(Image: Zen Buddha Silence, by Marilyn Barbone)
March 29, 2020
We continue with examples of Boole’s quantitative investment process in action.
A few weeks ago, we looked at Valaris (VAL), the cheapest stock I’ve ever seen: http://boolefund.com/valaris-val/
Previously, we looked at Ranger Energy Services (RNGR): http://boolefund.com/ranger-energy-services-rngr/
Before that, we looked at Macro Enterprises (Canada: MCR.V): http://boolefund.com/macro-enterprises-mcr-v/
This week, we are going to look at Diamond Offshore (DO)—which has very low debt compared to the other offshore oil drillers. The company has $250 million in debt due in November 2023, $500 million due in August 2025, $500 million due in 2039, and $750 million due in 2043. Diamond Offshore has $156 million in cash, plus a $950 million undrawn credit facility. (Also, DO has no secured or guaranteed debt.) If there is a global recession, or if the oil war launched by Saudi Arabia lasts for at least a few years, then Diamond Offshore will still be a survivor, whereas many other offshore oil drillers may not be.
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First we screen for cheapness based on five metrics. Here are the numbers for Diamond Offshore:
- EV/EBITDA = 2.77
- P/E = 0.45
- P/B = 0.08
- P/CF = 0.50
- P/S = 0.09
These figures—especially EV/EBITDA, P/E, and P/B—make Diamond Offshore one of the top ten cheapest companies out of over two thousand that we ranked. (Note: This assumes a medium-case recovery with EBITDA at $801 million and net income at $549 million. The current market capitalization is $247 million.)
Next we calculate the Piotroski F-Score, which is a measure of the fundamental strength of the company. For more on the Piostroski F-Score, see my blog post here: http://boolefund.com/piotroski-f-score/
Diamond Offshore has a Piotroski F-Score of 7. (The best score possible is 9, while the worst score is 0.) This is a very good score.
Then we rank the company based on low debt, high insider ownership, and shareholder yield.
We measure debt levels by looking at total liabilities (TL) to total assets (TA). Diamond has TL/TA of 44.6%, which is decent. It’s important to note that most of the company’s debt is due in 2039 or later.
Insider ownership is important because that means that the people running the company have interests that are aligned with the interests of other shareholders. At Diamond, insider ownership is approximately 53%.
Shareholder yield is the dividend yield plus the buyback yield. The company has no dividend and is not buying back shares. Thus, shareholder yield is practically zero.
Each component of the ranking has a different weight. The overall combined ranking of Diamond Offshore places it in the top 10 stocks on our screen, or the top 0.4% of the more than two thousand companies we ranked.
The final step is to study the company’s financial statements, presentations, and quarterly conference calls to (i) check for non-recurring items, hidden liabilities, and bad accounting; (ii) estimate intrinsic value—how much the business is worth—using scenarios for low, mid, and high cases.
See the company presentation: http://investor.diamondoffshore.com/static-files/6dd72109-658b-455a-ad9b-1dd3814a44ce
Diamond Offshore has 4 drillships and 11 semisubmersibles. All the drillships are contracted at above market rates through 2022. Diamond uses unique, innovative technologies that deliver superior performance and improved economics to the company and its customers.
The moored market is underserved. The highest expected growth is in moored semisubmersibles. Also, from 2013 to 2019, the overall number of moored semis declined from 83 to 42. Moreover, Diamond Offshore has the largest backlog in moored semis, 2x larger than the next competitor.
Intrinsic value scenarios:
- Low case: If oil prices languish below $55 (WTI) for the next 3 to 5 years, Diamond Offshore will be a survivor because it has significantly lower debt than most of its competitors. ($250 million in debt is due in November 2023, $500 million is due in August 2025, $500 million is due in 2039, and $750 million is due in 2043.) In this scenario, Diamond is likely worth at least half of current book value (which is depressed) of $23.47. That’s $11.74, over 550% higher than today’s $1.79.
- Mid case: If oil prices are in a range of $55 to $75 over the next 3 to 5 years—which is likely based on long-term supply and demand—then Diamond Offshore is probably worth at least current book value (which is depressed) of $23.47 a share, roughly 1,210% higher than today’s $1.79.
- High case: Under a full market recovery, Diamond Offshore is probably worth 2x current book value (which is depressed) of $23.47 a share. That works out to $46.94 a share, over 2,500% higher than today’s $1.79.
Diamond Offshore (DO) is a very cheap stock. Assuming the return of normal circumstances within the next 3 to 5 years, the potential upside is between 1,200% and 2,500%. Even in the worst case scenario, DO will survive (unlike many other offshore drillers) and likely have over 550% upside.
BOOLE MICROCAP FUND
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: http://boolefund.com/best-performers-microcap-stocks/
This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.
There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.
The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.
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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.