S&P Lowers Rating on Diamond Offshore Drilling (DO) to 'A-'; Outlook Negative

Standard & Poor's Ratings Services today lowered its corporate credit and unsecured debt ratings on Diamond Offshore Drilling Inc. (NYSE: DO) to 'A-' from 'A'. The outlook is negative.

"The downgrade reflects our assessment of Diamond's financial risk profile as 'significant,' reflecting weaker credit measures due to our assumption of lower day-rates and utilization, in light of deteriorating market conditions," said Standard & Poor's credit analyst Susan Ding. "We believe that the large supply of newbuild rigs coming online over the next one to two years, in conjunction with volatile commodity prices and uncertainty surrounding exploration and production spending for 2015, will significantly heighten recontracting risk and pressure day-rates, especially in the midwater and lower-specification jack-up segments," said Ms. Ding.

We view Diamond's concentration in the midwater segment as a negative rating factor because the segment is under pressure as newer, more technologically advanced drillships are entering the market. We believe Diamond may also be disadvantaged due to the older age of its fleet compared with some of its peers.

Our ratings on Diamond also reflect the application of our group methodology criteria, in which we assess Diamond as a "moderately strategic" entity of Loews Corp. (A+/Stable/--). Diamond is 52.3% owned by Loews (as of Dec. 2, 2014). We consider Diamond "moderately strategic" to Loews because we believe that the company is important to the group's long-term strategy and has the long-term commitment of senior group management. We also believe that in periods of stress the group would provide support to Diamond if needed, and that Diamond could reduce and/or eliminate the special dividend to stockholders. As a result, the corporate credit rating is one notch above Diamond's stand-alone rating of 'bbb+'.

Our assessment of Diamond's "strong" business risk profile reflects its sizable fleet of mobile offshore drilling units and the multiyear cash flow visibility afforded by its significant backlog of drilling contracts. Diamond is in the process of upgrading its fleet and expects to invest about $5 billion (since 2009) in newbuilds, mostly in ultra-deepwater and deepwater assets.

We view Diamond's financial risk as "significant." Diamond has historically maintained low debt levels and high cash balances. Furthermore, Loews has been supportive of the company maintaining a conservative capital structure. Nevertheless, we expect credit measures to be weaker in the next 12 to 18 months as the company invests in its newbuild program, while day-rate and utilization may slip as new supply comes into the market over the same period. We assess Diamond's liquidity as "strong," meaning that we expect liquidity sources to exceed uses by at least 1.5x for the next two years. High cash balances, continued good internal cash flow generation, and good availability under the company's $1.5 billion revolving credit facility maturing in 2019 support our assessment of the company's liquidity position.

The negative outlook reflects our expectation that the oversupply in the offshore rig market and commodity price volatility will heighten competition and recontracting risk over the next two years, resulting in downward pressure on day-rates and utilization, particularly in the mid-water segment, where Diamond has a significant concentration.

We could revise our outlook to stable if the competitive landscape for the offshore drillers improves or if Diamond is able to mitigate some of the recontracting risk and FFO to total debt improves to above 45% on a sustained basis.

We would consider a downgrade if operating conditions continue to weaken in the offshore drilling market or if management deviates from its historically conservative practices and increases its debt leverage substantially to fund special dividends, newbuilds, or acquisitions, resulting in FFO to debt declining to less than 30% for a prolonged period.

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