The offshore drilling industry is caught in a difficult time. Despite commodity prices that continue to be supportive of drilling activity, including $100 per barrel crude oil in the United States, significant headwinds persist. Most concerning are the conservative capital expenditure plans being employed by big oil companies across the globe in light of unimpressive returns on new projects.
This is causing distress on certain oil drillers. Some, like Seadrill, are still doing well and are putting up resilient earnings.
Others, like Diamond Offshore Drilling, aren't doing so well. Diamond Offshore is seeing its fleet status deteriorate due to declining dayrates and worsening utilization. Going forward, the situation isn't likely to improve in the short term based on the high capital expenditures required to upgrade its fleet.
Significant headwinds persist
Diamond Offshore had an ugly second quarter. Revenue and net income fell 8% and 51%, respectively. Utilization for its ultra-deepwater and deepwater floaters has collapsed over the past year. In the second quarter of 2013, utilization stood at 92% for the ultra-deepwater and 99% for the deepwater floaters.
Now, utilization stands at 51% for the ultra-deepwater and 51% for the deepwater floaters. By comparison, Seadrill's dayrates are much better. In its own most recent quarter, Seadrill's dayrates for floaters clocked in at 91%. The rest of its fleet achieved 95% utilization.
Diamond Offshore's dayrates increased last quarter, but its fleet faces stress going forward. One of Diamond's key newbuilds, the Ocean BlackRhino, secured a disappointing contract. That's because it took the contract that a separate rig was to assume next year -- an option that customer Murphy Oil can execute includes lower dayrates than analysts expected.
This isn't going to help Diamond Offshore's bottom line, and its significant fleet upgrading needs will only put more pressure on profits going forward. Diamond Offshore is in the middle of a major new-build program. It's spending a lot of money to upgrade its fleet. In fact, it expects to double its capital expenditures in 2014. This year, the company expects to spend $2.1 billion on new-builds and other upgrades.
Add it all up, and it's no surprise why Diamond Offshore's profits fell so significantly this quarter. With pressure on dayrates and increased downtime, combined with increased costs to upgrade its fleet, next quarter will probably be difficult as well.
Diamond Offshore does pay a nice dividend, which should provide some downside protection during this difficult time. And it also regularly declares a special dividend. The two payouts combined offer about a 7% yield. But even on this measure, Seadrill beats it with a double-digit dividend yield.
The long-term economics of offshore drilling are favorable based on the fact that demand is set to rise, especially in the emerging markets. But not all drillers are identical. Some will navigate the near-term headwinds better than others, and it appears that Diamond Offshore is at a disadvantage.
Take a pass on Diamond Offshore
My coverage of Diamond Offshore has been negative for most of the past year for many of the reasons that are weighing on the company currently. Its fleet status and earnings reports are not nearly as impressive as its rivals, such as Seadrill. In addition, significant costs to upgrade its fleet are an ongoing concern. Plus, Seadrill's much higher dividend, at approximately 10%, is another reason to turn away from Diamond Offshore.
The global oil-drilling industry will enjoy some undeniable tailwinds over the long term. The demand for oil should be strong for many years, particularly in underdeveloped nations that are growing rapidly. In the short term, however, the industry faces many hurdles.
Oil majors are seeing unimpressive returns on new projects. In an effort to keep their profits high, they're postponing new rig orders. Many oil drillers, like Seadrill, expect contracting activity to recover soon. For others, like Diamond Offshore, the recovery isn't such a sure thing.
For these reasons, investors interested in the oil-drilling industry should continue to give preference to Seadrill over Diamond Offshore.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.