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Summary

  • Transocean reported a strong Q2, but shares failed to react.
  • Negative outlook misguided.
  • $40 target price for this year, $50 by next year.

Even after Transocean (NYSE:RIG) reassured investors revenue and profits were sound for the rest of the year, shares barely rebounded. The stock is still off from the $46 level set in June, and is down 10 percent on the month. Part of the bearishness stems from macroeconomic uncertainty for deep drillers. The other cosmetic reason for the lower share price is that analysts are forecast a negative outlook for Transocean. In light of strong second quarter results, the market will soon realize the upside for shares of Transocean.

Healthy balance sheet

Transocean has plenty of cash on hand, with $1.5 billion. There is also $3 billion in liquidity, which means the firm will not need to borrow or take on credit at unfavorable terms. Even if Transocean's debt were downgraded, it would have minimal impact on its quarterly cash flows.

Transocean also benefited from the spinoff of Transocean Partners (NYSE:RIGP), raising $420 million (net) in the process. The IPO was so highly demanded it was oversubscribed, and mirrors the success of Seadrill's (NYSE:SDRL) North Atlantic Drilling (NYSE:NADL) IPO. Investors should keep in mind that Transocean Partners might weigh on Transocean shares in the near term. The spinoff is a pure play MLP (master limited partnership) for three drill ships. Conversely, Transocean has an old fleet that is less attractive as a growth asset. Still, the firm expects to cut operating expenses in 2014. It projects expenses will be in the range of $5.1 billion - $5.3 billion.

Dividend is safe

Transocean raised its dividend to $3 per share, but the market is skeptical this rate will hold. The firm expressed, at its conference call, its motivation for maintaining its attractiveness for income investors, but keeping costs from going up. Moreover, rate ranges did not change from the previously reported quarter.

Deepwater rates were still in the mid $300,000 to $400,000, while ultra-deep water ranges were up to $500,000. Fleet utilization was 78% in Q2. Transocean ended the second quarter with a backlog of $25 billion.

Risks

A dramatic downturn in the global economy would hurt oil prices, which in turn would hurt drill rates. This would put the dividend rate at risk.

Transocean could also issue lower guidance for 2015. The earliest any guidance it provides will be several months from now.

Bottom line

Transocean's operations operated effectively enough last quarter that earnings improved once again. Bears might be justified anticipating weakness ahead for the sector, but Transocean could par costs further should competitive pressures or macroeconomic risks rise. At a dividend rate of 7.1 percent per share (based on a recent price of $39.24) a forward P/E of 12, and a leverage of 47.7%, the stock looks undervalued. Shares should head back to above $40 as economic uncertainties abate. By next year, it could trade at a forward P/E of 15, or at reasonable $50 stock price.

Disclosure: The author is long RIG. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Transocean Could Head To $50