BORR - Diamond Offshore Drilling - Significant Progress Expected In 2024 - Buy

2023-11-28 17:34:09 ET

Summary

• Diamond Offshore Drilling reported better-than-expected third quarter results with revenues and adjusted EBITDA coming in well above expectations. As a result, the company raised full-year guidance.
• While the company intends to return capital to shareholders, it will take more time until free cash generation becomes sufficient for the initiation of a dividend and/or a share repurchase program.
• 2024 should benefit from a much lower number of shipyard days and a resulting decrease in offhire time and capital expenditures.
• While offshore oil and gas service stocks have been volatile as of late, I consider the recent weakness an opportunity to initiate positions.
• At current levels, Diamond Offshore Drilling's stock provides for almost 50% upside based on my adjusted EBITDA estimate for 2025.

Note:

I have previously covered Diamond Offshore Drilling, Inc. ( DO ), so investors should view this as an update to my earlier articles on the company.

Decent Q3 Results And Raised Full-Year Guidance

Earlier this month, Diamond Offshore Drilling ("Diamond Offshore") reported better-than-expected third quarter results with revenues and adjusted EBITDA coming in well above previously-communicated expectations :

On the conference call , management attributed the outperformance to the semi-submersible rig Ocean Courage finishing its most recent contract later than previously anticipated and the recognition of a $4.3 million early termination fee for the Ocean Apex as well as the deferral of certain contract preparation expenses for the drillship Ocean BlackHawk .

Consequently, the company raised its full-year outlook:

Strong Liquidity Following Recent Debt Refinancing

However, elevated capital expenditures related to special periodic survey and contract preparation requirements resulted in negative free cash flow of $31.4 million for the quarter.

Following the recent comprehensive debt refinancing , Diamond Offshore finished Q3 with $146.8 million in unrestricted cash and $550 million in long-term debt. Including the company's undrawn $300 million revolving credit facility, total liquidity amounted to almost $450 million.

Near-Term Dividend Initiation Still Unlikely

While debt covenants no longer preclude the company from returning capital to shareholders, it will take more time until free cash flow generation will be sufficient for the initiation of a dividend and/or a share repurchase program, as outlined by management on the conference call (emphasis added by author):

As we continue to transition to higher dayrate contracts and increased EBITDA and cash flow generation in Q4 of this year and throughout 2024, we will grow into our ability to return capital to shareholders vis-à-vis the covenants and the indenture and the revolver, and anticipate being in position to do so subject to Board approval as we move into 2025 .

Backlog Up Slightly

Last week, Diamond Offshore also released a new fleet status report with total backlog amounting to $1.66 billion, up slightly on a sequential basis:

Of particular note, the semi-submersible rig Ocean Patriot was awarded a multi-year plug and abandonment contract in the UK North Sea with an impressive EBITDA margin of 50%:

Additionally, the Patriot was successful in its pursuit of a long-term P&A campaign with TAQA, commencing in early 2025 with a total contract value of approximately $210 million. The contract is for 35 P&A wells representing approximately three years of firm term, plus up to additional 17 option wells that could extend the term to four years in total. This contract will allow the Patriot to earn approximately $35 million of fully burdened EBITDA per year for the life of the contract.

While the rig hasn't lined up any work for 2024 so far, management remains optimistic on the Ocean Patriot's prospects for next year with a number of near-term opportunities currently being pursued.

In contrast, the semi-submersible rig Ocean Onyx is likely to remain cold-stacked for the time being as there's currently no work available at terms sufficient to justify reactivation of the unit.

Last week, the company also announced a short-term contract for the drillship Ocean BlackRhino offshore Guinea-Bissau at a dayrate north of $500,000 which represents the highest reported charter rate for an offshore rig in almost a decade.

Termination Of Rig Management Agreements For Drillships Vela and Auriga

Please note that Seadrill Ltd. ( SDRL ) has terminated the marketing agreements for the managed drillships Auriga and Vela following its acquisition of Aquadrill LLC earlier this year. Consequently, Diamond Offshore does not expect the management agreements to be extended beyond the rigs' current contract term.

2024 Outlook

Looking into 2024, the company has most of its active fleet contracted with the Ocean Patriot the only notable exception.

In addition, in the second half of the year, two of Diamond Offshore's high-specification drillships will complete lower-margin legacy contracts and become available for work at prevailing market rates.

Diamond Offshore will also benefit from substantially lower special survey requirements with shipyard days expected to decrease by almost 80% next year.

However, management abstained from providing preliminary guidance for 2024 (emphasis added by author):

We plan to provide specific guidance for 2024 during our Q4 earnings call early next year as we are currently working through a number of opportunities that could positively influence our guidance .

In the meantime, as I shared last quarter, we are positioned for a significant step-up in EBITDA and cash flow generation in 2024 . We expect to incur only 100 days in a shipyard in 2024 for rig upgrades, contract preparation activities and SPSs, excluding mobilization, as compared to approximately 450 days off contract in 2023, leading to more revenue generating days and higher dayrates.

The BlackHawk’s operating cost should go down significantly as it begins work in a lower cost region, not to mention its significantly higher dayrate. And our CapEx expenditures should decrease meaningfully as a result of two SPSs, as compared to five this past year.

All of these factors combined provide the foundation for 2024 to continue the improved financial performance that we expect to begin in the fourth quarter of this year.

With managed rigs Auriga and Vela anticipated to leave the fleet in the first half of 2024, much will depend on the company's ability to secure near-term work for the Ocean Patriot as well as follow-on work for the high-specification drillships Ocean BlackRhino and Ocean BlackLion in the second half.

Valuation and Price Target

Valuation-wise, Diamond Offshore currently trades at approximately 4.4x EV/Adjusted EBITDA based on my estimates for 2025:

Assigning an EV/Adjusted EBITDA multiple of 6x would yield an $18 price target for the shares thus providing for almost 50% upside from current levels:

While the recent lull in contracting activity has impacted offshore drilling stocks, long-term industry prospects remain intact.

With Diamond Offshore Drilling's shares offering the most upside relative to U.S. exchange-listed peers, investors should consider using the recent weakness to initiate a position.

Key Risk Factor - Oil Price Correlation

Please note that offshore drilling stocks remain heavily correlated to oil prices so any sustained down move in the commodity would almost certainly result in industry shares taking a further hit.

Bottom Line

Diamond Offshore Drilling reported better-than-expected third quarter results and raised full-year projections. However, some of the outperformance was related to the recognition of an early termination fee and deferral of certain contract preparation expenses.

Following the recent refinancing, the company will no longer be restricted from returning capital to shareholders but it will likely take another year until the company generates sufficient cash flows.

On the conference call, management remained optimistic regarding the company's prospects for 2024 and beyond.

While offshore oil and gas service stocks have been volatile as of late, I consider the recent weakness an opportunity to initiate positions.

At current levels, Diamond Offshore Drilling's stock provides for almost 50% upside based on my adjusted EBITDA estimate for 2025.

For further details see: