This company is paid a “day rate” by large oil companies who use its offshore equipment and crews. Its fleet of offshore drilling rigs, semisubmersibles and drill ships are currently deployed all around the world. The company also has a 1.1% dividend yield, paid quarterly.
Diamond Offshore (DO)
from Porter Stansberry’s Investment Advisory
Diamond Offshore (DO) provides contract drilling services to the energy industry.
The Tisch family is without question some of the best value-oriented investors around. Through its publicly held Loews Corp., the Tisch family owns more than 50% of all outstanding Diamond shares. James Tisch serves as chairman of the board.
Our favorite valuation metric is enterprise value (EV) – that’s the company’s market cap plus its debt minus its cash holdings – divided by a company’s earnings before interest, taxes, depreciation, and amortization (EBITDA). Generally, we like to buy capital-efficient companies when their EV equals less than 10 times EBITDA, but since DO typically trades in the 6.5-7.5 range, we’d consider anything less than 6.5 a great buy. Today, DO trades for an incredible 5.8 times EV/EBITDA.
We think this is a great opportunity, but plenty of other analysts disagree. To be fair, the market has a right to be skeptical of Diamond’s prospects, due to:
•Safety and environmental risks inherent within the offshore-drilling business
• Waves of brand new equipment/rigs (supply) are hitting the market, while demand is wavering in some parts of the world
•A recent rash of “dry” holes off Brazil and Indonesia has led exploration companies to give up on these projects, which frees up additional rigs to re-enter the competitive markets
•Day rates and utilization rates have fallen
•Falling oil prices generally slows demand for the drilling-services industry
Most industry pundits – including Jim Tisch – believe the current down cycle will persist in 2014.
With all this negativity, why make this recommendation? Well, we’ve looked at the numbers over several of these cycles, and Diamond’s management team has always generated incredible cash returns regardless of where we are in the capital cycle.
Since DO went public in 1995, there have been four separate two-year periods during which the stock more than doubled. And in two of these runs, the stock shot up by more than five times. However, the stock has crumbled by more than 40% on four other occasions. That’s a bumpy history for a company that has been public less than 20 years.
But over the long haul, the cumulative results have been more than satisfactory. Since 1996, DO investors who reinvested their dividends are up 420% (around 10% per year). Reinvesting your dividends in an S&P 500 Index would have yielded only 298% over that same period.
Personally, we think all of this “down cycle” talk is a bit overblown. Anadarko has created some solid demand in New Zealand and Australia for Diamond’s services, and there’s talk of a North Sea drilling bonanza off the coast of Scotland.
But the biggest demand will come closer to home. We believe that the world’s renewed interest in the Gulf of Mexico will soak up a great deal of the perceived excess supply.
Buy Diamond Offshore (NYSE: DO) up to $49. Hold your position with a 25% trailing stop.
Porter Stansberry, Porter Stansberry’s Investment Advisory, www.stansberryresearch.com, 888-261-2693, February 2014