Diamond Offshore Goes Deep

By Will Ashworth | January 21, 2011 AAA

Diversified holding company Loews (NYSE:L) owns 90% of CNA Financial (NYSE:CNA), 66% of Boardwalk Pipeline Partners LP (NYSE:BWP) and 50.4% of Diamond Offshore Drilling (NYSE:DO). Today, we'll focus on Diamond Offshore, as it's a better buy than its controlling shareholder.

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Deepwater Rig Order
Diamond Offshore provides deepwater offshore oil and gas drilling for energy companies around the world. Its fleet of rigs is one of the largest in the industry employing 5,500 people. It's a heavy hitter that's about to get even bigger in the deepwater drilling business. On January 3, 2011 it announced it had placed a $590 million order with Hyundai Heavy Industries to build an ultra-deepwater drillship capable of drilling in 12,000 feet of water. Delivery is scheduled for the second quarter 2013. It also retains the option to order a second ship by 2011. Over the past four years, it's added six ultra-deepwater drillships to its fleet.

Special Dividends
Many investors believe that special dividends are superior to both regular dividends and share repurchases, because they can be allocated in a timely manner when cash flow is highest. Since the beginning of 2006, Diamond has returned $29.13 in regular and special dividends to shareholders with absolutely no share repurchases and a small 12.5 cents a share quarterly dividend, saving the lion's share of the rewards for special dividends. The philosophy's paid off with above-average total returns compared to the S&P 500. From the beginning of 2006 to the end of 2010, its total returns are 29.5% while the index during this period managed a meager 0.7%. Its philosophy about shareholder value alone should have you considering its stock. Not many companies think this way.

Gulf of Mexico
When the Maconda oil spill first occurred, the markets were slow to react. Although the Deepwater Horizon drilling rig exploded on April 20, 2010 and then sank two days later, BP's (NYSE:BP) stock didn't take a noticeable dive until April 29 when its shares lost $4.70 on 85 million in volume. Others involved in the disaster experienced similar declines including Transocean (NYSE:RIG), Halliburton (NYSE:HAL) and Cameron International (NYSE:CAM). Almost a year later and their stocks have recovered most of the losses. Interestingly, Diamond Offshore, which wasn't involved, hasn't regained nearly as much as its peers have despite the fact it's reduced its Gulf of Mexico exposure from 32% of revenues at the end of 2009 to 21% at the end of the third quarter in 2010. Its total return since the spill is around negative 15% and if not for the $3 in special dividends since April, the return would be substantially worse. Older fleet, Gulf of Mexico, lower contracted day rates; you name the problem and the decline still doesn't make sense. Its revenues and profits are down in 2010 but it still earned more $6 a share in the past year. This is a definite buying opportunity.

The Bottom Line
Diamond Offshore traded above $140 in 2008. Today, its stock is half that. Although its revenues aren't as high as they once were and profit margins have slid some, a 50% haircut from its highs two years ago seems a bit much. Patient investors will be rewarded.

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