Transocean Earnings Analysis: A Buy at Current Levels

I liked Transocean's (RIG) earnings release (conference call transcript here). You may want to visit Transocean's website here and download the power point presentations at the end of Q2 09 and Q3 09 to see the information based on which my comments are made.

Guidance indicates strengthening confidence in day rates. At the end of last quarter, Q4 09, high spec average day rates were estimated at $408k/day; the November release shows expectations creeping up to $419k/day.

Looking forward, Q1 2010 and Q2 2010 show day rate expectations rising from $426k and $431k respectively at the end of last quarter to $423k and $433k this quarter - this is roughly flat quarter on quarter. What is encouraging is the Q3 2010 rate expectation coming in at $458k/day; this is 6% over rates expected in Q2 2010.

For mid-water drilling, the news is not so positive. Last quarter expectations for Q4 09, Q1 2010 and Q2 2010 were $343k/$346k/$342k. The current quarter comes in at $343k/$335k/$336k; which is indicative of softness in the mid-water market. Rates introduced for Q3 2010 are $348k which is indicative of stability in day rates.

For jack ups, the news is also not so positive. Last quarter expectations for Q4 09, Q1 2010 and Q2 2010 were $161k/$163k/$156k. The current quarter comes in at $155/$161/$153; which is indicative of continuing softness in the jack up market. Rates introduced for Q3 2010 are $147k which is indicative of continuing deterioration.

Strength in deepwater and stability in midwater will more than offset any weakness in the jack up market.

Out of service rig months expected during 2010 at the end of the prior quarter were 25/33/20/12. In the November release, out of service rig months is down to 16/25/15/8. This is a considerable decline in out of service expectation. Two observations; with utilization rising as is evident from the reduction in out of service months; it is very clear that RIG's day rate expectations are conservative; even modest. Rising utilization normally causes fairly dramatic increase in day rates in a tight market. The second is that lower time out of service is indicative of rising revenue - the back log may start rising again on a 1 year horizon.

The cost trend shows an escalation for q3 2009; from $1,277 in Q2 09 to $1,396 in Q3 09. But looking into the cost component shows that rig operating costs are declining (from a peak of $922 in q4 08 to $737 this quarter). Out of service costs and drilling support/other direct costs have caused the increase. Going ahead, the out of service costs can be expected to decline as time out of service declines. Drilling support costs are small relative to rig operating expenses; and frankly easier to contain. No doubt rig operating cost will face inflation as demand picks up; but when it does, there should be no margin dilution because there will be a more than proportionate increase in day rates.

Contract backlog is down from $33.7 billion last quarter to $32.2 billion. With softness in the market this must be expected ahead of new contracts. In my view, there is evidence in management expectations to indicate backlog will start building sometime in 2010; this is a big positive.

Cash flow backlogs excess over debt has risen from $4.4 billion at the end of last quarter to $4.8 billion at the end of this quarter. The cash conversion for Q3 09 has obviously been ahead of expectation; this is a big positive.

By end of 2010, the backlog will have generated an excess of $1.9 billion over debt maturities. In my view, a special dividend or buyback activity is very likely.

All in all a very pleasing first glance at RIG's results. It trades at a very small premium to my fair value calculation. My review of results indicates that firm catalysts for growth in share value are now well in place. From an economic cycle perspective, the energy sector can be expected to outperform in 2010.

I would rate rig a buy at current levels.

Disclosure: (1) Long RIG (2) Ex Employee

Comments

[long_on_oil:]

Yuck lets hope Seeking Alpha's posts don't become like Yahoos messenger. Hopefully SA will find a way to keep posts like the first two from becoming part of the article.
That being said, this is a great article and as a RIG stockholder I look forward to many more. I really like the fundamentals of RIG, I am a long time stockholder and hopefully one day I will break even again...lol
As a stockholder it would be nice to see some kind of special dividend but a nice bump in the stock price would be even better.
Keep up the good work.

Nov 05 08:12 AM

[Wallach:]

As far as I understand, the dayrates and out-of-service time reflects only operating rigs. If one was to average in the stacked rigs, the numbers would not look as good.

Nov 05 08:15 AM

[Shiv Kapoor:]

RIG has Trident 9 idle/warm stacked; which might go stacked; my view is that it will not - it will probably get work at lower day rates. Trident 6 is stacked - probably likely to stay that way as the jack up market is looking weak. These are jack ups which are unlikely to have a significant impact on results.

Sedco 709 is coming of contract in Nov 09; its running at $205k/day; the client has fixed options. This is a dynamically positioned midwater vessel; I do not believe it will be stacked, though it might be idle/warm stacked for a short while.

Actinia and GSF 135 are good through Apr/May 2010.

Overall, I do not see stack risk for 2010 as significant.

In fact a little bit of stacking in mid water will be good for day rates (utilization is calculated excluding cold stacked rigs) and as utilization rises, so do day rates.

On Nov 05 08:15 AM Wallach wrote:

> As far as I understand, the dayrates and out-of-service time reflects
> only operating rigs. If one was to average in the stacked rigs, the
> numbers would not look as good.

Nov 05 09:22 AM

[William M. ...:]

Deep-water drilling has been in a boom shallow water drilling has been next to dead for a year and over supply of Jack-up rigs keeps prices down compared to shortage of deep-water rigs vs new international finds. One need only look at the long-term price charts of firms with deep-water rigs e.g. RIG, DO, NE, ESV. Just look at how they all have done over the last 9 months once it was clear Oil was going to stay above $65.

Nov 05 12:15 PM

[Mobywhite:]

Clearly the long term play going forward is companies focused on the deep water segment of the market.

That being said, jack ups will have their day one more time as the world economy recovers and all the new cars on the roads lead to ever higher demand for oil. When oil hits $150 again and stays there or goes higher oil will be pulled out of the ground as quickly as possible to take advantage of that price and every means of extracting it will be used. All those jack ups should see a lot of use until the world supply of energy switches to cheaper cleaner forms in gas, wind and solar.

The only real question is when that will happen and how best to utilize your cash in the mean time.

Personally I'm lousy at timing and have learned to aggresively play major trends like this. I own about a dozen oil/gas companies and RIG and ESV as my favorite deep water plays.

Nov 05 01:08 PM

[mbkelly75:]

RIG looks good right now. It has been trending up since it formed a Golden Cross with the MAs on 27 Mar earlier this year. It is not under-valued right now since it has a P/S of 2.17 and a P/B of 1.43 (both need <1 to show possible under-value) , but it looks like a deal anyway with a Quick Ratio of 1.41 (>1 is good), a PEG of 0.42 (<0.50 is a buy), and a P/FCF of 9.65 (<15.0 is good and shows possible buy). No dividend but it looks like a great trade stock right now. Good job at pointing it out.

Nov 05 01:37 PM

[Snitzer:]

I like RIG but I restructured towards dividend payers and let it go. But it's on all my watch lists, with buy points staked out and if the alarms go off and I've the cash then it's back in again. If they paid dividends, any dividends, it would add luster to an already attractive stock.

Nov 06 01:33 AM

[johnz:]

this is a very good article. RIG is clearly beating the market but not really outperforming OIH.
looking at car growth rates and the economic activities revitalizing, particularly in China, I would like to think oil has long term bottemed out at around 65, that's not even fully taking the weak dollar into account, which may range bound between 140 and 160.
In my view, RIG should be a core asset outperforming OIH, as it's a better managed company and in a bright segment. Given where OIH is now, RIG should be around 95 already.

Nov 06 04:24 PM

[bassmaster17:]

I'm baffled as to why the offshore contractor and services names are not surging in the wake of the Pemex news after all Mexico is the 2nd biggest importer of US oil and their offshore fields won't be developed until 2014!!! The new finds have not been on land and with a P/E of 8 RIG is quite the value....I'm willing to bide my time and wait.

Nov 25 01:21 PM