Transocean, Ensco, Diamond Offshore Downgraded by Deutsche Bank; Deteriorating Assets Limits Profitability

Deutsche Bank downgraded the major deep water rig producers in their more recent research report.

Deutsche Bank analysts anticipate that secular demand weakness paired with declining rig utilization for older generation rigs will result in asset impairment and falling profitability as older rigs won't come out “of cold stack.”

Deutsche Bank anticipates impairment for older rigs and said “We see significant further deterioration in the offshore drilling market as relatively flat demand is met with a relentless surge of new supply. More problematic is the increasing likelihood that a huge chunk of the existing fleet will ultimately become impaired and/ or obsolete.”

Deutsche Bank anticipates the downward cycle to continue for an extended period of time: “The current, primarily supply-driven down cycle is likely to play out over a longer period of time and result in a deeper trough. This dynamic has occurred at least two other times in the broader oilfield asset market: Offshore support/ supply vessels (OSVs) in the early 2000s and the US land drilling market in the mid to late 2000s.”

This means that the older rig fleet may lose relevance with energy developers, and even with more competitive pricing, higher supply chasing after constant demand may result in some rigs no longer being put to use. Assuming older generation rigs are no longer used for oil production deep water rig manufacturers like Transocean RIG will have to build out a newer generation of rigs, and absorb on-going cost of revenue/research & development, paired with depreciation and amortization costs, along with falling top line revenue from cyclical weakness.

Lowered Transocean's rating from Hold to Sell; Price target lowered from $45 to $27:

“Over 70% of RIG's midwater fleet will come off contract by the end of 2015 in what we expect will be a very soft market for older, midwater assets and thus project weak utilization. Our 2014 and 2015 EPS projections fall to $3.64 and $2.30 from $4.45 and $3.40, respectively. The nearly 100 new build floaters set to enter the market may force RIG to stack its older, un-contracted assets.”

Lowered Ensco's ESV rating from Hold to Sell; Price target lowered from $52 to $41:

“For Ensco, adjustments to subsequent quarters/years reflect last week's earnings release, the most recent fleet status updates as well as our updated dayrate and utilization assumptions which affect un-contracted rigs. We are concerned about Ensco's Asia-Pacific jackup fleet as nearly all rigs will re-price by the end of 2015 and the region could be the first jackup market to crack given its proximity to shipyards and the low operating costs.”

Deutsche Bank lowered Diamond Offshore's DO rating from hold to sell; the price target was lowered from $60 to $34:

“For Diamond, adjustments to subsequent quarters/years reflect the 2Q'14 earnings release, the most recent fleet status updates as well as our updated dayrate and utilization assumptions which affect un-contracted rigs. Diamond has significant re-pricing exposure as over half of the company's fleet becomes available by the end of 2015 including nearly the entire midwater fleet. Given the old age of the midwater assets and the widening bifurcation between new and older assets, we do not expect these rigs to find steady employment.”