Why Diamond Offshore Drilling Dropped

While Fools should generally take the opinion of Wall Street with a grain of salt, it's not a bad idea to take a closer look at particularly stock-shaking upgrades and downgrades -- just in case their reasoning behind the call makes sense.

What: Shares of Diamond Offshore Drilling (NYSE: DO  ) slipped 2% this morning after Wells Fargo downgraded the oil and gas driller from outperform to market perform.

So what: Along with the downgrade, analyst Matthew Conlan lowered his valuation range to $54-$56 (from $70-$72), representing about 6% worth of upside to yesterday's close. While contrarians might be attracted to the stock's steady slide over the past year, Conlan thinks the appreciation prospects remain limited given his view of lower utilization and rates going forward.

Now what: According to Wells Fargo, Diamond Offshore's risk/reward trade-off is pretty balanced at this point. "We have factored in lower utilization and rates for DO's older floaters, including the modeled stacking of a few rigs (Saratoga, Lexington), and vaguely dispersed downtime for other mid-water rigs," noted Conlan. "We are decreasing our valuation range to $54-$56 from $70-$72, representing EBITDA multiples of roughly 6.6-6.8x 2014E EBITDA and roughly 5.5x 2015E EBITDA, including an estimated $1.5B of net debt increase DO will have to incur during 2014 to complete its construction program." Of course, with Diamond Offshore shares now off about 35% from their 52-week highs and trading at a single-digit forward P/E, long-term value Fools might want to take advantage of Wells' short-term concerns.

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