Transocean: Offering Growth At A Reasonable Price

Jan.22.14 | About: Transocean Ltd. (RIG)

Activity in the upstream space is largely driven by the outlook for oil and gas prices. According to consulting firm Wood Mackenzie, the number of deepwater exploration, appraisal and development wells drilled each year is expected to increase from around 500 per year in 2012 to close to 1250 per year by the end of 2022. Similarly, the capital expenditures are expected to increase from $43 billion in 2012 to close to $114 billion in 2022.

The higher drilling activity provides ample demand for off shore rigs providers such as Transocean (NYSE:RIG). Throughout the rest of the article I will be analyzing the company's position in the market and showcase why I believe the company will be able to capitalize on the growth of the offshore drilling market.

Company Overview

Transocean is an international provider of offshore contract drilling services for oil and gas wells. It specializes in deepwater and harsh environment drilling, oil and gas drilling management, drilling engineering and drilling project management and logistics services.

Improving Efficiency

During the quarter, the company increased the efficiency of its key revenue drivers. It reported revenue utilization of 94 percent in the third quarter up from the second quarter's 93.1 percent. The revenue efficiency of ultra- deepwater was 92.5 percent compared with 91.1 percent in the previous quarter. Moreover, total fleet rig utilization for the quarter was 83 percent which is higher than the previous quarter's utilization of 80 percent.

In addition to improving operating efficiencies the company also plans to reduce the cost of operations for margin improvement. The reduction is expected to be around $800 million through 2015. Out of the total cost reduction, $225 million will be saved from cost controlling. The cost control strategies will adhere to a proper maintenance schedule and reduce offshore head count. The cost curtailing efforts will increase the bottom line.

Ultra-Deepwater: The Growth Driver

Transocean has been focusing on ultra-deepwater drilling markets. The company has the largest floater fleet coupled with well-positioned global foot prints so it is enjoying a premier position in the ultra-deepwater market. Its backlog in the ultra-deepwater offshore drilling market is expected to be around $4.4 billion in 2014 and this represents 54% of the company's total backlog.

The company will not lack business as it has $29.8 billion in backlog orders. With increasing efficiencies and a backlog of orders the company's revenues are most likely to grow in the future.

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Source: Company's Corporate Presentation

The company is continuously putting efforts into strengthen its asset portfolio in the ultra-deepwater drilling segment with plans to have around 50 percent of the portfolio in ultra-deepwater rigs. Currently, a nearly 53 percent share in the backlog is accounted for ultra-deepwater drilling. The figure below demonstrates the position of backlog by asset class.

Future Outlook

Going forward, the industry expects that deepwater drilling will receive a boost from the Gulf of Mexico mainly driven by the three ultra-deepwater discoveries in the region.

In addition, the company announced it was awarded a 5 year contract from Chevron (NYSE:CVX). The deal requires Transocean to build an ultra-deep water drillship. Construction of the new drillship is expected to commence during the fourth quarter of 2016 and will contribute an estimated revenue backlog of approximately $1.1 billion.

1. Average Daily Revenues

The average daily revenues for ultra-deepwater, deepwater and high specification jackups are higher than that of standard jackups and other low-specification rigs. In 2013, the average daily revenue for Transocean was $389,000. However, going forward the company is expected to increase the number to $446,000 by 2020.

2. Effective Annual Rig Counts

The company has divested its fleet of standard jackups rigs to focus on higher specification rigs as well as deepwater and ultra-deepwater rigs. During 2013, the effective annual rig count comes was 86.1and this is estimated to grow to 102 by the end of 2020.

3. Utilization

Transocean's utilization is the total actual number of earning days as a percentage of the total number of calendar days in the period. The company operated with 79% utilization in 2013. Going forward, the company is offloading older and less efficient rigs in favor of higher specification rigs that have better utilization rates. Therefore it is expected that the company will recover the utilization and steadily climb to 83% by the end of 2020.

Trading at a Discount to the Industry

The company is currently trading at a trailing 12 month P/E ratio of 10.46 that is lower than the industry's average of 13.4. With the 1-year forward P/E ratio of 8.59 the stock also seems to be inexpensively priced. Given the growth prospects of the industry coupled with Transocean's strategic place within the industry I believe that the company's ability to generate future revenues will be strengthened further. When considering these factors it becomes evident that the company does not deserve to be traded at a lower price multiple. It should be traded closer to the industry average.

Concluding Remarks

The company is currently offering an attractive dividend yield of 4.59%. With the prospects for higher earnings along with the increase in the dividend I believe that Transocean will not remain ignored by investors for very long.

Moreover, the company has a strong backlog position supported by ultra-deepwater drilling revenues. With increasing efficiencies and backlog of orders Transocean's earnings will continue to rise. The share price of the company has been trading at a huge discount to the industry creating an opportunity for not only income-seeking investors but also for growth-seeking investors.

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.