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Published: August 30, 2010
The energy industry has been especially
turbulent recently, and investors looking for opportunity in
companies afflicted by the offshore rig explosion and subsequent
oil spill in the Gulf of Mexico are positioned right in the
middle of the hurricane.
I've spent some time in the hurricane and have concluded that
the share prices of BP plc (NYSE: BP) and Transocean
(NYSE: RIG) have fallen to levels that more than discount
the downside risk to their operations.
Risk for these stocks stem from cleanup costs, litigation on who
is to blame in the calamity and the loss of reputations that
will be extremely difficult to rebuild. However, uncertainty is
high and no one has a crystal ball on how things will shake out.
A safer bet may be to steer clear of these risks and focus on
other industry players that are seeing
collateral damage from the debacle and are far less likely
to see their operations torpedoed by the above risks.
One such opportunity is Diamond Offshore Drilling (NYSE: DO),
which along with Transocean, is among the largest offshore
drilling firms in the world. Diamond had seven of its 13
semisubmersible rigs operating in the Gulf when the disaster
struck, and is losing plenty of revenue due to the subsequent
government moratorium halting drilling out of safety concerns
for another spill.
This is obviously a near-term setback, as is the negative
sentiment that has swept over the industry. Diamond's share
price has fallen roughly -24% since early May and is down almost
-60% from when the
economy was in full swing and oil prices were reaching
all-time highs a couple of years ago.
A frothy oil price is unlikely to be reached again for some
time, but economic growth should eventually pick up. The oil
leak has been plugged and the Gulf region can begin the painful
task of returning to pre-spill condition. BP and related parties
will remain entrenched in this process for years to come.
Diamond Offshore, on the other hand,
operates in other parts of the globe with a focus on Brazil,
Mexico and many parts of Asia. The company can easily shift
production and capitalize on the most economical offshore
drilling locations. In fact, it may earn additional business as
Transocean remains distracted in the Gulf.
For the full year, Diamond should still earn around $7 per
share. This includes a good amount of downside from the
moratorium and gives the stock a very low forward
P/E of less than nine times
earnings. The lowest multiple the stock had previously seen
in the past 15 years were in 2008 and 1998 -- when the average
P/E fell to 11.6 and 13.7, respectively. A key driver in this
relationship is earnings, which fluctuate along with the price
of oil and subsequent demand for offshore oil and gas
exploration. Activity remains healthy, as management had a
strong $8.2 billion backlog (representing more than two years of
revenue) going into the current economic downturn.
Operationally, Diamond Offshore posts industry-leading returns
on invested capital and had already been actively redeploying
rigs out of the Gulf into more lucrative parts of the world,
such as Brazil, Angola and Australia. It has also spent billions
upgrading its fleet during the past decade, which helps support
utilization of its fleet and the day rates customers pay for its
rigs.
Action to Take --> Diamond
Offshore stands out as a solid choice, as it not directly
involved with the Gulf oil spill risks and has only been hit by
the short-term drilling ban in the region. Upside exists from an
improvement in the currently negative industry sentiment,
economic recovery and long-term appeal for offshore drilling as
land-based reserves deplete over time.
A return to more normalized double-digit earnings multiples and
profit recovery should combine to push the shares up by at least
+40% in the next couple of years. Given current industry
dynamics, buying the shares is a relatively low risk way to
profit from more normalized energy conditions.
-- Ryan Fuhrmann
Contributor
StreetAuthority |
