Why Diamond Offshore Investors Are Drilling Amid Rough Waters


NEW YORK (TheStreet) -- Offshore drilling giant Diamond Offshore (DO) are receiving a vote of confidence from investors which sent the stock up 3.4% Wednesday, despite there being no news to support the optimism. And the stock is up another 1.25% as of 10:30 a.m. Thursday. Yet these shares are down 62% since trading at $92.62 in April 2010. How much longer are investors going to wait for Diamond's value to be realized?

This looks like a head fake, given Diamond's recent fleet status update, which showed day rates were lower than expected. This means future revenue is likely to disappoint. These shares could still fall another 8% to 15% to around $30 or $32. And now's not the time to bet on the bottom.

Must Read: Warren Buffett's Top 10 Dividend Stocks

Some of Diamond's jump was a lift in the broader market. On Wednesday, the Dow Jones Industrial Average (DJI) , Nasdaq (IXIC) and S&P 500 (SPY) posted gains of 1.64%, 1.9% and 1.75%, respectively. And while the larger market is sinking Thursday, Diamond keeps heading up for now.

Investors would be wise to lock in gains now and look for safety elsewhere.

These gains reverse a trend that has seen Diamond stock decline steadily by 33% since shares hit a June high of $51. And even with this week's uptick, Diamond shares are still down 37.5% on the year to date, trailing the 5.9% gain in the S&P 500.

Compared to peers Transocean (RIG) , SeaDrill (SDRL) and Ensco (ESV) , Diamond pays one of the lowest yields in the group, at 1.5%.

By contrast, Transocean and SeaDrill pay yields of 10% and 16.5%, respectively. Meanwhile, FBR's Thomas Curran and Daniel Martins have pointed out the threat to yields in the sector due to the cost of credit protection. So even there, Diamond investors can't find strong justification.

Even Ensco, which is more susceptible to a market oversupply of rigs, pays a yield of 7.8%. Despite Ensco's risk, its dividend gives investors an incentive to be patient. Diamond, meanwhile, offers no such safety.

From a relative fundamental perspective, Diamond's metrics leave little to be desired.

Not only does its gross margin of 42% lag the industry average of 52%, according to Yahoo! Finance, its gross margin trails that of Noble (NE) , Ensco and Transocean, which deliver margins of 50%, 52% and 43%, respectively.

The same goes for Diamond's operating margin of 23%, which is the lowest among the four companies. Yet Diamond's price-to-earnings ratio of 11.5 is the highest of the four. This doesn't make sense, especially since Diamond produces the least amount of revenue growth of the four companies. 

So with revenue and margins trailing its peers, investors will need a miracle to make money off of a stock that's really expensive despite how depressed the shares look. The industry is suffering from a downturn. This suggests that these shares still have some room to fall.

Diamond's CEO Marc Edwards remains confident, however. While speaking to analysts, he said his company is well-positioned to endure the cycle, adding that "when the opportunities come and the market changes, we have been very successful in returning shareholder value."

Yet these shares are down 62% since April 2010. Investors need to remember that.

Must Read: 10 Cars That Retain Resale Value After 5 Years

At the time of publication, the author held no position in any of the stocks mentioned.

Follow @Richard_WSPB

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates DIAMOND OFFSHRE DRILLING INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation: 

"We rate DIAMOND OFFSHRE DRILLING INC (DO) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its reasonable valuation levels, largely solid financial position with reasonable debt levels by most measures and expanding profit margins. However, as a counter to these strengths, we also find weaknesses including feeble growth in the company's earnings per share, deteriorating net income and disappointing return on equity."