Transocean: Not Undervalued For Long

May.24.13 | About: Transocean Ltd. (RIG)

Deepwater and Ultra-Deepwater exploration and drilling have shown a remarkable increase over the past few years. This is due in part to the development of new technologies which have reduced operational costs and risks, as well as the finding of reservoirs that will produce high production wells. There are many zones throughout the world that possess the potential for high quality production that not so long ago were "out of reach."

Oil and gas service companies such as Halliburton (NYSE:HAL), National Oilwell Varco (NYSE:NOV) and Baker Hughes (NYSE:BHI) have pushed the envelope with their engineering and technological advancements. Many of these advancements have opened up a greater amount of opportunities in areas such as the Pre-Salt region off the coast of Brazil, the U.S. Gulf of Mexico and the Barents Sea off the northern coast of Norway.

Each of these regions will looking to increase production and capitalize on their resources. The Pre-Salt region off the coast of Brazil is a "hot spot," opening up many opportunities for oil and gas companies like Petrobras (NYSE:PBR) and OGX Petroleo e Gas (OTCPK:OGXPY). The Pre-Salt region off the coast of Brazil has massive recoverable oil and natural gas reserves. Estimates are that there are more than 50 billion barrels of oil equivalent (BOE) in the Pre-Salt region alone.

As the U.S. Gulf of Mexico has produced over four billion barrels of oil in the past eight years, this area remains one of the world's most prolific producing regions as well as one of the most challenging. According to the EIA Gulf of Mexico federal offshore oil production accounts for 23 percent of total U.S. crude oil production and federal offshore natural gas production in the Gulf accounts for 7 percent of total U.S. dry production.

Recently, Norway has raised its estimate for undiscovered oil and gas by 31% to 8 billion barrels of oil equivalent in the Barents Sea. Recently, Norway and Russia resolved a 40-year-old dispute over dividing the Barents Sea and part of the Arctic Ocean. Currently, the Norwegian Government is looking to increase its production in the Barents Sea. Statoil ASA (NYSE:STO), which operates over 80% of Norway's oil and natural gas production, has said it will to spend $13.8 billion USD with Petoro AS and Eni to develop the Skrugard and Havis regions in the Norwegian Barents Sea.

Below is a map of the Barents Sea Oil and Gas License blocks and fields in 2012.

Click to enlarge

Each of the listed regions will present many opportunities for deepwater and ultra-deepwater drillers over the next ten years. As each of these countries has opportunities to increase oil production, this will provide many favorable circumstances for drilling companies. One company that has set up its fleet to focus on harsh environment and Ultra-deepwater drilling is Transocean Ltd (NYSE:RIG).

Even though Transocean has operations around the world, the bulk of its revenues come from in the U.S. Gulf of Mexico, Brazil and Norway. Over the past three years, as Norway has resolved its zoning issues with Russia, the Norwegian government is looking to increase its production in the Barents Sea. Transocean has benefited from this as revenues from Norway have increased from $756 million in 2010 to $1.174 billion in 2012. This represents an increase of 55.29%. Currently, Transocean has ties with Norwegian oil company Statoil and this relationship have proven to be beneficial for both companies. Transocean has 7 rigs operating in Norway and as production increases in the Barents Sea this number should increase.

Due to production increases in the U.S Gulf of Mexico, Transocean's revenues in this zone have increased significantly. Transocean reported U.S. based revenues at $1.937 billion in 2010 while it reported revenues of $2.472 billion in 2012. This signifies an increase of 27.62%. On May 17th, Rigzone released the article: Statoil Sets Eyes on GOM to Help Increase Production Growth. The article notes that Norwegian company Statoil was the highest bidder on 15 leases in the central region of the U.S. Gulf of Mexico. As major Oil and Gas companies such as Statoil and Royal Dutch Shell (NYSE:RDS.A) have increased their presence in the U.S. Gulf of Mexico, they will be contracting Transocean and other drillers for their Ultra-Deep Water needs. Currently, Transocean has 15 rigs deployed in the U.S. Gulf of Mexico.

Brazil is fast becoming the Latin American leader in oil and gas production. As Brazil looks to increase production over the next ten years in conjunction with Petrobras, this will provide opportunities for drillers such as Transocean. Revenues in Brazil have decreased over the past three years. In 2010, Brazil based revenues were reported at $1.288 billion while Transocean reported a revenue of $1.114 billion. Even though the revenue in Brazil has declined, this still represented 12.11% of Transocean's total revenues. Currently, Transocean has 9 rigs deployed in Brazil.

As opportunities arise in the Deepwater, Ultra-Deepwater and harsh environment drilling, Transocean will look to capitalize on them. According to the 2012 annual report the company states, "We expect our total revenues for the year ending December 31, 2013, to be higher than our total revenues for the year ended December 31, 2012, primarily due to increased dayrates, fewer expected out of service and idle days and increased drilling activity associated with the commencement of operations of our newbuild unit delivered in 2012, the newbuild unit delivered in the first quarter of 2013 and those newbuild units to be delivered later in 2013."

Analysts Estimates

Analysts at MSN Money are estimating significant growth for Transocean in 2013 and 2014. EPS estimates for FY 2013 are $4.49 while estimates for 2014 increased to $5.99 per share.

Price Targets

  • Finviz has a price target for Transocean is $61.06.
  • Recently analysts at FBR Capital gave Transocean a price target of $60.00.
  • In March of 2013, Barclays gave Transocean a price target of $71.00.

PEG Ratio = Price to Earnings Ratio / Annual EPS Growth

PEG Ratio indicates potential value of an equity and is calculated by dividing Price to Earnings (P/E) ratio into earnings growth rate. A low PEG ratio usually implies that the equity is undervalued, a high PEG ratio can indicate that the company is currently overvalued, where as PEG of 1 may indicate that an equity is reasonably priced under given valuations.

A. Average annual growth rate = (A / P) ^ (1 / T) - 1 = R


B. Annual growth rate

  • EPS 2010 = $2.99
  • EPS 2011 = $-17.79
  • EPS 2012 = $-0.62
  • EPS 2013 = $4.49 (Estimate MSN Money)
  • EPS 2014 = $5.99 (Estimate MSN Money)

(A / P) ^ (1 / T) - 1 = R

(5.99 / 2.99) ^ (1 / 5) - 1 = R

R = 14.91%

Earnings per share average growth rate over the 3 past years and estimated 2 years forward = 14.91%

Forward PE Ratio = 8.73 (MSN Money)

8.73 / 14.91 = 0.59

PEG Ratio = 0.59

A current PEG ratio of 0.59 based on an EPS average growth rate from 2010 to 2014 indicates that based on the next few years estimates the stock is currently undervalued.

As technological advancements have made once inaccessible oil and gas fields available this has opened opportunities for deepwater drillers such as Transocean. Currently, Transocean is in the process selling off older rigs and purchasing new rigs to better suit the newer need of the business. These newer capabilities will provide Transoceans customers with the latest capabilities to access these challenging regions. Two ultra-deepwater regions and a harsh environment zone that are in the process of increasing oil and gas production are the U.S. Gulf of Mexico, Brazilian Pre-Salt region and Norway's Barents Sea. All of these regions have provided and will continue to provide Transocean with many opportunities for growth. Over the past few years Transocean has significantly increased its revenues in the U.S. Gulf of Mexico and Norway's Barents Sea. According to Transocean's PEG ratio, the company is currently undervalued. As the company focuses on capitalizing in these regions this will drive Transocean's earnings, revenues and day rates up. As these key factors increase, they will drive the company's shareholders value up, ensuring that Transocean will not be undervalued for very long.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.