Diamond Offshore's Big Asset Impairment Sends Second Quarter Earnings to a Deep Loss

By Markets Fool.com


Image source: Getty Images

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Diamond Offshore's (NYSE: DO) per share loss of $4.30 this past quarter stands in pretty stark contrast with the company's more recent earnings, but that's because the company took some pretty large non-cash charges to the income statement. Without those charges, the company's earnings looked surprisingly healthy considering how tough the offshore rig market is these days. However, management is still warning investors that things will likely get much worse before they get better. Here's a quick snapshot of the company's recent results and why management is giving investors ample warnings about the near term future.

By the numbers

Results (in millions, except per share data) Q2 2016 Q1 2016 Q2 2015
Revenue $388.7 $470.5 $634.0
Operating income ($626.7) $111.6 $134.1
Net income ($589.9) $87.4 $90.3
EPS ($4.30) $0.64 $0.66

Source: Diamond Offshore earnings release

As you might have guessed looking at those results for the most recent quarter, there were some pretty large charges and impairments that impacted earnings results. For the second quarter, Diamond took a pre-tax $678 million asset impairment for 8 of Diamond's semi submersible rigs. According to management, this resulted in a $4.46 after-tax per share impact on net income. So on a pure operations standpoint, the company is still making money.

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The largest declines in profitability came from the company's ultra-deepwater segment. In fact, the rest of the company's segments saw an increase in operational profits thanks to either higher revenue or lower operational costs.

Source: Diamond Offshore earnings release, author's chart

One thing that management did note is that results were significantly impacted because of unplanned downtime related to unplanned maintenance on blow out preventors on four of its ultra deepwater rigs. These blow out preventors were part of the deal that Diamond signed with General Electric earlier this year. As we head into the next quarter, we should expect earnings from its ultra deepwater segment to increase.

The highlights

  • Management decided to cold stack two of its rigs -- Ocean Endeavor and Ocean Scepter -- in order to cut costs while demand for offshore rigs remains weak
  • Diamond decided to also intend to scrap two rigs -- Ocean Quest and Ocean Star.
  • The deepwater rig Ocean Apex began an 18 month contract with Woodside Petroleum at $285,000 per day. That new contract is a large part of the reason we saw deepwater earnings increase in the quarter.
  • In a move similar to its General Electric deal in the first quarter, Diamond signed a joint development project with Trelleborg to develop itsHelical Buoyancy riser technology. This technology reduces vibrations for offshore drilling applications, which helps to reducemaintenancerequirements.
  • CFO Gary Krenek retired in May and was replaced by Kelly Youngblood, who spent 28 years at Halliburton before hand.

From the mouth of management

There were some upticks in Diamond's operations this past quarter. Before investors get too excited about the recent quarter, though, CEO Marc Edwards threw a giant bucket of cold water at them as he described what he foresees as a brutal market for offshore drilling in the next couple years.

Clearly, our customers continue to curtail offshore capital expenditures. In this past week alone, 2 large offshore players have further reduced 2016 investment spend, and we are estimating that our clients' 2017 CapEx will further decline. This is in addition to the approximate 40% reduction that we experienced from 2012 to 2016. In conjunction with newbuilds continuing to enter the market and contracted rigs rolling off-contract, this has created the perfect storm for the drillers who are overexposed to the sixth-gen asset class.

We may have seen a bottom in the oil price, but it is clear that volatility will be with us for some time to come. Some of the larger diversified oilfield service providers have declared a bottom in activity and are suggesting that a recovery is imminent. While this may be the case for certain onshore basins, it is not so for deepwater drilling. Utilization is still declining at almost 5% per quarter and contracting is essentially next to 0. Before we can declare a bottom, we at least need to see a level of fixture awards that matches the number of contracts that are reaching the end of their term. And for our industry sector, this has yet to happen.

Of course, we all know that our industry is cyclical, and we will see a recovery. However, this time, it is likely to be slow and protracted. Our clients will first have to fix their cash wheels and then eliminate the partner drag that is holding back much of the current deepwater activity. Nevertheless, we believe that future high demand and the commensurate supply stack required to meet this demand suggest that as we move into the next decade, deepwater will have to deliver a level of incremental production that is equivalent to the entire portfolio that is currently produced from North American unconventionals today. Simply put, the long-term fundamentals for our business are and will remain intact.

What a Fool believes

Diamond Offshore is pulling the right levers in this downturn. It's cutting costs and doesn't have a whole lot of capital obligations in the coming quarters to finish building out its fleet. It also has one of the better looking balance sheets in the business that will help it get through this downturn in relatively decent shape. We have yet to see its new equipment deal with General Electric bear fruit, but once that unplanned maintenance is taken care of we should see a decline in operational costs for its ultra deepwater fleet.

As Edwards put it, the market for offshore rigs is absolutely brutal today. For the company, that means batten down the hatches and ride out the storm for a couple more years. For investors, we have the luxury of looking elsewhere for our investments. Perhaps in a couple years when this market rebounds it will be worth taking a look at Diamond as a potential investment. In the meantime, though, it's probably best to wait this one out.

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Tyler Crowe owns shares of General Electric.You can follow him at Fool.comor on Twitter@TylerCroweFool.

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