Diamond Offshore: How Low Can It Go?

Offshore drillers have had a bad year to date. No company's shares have suffered more than Diamond Offshore (NYSE: DO  ) , however, which is down around 17% year to date.

The question is, how much worse can it get for Diamond? Well, there are split opinions on the matter.

Split opinions
Barclays believes that it can get much worse. Specifically, Barclays' analysts believe that Diamonds EPS for next year could come in around 63% below current forecasts, putting the company on a forward P/E of 26.2 times, not the 9.8 times currently quoted.

Meanwhile Morgan Stanley believes that Diamond's shares have hit a bottom and will rest around their current levels. In particular, Morgan's analysts believe that the majority of downward earnings revisions for Diamond have already taken place.

What's more, Morgan believes that many of the industry worries are overdone and the wave of new drilling units set to hit the market within the next few months will all find customers.

The problem that investors face is deciding which forecast or set of analysts have the most accurate outlook on the industry?

Unfortunately, it would appear that Barclays' dismal forecast is the most accurate. This conclusion is based on the fact that Diamond has just had a big customer cancel one of its rig contracts with the company.

Terrible news
The cancellation of the drilling contract for the mid-water semisubmersible Ocean Vanguard from Statoil ASA is an indication that the demand for rigs is just not there. A cancellation like this is bound to provoke a cancellation fee, something that Statoil is obviously willing to pay.

There are two conclusions to be drawn for this cancellation. Firstly, according to Wall Street figures, the Ocean Vanguard was expected to contribute around $0.49 per share per annum to Diamond's EPS; this valuable source of income has now disappeared.

Secondly, Vanguard is a third-generation unit, built in 1982. The cancellation confirms that customers are not really interested in standard spec rigs, favoring the newer sixth and seventh generations.

Hopefully, this will be the only cancellation that diamond has to suffer. However, Diamond does have one of the oldest floater units in the business with an average age of 34 years. Seadrill, in comparison, has an average age of slightly over five years.

Diamond also has one of the smallest percentages of ultra-deepwater capable floaters with only 30% of the fleet capable. The company is certainly not well positioned to ride out the rig market slowdown.

These poor metrics imply that Diamond will have to accept lower day rates for its drilling units, which will ultimately mean that the company's earnings will fall.

Industrywide
It seems as if things are only going to get worse for Diamond from here on out. The company's larger peer, Transocean  (NYSE: RIG  ) , recently released a fleet update that revealed the state of the rig market. The report did not make for good reading.

Transocean's report provided updates on four drilling units. Aside from one, all were contracted at lower day rates as shown below:

  • Dhirubhai Deepwater KG1 - Awarded a three-year contract at a dayrate of $440,000. The rig's prior dayrate was $510,000.
  • Paul B. Loyd, Jr. - Awarded a two-year contract extension at a dayrate of $430,000. The rig's prior dayrate was $447,000.
  • GSF Development Driller II - Awarded a three-well contract at a dayrate of $360,000. The rig's prior dayrate was $606,000.
  • GSF Constellation II - Customer exercised a one-year option at a dayrate of $165,000. The rig's prior dayrate was $165,000.

This data is relevant as these drilling units are roughly the same size and spec as Diamond's fleet. It can thus be assumed that when Diamond comes to renegotiate its contracts, lower rates are almost a certainty. These figures are a warning to Transocean as well, however. Although Transocean is trying to modernize its fleet, the company is still susceptible to contract cancellations and falling earnings forecasts.

Foolish summary
Overall, it looks as if Diamond's future is uncertain. It would appear Barclays' dismal outlook for the company has some truth behind it. After the recent contract cancellation and Transocean's falling day rates, Diamond's earnings seem set to fall over the next year or so as contracts are renegotiated at lower rates. Hopefully, no more customers will cancel their contracts with the company. 

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