Transocean: 5% Yield And Good Growth Ahead

| About: Transocean Ltd. (RIG)

Transocean (NYSE:RIG) is one of the largest offshore drilling companies in the world, owning 80 rigs or about 12% of the worldwide fleet with 12 newbuilds currently under construction. Currently, it offers an attractive dividend yield near 5%, which is however below the yield offered by debt-laden competitor Seadrill (NYSE:SDRL) or Diamond Offshore (NYSE:DO) which I've researched recently. Transocean has a market capitalization of about $16 billion and trades on the New York Stock Exchange and the SIX Swiss Exchange.

Company Overview

Transocean Ltd. is one of the world's largest offshore drilling contractors. The company is based in Vernier, Switzerland near Geneva, and has offices in 20 countries. The Swiss-based company rents floating mobile drill rigs, along with the equipment and personnel for operations, to oil and gas companies. It owns nearly half of the 50 or so deepwater platforms in the world. Transocean employs more than 18,400 people worldwide and specializes in technically demanding sectors of the global offshore drilling business, with a particular focus on deepwater and harsh environment drilling services.

In 2010, Transocean was implicated in the Deepwater Horizon oil spill resulting from the explosion of one of its oil rigs in the Gulf of Mexico. Numerous lawsuits have been filed against the company and unaffiliated defendants related to the Macondo well incident. Transocean is subject to claims alleging that it is jointly and severally liable, along with [[BP]] and others, for damages arising from the Macondo well incident. In January 2013, Transocean agreed with the U.S. Department of Justice to pay $1.4 billion in fines, recoveries and penalties, excluding interest, over a five-year period through 2017. However, this issue is not completely resolved and more costs regarding litigation may arise in the future as the ultimate liability risks remains unknown.

Offshore Drilling Industry

The offshore drilling industry has high barriers to entry given that it is a capital intensive business, it needs experienced management and operational staff, and a good reputation with customers and suppliers. It is also highly competitive and fragmented, including several large companies that compete on a global scale, and numerous smaller companies that compete on a local basis. Transocean's major competitors are Seadrill , Ensco (NYSE:ESV), Diamond Offshore , and Noble (NYSE:NE), beyond others. Transocean's market-share is above 22% across all water-depths.

The core business of an offshore drilling company is to contract out its assets to oil companies for them to extract oil from the seabed. Therefore, these companies rely heavily on how much oil companies spent on offshore upstream activities, which include the exploration, recovery, and production of oil. Naturally, the big oil majors like Exxon Mobil (NYSE:XOM), Petrobras (NYSE:PBR) or Total (NYSE:TOT) are the main clients of offshore drilling companies. In recent years, oil companies have placed increased emphasis on exploring for hydrocarbons in deeper waters. This deepwater focus is due, in part, to technological developments that have made such exploration more feasible and cost-effective. Therefore, water-depth capability is a key component in determining rig suitability for a particular drilling project. Transocean is very well positioned to benefit from deepwater offshore drilling growth, given that more than 60% of its revenues come from its ultra-deepwater and deepwater assets.

Transocean's rigs are mobile and can be moved around the world according to prevailing market conditions, so its geographic exposure can change significantly over the long-term. Nevertheless, although the majority of Transocean revenues are generated abroad, the U.S. is still the company's largest market accounting for 27% if its revenues. The second-largest market is Norway with a weight of 13%, followed by Brazil (12% of revenues) and the U.K. (11%). Its largest customers are Chevron (NYSE:CVX), BP and Petrobras, accounting each one for about 11% of Transocean's revenues.

Offshore drilling plays a very important role in the future of global oil production, with big investments in areas such as West Africa, the Gulf of Mexico, and Brazil being essential to the global oil supply. These locations pose unique challenges for oil exploration and production, as new deposits are mostly found in deep waters and harsh climates. Therefore, ultradeep and deepwater have good growth prospects over the long-term, which is Transocean area of expertise. The company's strategy is to gradually reduce its exposure to lower-specification, less-differentiated assets and increase its exposure to high-specification assets, both floaters and jackups. Transocean continues to execute on its strategy with the divestiture in 2012 of 38 shallow water drilling rigs to Shelf Drilling for $1.05 billion, and also completed nine single-asset sales of jackups and floaters during the year for about $380 million. It currently has a fleet of 79 offshore drilling units and twelve ultra-deepwater units under construction. Transocean has the most floater rollovers in the industry in the next 12 months, making it more exposed to negative pressure on dayrates than its peers.

Financial Performance & Dividends

The offshore drilling industry has experienced strong fundamentals over the past few years, with customer demand driving upward pricing for dayrates in all rig classes. Oil prices have remained at a level that supports activity across all water depths, and in particular, growth in the ultra-deepwater market. However, Transocean's financial performance has been relatively impressive over the past two years despite the negative effect of the Macondo well incident.

In 2012, Transocean's revenues were $9.2 billion, an increase of 14.6% from the previous year. Its EBITDA increased to $3.9 billion, reaching a margin of 39%. This margin is relatively high but below its industry average and much lower than its peer Seadrill, which had an EBITDA margin above 50% in 2012. Its net loss was $219 million, including $1.6 billion in after-tax charges, primarily related to a loss on impairment of assets included in discontinued operations and estimated loss contingencies associated with the Macondo well incident. Without these extraordinary effects, the company's net income would have been about $1.4 billion. Although these results are clearly weak, it was much better than its reported loss of near $5.7 billion in 2011. During the first nine months of 2013, Transocean's revenues increased by 4% to $7.15 billion and its operating income skyrocketed to $1.8 billion, from only $1 billion during the same period of 2012. The company returned to profit, achieving almost $1.2 billion in net profit.

Transocean's contract backlog is currently about $30 billion, which represents more than 3 years of revenues and provides very good visibility about the company's future financial performance. Going forward, Transocean has a $800 million cost cutting initiative ongoing which should push margins higher by 2015. According to analysts' estimates, Transocean's revenues should increase by 6.9% in 2014 and 4.8% in 2015, and its EBITDA is expected to increase by 35% from 2013 to near $4.8 billion. Its EBITDA margin should close its most of its gap to the sector's average, reaching almost 45% in 2015.

Regarding dividends, Transocean introduced its first regular dividend in nine years in 2011, but decided to halt it while working through the prolonged legal process to determine liability for the 2010 Gulf of Mexico spill. Transocean has resumed its dividend related to 2012 earnings at $2.24 per share, or $0.56 per quarter, in May 2013. At its current stock price, Transocean offers an extractive dividend yield of 5%. Taking into account its trailing twelve months earnings the company's dividend payout ratio is only 51%, which is a relatively low payout and has plenty of room to increase without challenging its dividend sustainability.

Although Transocean offers a modestly higher dividend yield than its industry average, its yield has very good growth prospects especially after activist investor Carl Icahn won a battle with the company to increase its dividend. Transocean agreed to increase its dividend to $3 per share, an increase of 34% related to 2013 earnings. This will represent a payout ratio close to 70%, which is still acceptable for a company with good growth prospects and high profitability like Transocean. Its forward dividend yield is about 6.7%, among the highest in its sector.

Moreover, Transocean has determined that an Master Limited Partnership-type vehicle [MLP] could complement its capital structure by providing additional flexibility. The company plans to IPO a minority stake in a new MLP in mid 2014, but the timing remains uncertain. This will allow Transocean to sell some of its assets to the MLP, increasing its cash flows and allowing a higher and sustainable dividend yield. Transocean's dividend and growth is also supported by its relatively strong balance sheet. As of 30 September, 2013, its net debt was about $6.5 billion or a net-debt-to-EBITDA ratio of 1.8x which is relatively low and much lower than for instance Seadrill, which has a leverage ratio above 4x.


Transocean offers a high-dividend yield which is sustainable and is expected to increase even further over the next few months, as the company will increase cash returned to shareholders. Its high yield should provide a support for its share price and despite the recent weakness, Transocean seems to be a buy on dips. For long-term investors, the Macondo litigation issue is still represents a overhang but it should not jeopardize its dividend sustainability as most costs were already undertaken.

Disclosure: I am long DO. 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.

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