Diamond Offshore's Cost-Cutting Measures Spur a Big Earnings Boost

Image source: Diamond offshore investor presentation.

With the offshore market as weak as it is right now, there isn't a whole lot you can ask from a rig company other than keeping its costs under control. Thankfully for investors in Diamond Offshore Drilling (DO), the company did just that this past quarter to report better-than-expected earnings. Here's quick snapshot of what happened this quarter and what to focus on in the future. 

By the numbers

Source: Diamond Offshore earnings release.

The highlights
One thing you have to give Diamond credit for is reducing its operating expenses. Compared to this time last year, contract drilling expenses declined more than 30%, even though revenue declined 17% over the same period. 

Much of that cost savings came from the scrapping or cold-stacking of its older mid-water fleet. These rigs have seen the largest drop-off in demand since they are less capable of some of the highly technical projects we see going on in the deepwater regions. So, instead of keeping them in working condition, Diamond has decided to send many of them to be cold stacked or retired completely. In taking these measures with its mid-water fleet, Diamond was able to knock off close to $100 million on expenses compared to this time last quarter. 

Another promising aspect in this deal was the fact that the company was able to secure a 1-year contract for its Ocean Guardian rig in the U.K. North Sea. The mid-water rated rig will start work in March of 2016 and will earn a $220,000 per day rate. It's not a very lucrative contract compared to what we saw a couple years ago, but it's certainly preferable to spending money to keep the rig in working condition at the shipyard for no pay. 

Diamond was also able to renegotiate one of its contracts with Petrobras (PBR 1.43%). It will extend the existing contract for the Ocean Courage ultra-deepwater rig out to July of 2020 for $380,000 per day, down from its existing contract of $455,000 per day. In exchange, the two companies will terminate the contracts for its Ocean Alliance and Ocean Clipper rigs. This may not sound like a great deal, but it does ensure one of its newer rigs remains under contract for several years while two of its older rigs, which are candidates to be scrapped, can be taken off the market. Long term, this will help to clear the glut of rigs on the market and allow Diamond and others to get contracts for their high-specification rigs. 

The lowlights
One thing that is still a concern for Diamond is that it still has a good portion of its rigs coming off contract between now and the end of the first quarter of 2016. Based on its current rig fleet status report, it has six rigs that are slated to go off contract, which represents $1.89 million in day rate revenue. A couple of them are also potential candidates to be scrapped since they are more than 25 years old, so we could see more drops in drilling expenses. At the same time, a few of those rigs are newer, high-spec rigs that will cost quite a bit to remain actively marketed.

What a Fool believes
Despite the huge headwinds in the offshore rig market, Diamond had some things swing its way this quarter. With only one rig current under construction, the company's capital expenditures will be quite low in 2016 when so many rigs will roll off current contracts for Diamond and a slew of other rig companies. It will be a challenge to manage costs next year as well as Diamond did in this last quarter because there will be so many other rigs out of work.

There are still quite a few rigs on Diamond's fleet that are candidates to be scrapped, and taking them out of commission will likely lead to some asset writedowns and losses in the coming quarters. With a squeaky-clean balance sheet and a strong credit rating, though, Diamond should be able to get through this downcycle relatively well. What remains to be seen is how the company plans to grow its fleet again once the market does turn.