Amid near-term uncertainties associated with the deepwater Gulf of Mexico (GoM) drilling moratorium, we upgrade Diamond Offshore Drilling Inc. (DO) to Neutral from Underperform, reflecting its leverage to the global deepwater markets, attractive yield and solid backlog position.
During the first quarter of 2010, the company signed 14 new contracts totaling approximately $1.5 billion in backlog. Consequently, contract backlog, which amounted to $9.1 billion in the first quarter, will likely alleviate the impacts of the ongoing economic uncertainties in 2010. The company has significant near-term contracts on the deepwater front, which should rein its downside risks, making it a defensive name in a weakening market.
The company reduced its special cash dividend to $1.375 per share from $1.875 in the first quarter due to poor market conditions, providing the company greater flexibility in buying rig assets. Although the current merger and acquisition environment offers very few opportunities, we believe the company will likely be active ramping additional spec newbuilds. Diamond was the most active driller in 2009, acquiring two ultra-deepwater semis from the insolvent Petromena.
However, the GoM oil spill is currently the central focus for offshore drillers. The increased regulations could have a greater impact in the long run, as roughly 20% of the company’s revenues come from its domestic floater operations. Moreover, the GoM moratorium could increase competition for deepwater drilling internationally, putting pressure on deepwater dayrates.
Diamond is experiencing dayrate pressure in the deepwater segment and lacks significant increase in tendering activity for projects in the deepwater segment. In addition, the dividend cut also reflects current and anticipated industry conditions as well as a decline in renewal contract dayrates from peak levels, indicating a potential weakness in the mid-water day rates.
Improvement in the existing fleet and the addition of new rigs on a selective basis has been the company’s long-term strategy, allowing Diamond Offshore to be one of the leading drilling companies. Diamond capitalizes on its financial strength to pursue opportunistic acquisitions from financially distressed sellers.
Read the full analyst report on “DO”
Zacks Investment Research
