash to pay for the rig and also secured an option to order a second drillship at a fixed price by March 31.

The new drillship includes a seven ram blow-out preventer, dual activity capability, five mud pumps, and a maximum hook-load capacity of 1,250 tons. Along with the latest drillship, Diamond's fleet of 47 rigs will have 14 that can drill in 5,000 feet of water or below.

Diamond's constant endeavors include expanding its fleet of ultra-deepwater rigs in order to take advantage of low costs associated with rig construction in recent times. Over the last four years, the company has acquired, ordered or upgraded six 10,000 foot ultra-deepwater units, in association with its Ocean Courage and Ocean Valor acquisitions in 2009.

Last year, the oil spill in the Gulf of Mexico restricted the development process that led to declining share prices of the offshore oil companies. Consequently, Diamond Offshore moved two of its Gulf-based rigs to overseas markets.

Upon the suspension of the moratorium, companies in the offshore oil industry are making efforts to enhance the deepwater assignments. Seadrill Limited's (SDRL) deal to acquire two ultra-deepwater semi-submersible drilling rigs, Seadragon I and Seadragon II, having a project price of $1.2 billion, is worth mentioning. Additionally, Chevron Corp. (CVX) announced plans for new multibillion-dollar projects in the region in the near term.

We believe Diamond Offshore has solid fundamentals to purchase both rigs and the potential to increase dividends, pay down debt, and purchase additional assets in 2012. A combination of upgrades and new construction has been the long-term strategy of the company and has allowed it to become a major in the industry.

However, we believe that Diamond'smaintenance expenditure will be significantly higher in the coming years as it operates with one of the oldest fleets in the industry. We also believe total operating expenses will likely increase at a faster pace than revenue in 2010 due mainly to a low utilization rate.

The company holds a Zacks #3 Rank, which translates to a short-term ‘Hold' rating. We also maintain our long-term Neutral recommendation for the stock.