Diamond Offshore Drilling, Inc. (DO)

LEGMAKER (< 20) Submitted: 5/12/08 10:01 AM : Start Price: $128.95 DO Score: -0.66

Diamond Offshore is one of the two true deep sea oil drillers selling in the US market. The deep sea market is most lucrative with respect to high specification floaters and deep drilling gps controlled semi submersibles. There are other deep drilling rigs called jackups, but they drill deep into the ocean floor and are supported by legs, so their ability to go into really deep water is limited. Transocean is probably the best play as deep drilling is all that they do, but DO has remained in the midwater to deep water regions so its margins could be better going forward although their company is not near as large.





Diamond Offshore is special because of how much of their profits are paid back to investors, instead of giving back to investors by re-buying shares; they have focused on an annual dividend that is quite large. It only seems right, as they pretty much know what they are going to make as they are under contract. This company is majority owned by Loews, which is a conglomerate that is run by the Tisch's. When they purchased this company, they bought it after the oil boom bust, and were able to pick up the company so cheap they could have sold everything for scrap and made their money back. Now they look like geniuses seeing where the oil business was going before anyone else did.





Diamond Offshore has shown continued strength as the market has remained strong with steady price increases from huge demand. DO was quite smart as they have realized profits quicker by signing contracts over 3 year periods as opposed to the five to seven year deals that most companies want. This has given them a strong position that is getting better and looks to stay strong through 2010.





Going back to their dividend, they offer the best in the business. Not only do they offer a regular dividend, but also a special dividend. This is good for those with tax implications as dividends are lower than that of real income. In 2005, RIG paid a $.45 dividend. The same year NE paid $.10, Rowan paid $.50 and Ensco paid $.10. DO paid a whopping total of $1.88 per share. 2006 was even better, as DO paid $4.55 while the only major increase in the group was RIG at $.90 per share.





Many do not realize that even with the run up in stock prices this sector still looks amazing. The reason is that starting last year was when the majority of old contracts began to expire, and new ones were being signed at much higher rates. As shallow and or standard requirement rigs will have steady demand through next year, deep water specifications looks to double by 2011 from this year. This benefits DO because all of their rigs have been upgraded to do deep water drilling. If we look at the deepwater floater builds and upgrades we see that 61 will be coming to market, but only half will be here by 2010. Even more pressing is that two-thirds of the 61 rigs are already contracted, which is understandable as they cost around a billion dollars to build. Oil price will also support demand even if the dollar strengthens considerably, as $40 oil supports today's deep drilling market. From 1995-1999 we saw oil trade within a very stable column, now it is doing the same only it is headed upward. It should contract sometime this year, but I do not see it going below $100 anytime soon.





Recent contracts for DO have seen major price improvements. They signed five of their non-5th generation rigs to 2 year contracts that pay at a day rate of anywhere from $225,000-$420,000 per day, and their three 5th generation rigs went for four years from $430,000 to $500,000 per day. All of these major projects are already delivered or will be delivered some time this year. Their backlog truly shows the demand within this sector. From 1997 to 2005 we see that their backlog was anywhere from $600 million to $2.5 billion. From 2005 these numbers have shot straight up to $3.6 billion to $7 billion in 2007 and $9 billion in 2008.





DO have reported that they see new costs increasing by 18%-20% in the upcoming years. This is due to additional maintenance and labor costs along with vendors increasing rates. From the second quarter of 2004 for three years, it looks as though revenues have far outpaced costs. At the beginning of this time frame costs were at approximately $120 million while revenues were about $180 million. In 2007, costs increased to just over $200 million while revenues ballooned to $650 million. If we look at 2007 day rates, there is further estimated revenue growth will all of the rigs. Some of the rigs will double their revenue going forward while other could quintuple.





DO remain cheap at 10 times forward earnings and a five year PEG ratio of .37. They are only one point higher than Transocean but some of RIG's earnings could be diluted somewhat with their extensive lock on deep water jackups. DO's revenues look to increase 40% this year and 15% next. Even better looking forward their growth is estimated to average over 30% per year for the next 5. I would take a look at this group as they have seen a little pressure on their prices with the sector downgrade. They could be looking to get a pop soon.

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