Most investors head for the hills when a stock is hit by
analyst downgrades. As for me, I want a closer look.
Value frequently materializes after an exodus.
I see value following the investor exodus from
Diamond Offshore Drilling (
, whose business is readily gleaned from its name: Diamond
provides offshore drilling rigs - in deep and shallow waters - to
large integrated energy companies. Clients include Royal Dutch
Shell (NYSE: RDS.a), BP (
), Petrobras (
), and PEMEX.
Diamond is a long-time holding in the
High Yield Wealth
portfolio. To be honest, it has been the rare
disappointment. Diamond's shares have simply failed to gain
traction. Worse, its shares have actually backslid in recent
months, and not in an inconsequential amount. Diamond's
price graph is hardly cause for celebration.
Then again, Diamond Offshore Drilling's price graph is hardly
cause for despair. Indeed, I see opportunity.
As a price-appreciation investment, Diamond has left much to
be desired. As an income investment, it has continually
performed. The company continues to pump out $3.50 per share in
annual dividends. At today's lower price, that translates
lush 7.4% yield
- one of the highest in the sector.
So why is Diamond's share price depressed? Issues cover
the macro and the micro.
On the macro side, overcapacity is a concern. Offshore
drillers have aggressively expanded in recent years.
Diamond's fleet has increased nearly 41%, going to 45 rigs from
32. Concurrently, a few large oil companies have hinted at plans
to reduce capital expenditures. Rising supply coupled with
falling demand has analysts sucking their thumbs and whining over
the possibility of lower dayrates and lower rig-utilization
On the micro side, Diamond Offshore Drilling has suffered
setbacks in Brazil, which accounts for more than 30% of its
annual revenue. Specifically, two of Diamond's rigs were
contracted to the Brazilian oil service company OGX, which filed
for bankruptcy in October 2013. Diamond took a $75 million
hit in the third quarter of 2013 related to OGX non-payments.
These concerns have lead to a cascade of downgrades, most of
which hit the market over the past month. Investors, in turn,
responded with a hard sell. Diamond's shares are down over 16%
year to date.
Time to buy. I say that because Diamond's shares are oversold
- WAY OVERSOLD.
For one, Diamond Offshore Drilling continues to make money and
cover the dividend. EPS in 2013 posted at $3.95, which is a
disappointment and a 23.8% reduction from EPS of $5.18 posted in
2012. Still, it was enough to cover the dividend. What's
more, EPS is expected to recover to $4.50 in 2014.
In other words, circumstances are better than recent share
performance would lead investors to believe. Indeed, I
believe they are even better than most analysts believe.
I expect Diamond will continue to make money, and make it at a
growing rate in the future. Even with the aforementioned issues,
Diamond's backlog is around $9 billion, nearly three years of
revenue, and provides sufficient visibility on the company's
What's more, long-term growth in worldwide
is unlikely to abate, and the low-hanging fruit is already
According to the 2013 World Energy Outlook, the total world
oil supply in 2012 was
87.1 million barrels a day (MBD), an increase of 11.9MBD over
the 75.2 MBD produced in 2000. Less than one-third of this
increase was in the form of conventional crude oil - the easy
stuff pumped directly out of the ground. More than two-thirds was
what the International Energy Agency calls "unconventional crude"
(light-tight oil, oil sands, and deep/ultra-deepwater oil) or
The long-term outlook for offshore drilling is clear:
will need to invest more to extract oil, whether they want to or
not. That will keep drilling contractors like Diamond Offshore
In the meantime, investors can pick up shares of a premier
offshore drilling contractor with a yield of 7.4% that trades at
a mere 10.5 times 2014 EPS estimates.
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