Balanced View on Diamond Offshore - Analyst Blog

We maintained our Neutral recommendation on Diamond Offshore Drilling Inc. DO on May 22, 2014. The company carries a Zacks Rank #3 (Hold).

Why Maintained?

Diamond Offshore Drilling is believed to have solid fundamentals with significant free cash flow potential and a clean balance sheet, which enhances the possibility of further share buybacks and/or special dividends in the years ahead. As of Mar 31, 2014, Diamond Offshore Drilling had approximately $420.1 million in cash and cash equivalents, while long-term debt was $2,244.3 million.

The company is aiming to increase its footprint in emerging markets (such as Brazil, Australia and West Africa) to reap benefits from the recent discoveries of deepwater fields. Again, the gradual improvement of the drilling market in the Gulf of Mexico (especially after the deepwater drilling ban was lifted), along with better bidding activity, will be favorable for a contract drilling company like Diamond Offshore.

Given oil's strong long-term fundamentals, the long lead times of deepwater projects, and the limited slack in the global deepwater drilling fleet, we do not expect any significant impact on dayrates. As a premium deepwater drilling contractor, Diamond Offshore Drilling enjoys strong leverage in this respect. Per the latest fleet status report, Ocean Princess, Ocean Monarch, Ocean Quest and Ocean Saratoga received contracts. These contracts indicate that there is still scope of work for older rigs.

Diamond Offshore Drilling has remained committed to returning excess cash to shareholders through special dividends. Since the beginning of 2006, in addition to its regular dividend, the company has been paying a special dividend. For the second quarter of 2014, Diamond Offshore Drilling paid a regular dividend of $0.125 and a special dividend of $0.75, amounting to a total of $0.875 per share.

However, Diamond Offshore Drilling expects delayed start-up of newbuilds, increased downtime for some of its rigs and higher operating costs in 2014, which is likely to affect the company's profitability. Further, the company's decision to reclassify four cold-stacked rigs as held for sale is likely to restrict its capacity to upgrade as happened in the case of Ocean Apex and Ocean Onyx.

Stocks That Warrant a Look

While we expect Diamond Offshore Drilling to perform in line with its peers. Stocks like Encana Corp ECA, CVR Refining, LP CVRR and Matrix Service Company MTRX are attractive picks in the near term. All of these stocks sport a Zacks Rank #1 (Strong Buy).

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