Our 2014 and 2015 earnings-per-share estimates for Diamond Offshore Drilling drop 26% and 34%, respectively.
On top of Diamond Offshore's (ticker: DO) newbuilds entering into service under difficult market conditions, we see lowered demand for deepwater capability and lowered dayrates.
Consequently, operators are settling for shorter contracts. We believe 2014 will see further rig deactivations and declining dayrates for less capable units. We also expect the oversupply in this class to lead to more well-to-well work, which will likely lead to contract gaps and lower earnings quality. We believe that an eight times multiple on 2015 estimated EPS is more than fair, with a resultant price target of $38 (down from $61 previously). With that much downside potential we are downgrading Diamond Offshore shares to a Sell rating (from Neutral).
Delivery of the first of three new drillships (Blackhawk) was completed last week. This new rig is set to hit the Gulf of Mexico on Anadarko Petroleum's (APC) behalf and remain active for the next five years. The second (Blackhornet) is set to follow suit in April, again for Anadarko-related work. The third (Blackrhino) will be completed this summer and remains on schedule to launch in first-half 2015. Work for the third ship is yet to be solidified, but is being actively marketed.
Midwater, deepwater and ultra-deep water supply and demand in 2014 has generated a significant amount of negative naysayers. Dayrate pressure is ratcheting revenues lower resulting in two to four well opportunities becoming the new long-term norm. That said, Diamond Offshore expressed its feeling that current rates are still within reason and will provide adequate margins, particularly for the newbuild and younger fleets within its stable. Case in point, the Onyx has been active under a one-year contract with Apache(APA) while the other deepwater newbuild (Apex) is set to start earning its keep
sometime near the end of this year and land a shorter-term contract.
The Quest and Monarch remain idle over customer credit issues and the Valiant's completion of previous contract work has left it idle. This rig was originally thought to have landed in West Africa after its special survey in the Canary Islands, but that did not materialize. Diamond Offshore is said to be heavily marketing this rig in the North Sea and Mediterranean areas. On the flip side, to avoid idle status, discussions for two jackups are underway in the Gulf of Mexico and was not disclosed in the most recent financial-strength rating. A drop in the bucket, but positive news, nonetheless.
Our new 2014 and 2015 EPS estimates are $3.74 (down from $5.07) and $4.72 (down from $7.20). While this may be viewed as a late downgrade to Sell after being Neutral on the name for many years, we believe that the downside scenario of both rate and utilization degradation have not been factored into the share price of Diamond Offshore yet. We believe it is still plausible that 2015 estimates could decline another 20% if the current headwinds persist.