(DO) Diamond Offshore Drilling Analyst Maintains Shares at Neutral

We have maintained our Neutral recommendation for Diamond Offshore Drilling Inc. (DO) given its solid fundamentals and financial disciplines, partially mitigated by stringent regulations as well as the lingering effects of the Gulf of Mexico (GoM) drill ban and related U.S. policies.

Texas-based Diamond Offshore is a major contract driller, providing comprehensive offshore drilling services to the global energy industry. We believe Diamond Offshore exhibits long-term earnings growth visibility based on its strong leverage to the offshore deepwater drilling market.

Again, the gradual improvement in the GoM drilling market, particularly after the deepwater drilling ban was lifted, as well as better bidding activity, will prove beneficial for a contract drilling company like Diamond Offshore.

The companies in the offshore deepwater drilling sector are experiencing improved market conditions. Hence, a gradually improving regulatory environment in the GoM region is expected to aid Diamond’s domestic fleet. Moreover, Diamond has also signed 10 new agreements recently that will likely contribute approximately $1 billion to total revenue and represent over 14 years of contract drilling backlog.

Diamond Offshore is constantly enhancing its broader territory in emerging markets like Brazil and West Africa. This is mainly intended to reap benefits from the recent deepwater field discoveries. The company’s Brazilian backlog saw solid growth with two-year extensions on Ocean Valor and the Ocean Baronessfrom Petrobas, as well as on deepwater rigs Ocean Quest and Ocean Starfrom OGX at dayrates of $270,000 and $300,000, respectively.

We also like the company’s financial discipline, which makes it one of the best-capitalized names in the industry. As of June 30, 2011, Diamond Offshore had approximately $279.9 million in cash, while long-term debt stood at $1,495.7 million with debt-to-capitalization ratio of about 26.6% (down from 27.2% in the preceding quarter).

However, we remain cautious about last year’s drilling moratorium and increased regulations that could have a lingering impact on the company. Again, Diamond Offshore remains leveraged to lower-spec deepwater and midwater floater markets where we believe utilization and dayrates could dampen over the next couple of years. We also remain skeptical due to the anticipated increase in newbuilds entering the market over the next few years.

Diamond, which competes with Noble Corporation (NE), retains a Zacks #3 Rank, which is equivalent to a short-term Hold rating.

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