Pre-Q2, Buy Diamond Offshore

We are maintaining our Buy recommendation and price objective on Diamond Offshore Drilling Inc. (DO - Analyst Report) shares ahead of the company's second-quarter results. Our continued favorable view of the company reflects its strong leverage to the favorable deepwater drilling outlook.

Diamond Offshore will report its second quarter results on July 24. We are lowering our 2008 EPS estimate ($10.07 vs. $10.50) to reflect increased expense estimates, while keeping our 2009 estimate unchanged.

With a backlog of $11 billion, Diamond offers a solid level of earnings and cash flow visibility. In addition to its regular dividend, the company paid a special dividend of $1.25 per share in each of the last three quarters and $4 per share earlier in 2007. Given its cash flow outlook, we expect this payout pattern to remain in place in the near to medium term. The company's strong presence in the international market will help sustain its dayrate growth momentum keeping in view the solid fundamentals of these markets.

In the U.S. Gulf of Mexico, dayrates for some of Diamond's high-specification rigs are currently of the order of $425,000 for future work. Diamond received a letter of intent for one of its seven high-spec floaters in the region, the fifth generation rig Ocean Confidence, for a dayrate of as high as $500,000 for future work. Following commencement of the contract in January 2008, the company is expected to receive a total of $730 million in revenue over the four-year contract period.

Our unchanged $145 price objective reflects 2009 P/E and EV/EBITDA multiples of 10.8x and 7.0x, respectively, both well within historical trading ranges and still at a discount to Transocean Inc (RIG - Snapshot Report).

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