After a sharp drop in its stock price, now is an excellent opportunity for a long-term investment in Transocean Ltd. (NYSE:RIG) stock at a cheap price. Transocean, the world leader in ultra‐deepwater market segment, will benefit from significant long‐term ultra-deepwater demand. Transocean has compelling valuation metrics and strong earnings growth prospects, and it has a remarkably low EV/EBITDA ratio of 5.82. Furthermore, the very rich dividend, yielding 7.67% a year, represents a gratifying income.
Moreover, the future prospects of the stock are excellent, because high-specification ultra-deepwater rigs are expected to achieve the highest utilization and the highest day rates over time. For example, more than 70 percent of Gulf of Mexico oil production is coming from wells in water depths greater than 1,000 feet. In addition, in my opinion, since high-specification ultra-deepwater rigs can operate in different depths, they might take market share from lower-specification jack-ups.
Transocean is the largest offshore drilling rig contractor in the world. RIG's market is global, given that rigs can be mobilized from region to region. The company was founded in 1953 and is based in Vernier, Switzerland.
The table below presents the valuation metrics of RIG; the data were taken from Yahoo Finance and finviz.com.
Transocean's metrics are excellent; the trailing P/E is low at 9.22, and the Enterprise Value/EBITDA ratio is extremely low at 5.82. According to James P. O'Shaughnessy, the Enterprise Value/EBITDA ratio is the best-performing single value factor. In his impressive book "What Works on Wall Street", Mr. O'Shaughnessy demonstrates that 46 years back-testing, from 1963 to 2009, have shown that companies with the lowest EV/EBITDA ratio have given the best return. Mr. O'Shaughnessy explains that EV/EBITDA is a better way to assess value-that is, how cheap or expensive it is-than looking at the PE ratio alone. The EV/EBITDA is neutral to a company's capital structure and capital expenditures. Stocks that have very high debt levels often have low PE ratios, but this does not necessarily mean that they are cheap in relation to other securities.
Latest Quarter Results
On August 06, Transocean reported its second-quarter 2014 financial results, which beat EPS expectations by $0.49 (43.80%), and beat Street's estimates on revenues.
The company reported adjusted earnings from continuing operations of $587 million, or $1.61 per diluted share, a 49.1% increase from second quarter 2013 adjusted earnings of $394 million, or $1.08 per diluted share.
Revenues for the three months ended June 30, 2014 were $2.328 billion, compared with revenues of $2.339 billion during the quarter ended March 31, 2014. Revenue efficiency for Transocean`s entire fleet was 95.0 percent in the second quarter, compared with 95.7 percent in the first quarter of 2014. Ultra-deepwater revenue efficiency was 94.0 percent, compared with 96.4 percent in the prior quarter. Fleet utilization was 78 percent, unchanged from the prior quarter.
The forward annual dividend yield is very high at 7.67% and the payout ratio at 70%.
Source: Charles Schwab
On August 12, Transocean announced the schedule for the payment of the second installment of its U.S. dollar-denominated dividend. The installment of $0.75 per share, or approximately $272 million, is based upon the number of currently outstanding shares. The installment represents the second of four quarterly installments totaling $3.00 per share, or approximately $1.1 billion in the aggregate, from additional paid-in capital approved by shareholders at the company`s 2014 Annual General Meeting held on May 16, 2014.
Although the payout ratio is pretty high, the decision of the company to keep paying a generous dividend demonstrates that it is a part of Transocean's strategy. Therefore, I believe that the dividend is sustainable. The dividend might be partially funded by the latest MLP public offering of Transocean Partners LLC (NYSE:RIGP).
A comparison of key fundamental data between Transocean and its main competitors is shown in the table below.
The stocks in the group have similar strong fundamentals, all of them are attractive.
According to Portfolio123's "All-Stars: Graham" powerful ranking system, RIG's stock is ranked second among all S&P 500 stocks that pay a dividend with more than 4% yield, only TECO Energy, Inc. (NYSE:TE) has a higher ranking. The "All-Stars: Graham" ranking system is based on investing principles of the well-known investor Ben Graham.
The ranking system is quite complex, and it is taking into account many factors like; trailing P/E ratio, price to book value, and EPS growth, as shown in the Portfolio123's chart below.
Back-testing over fifteen years has proved that this ranking system is very useful.
The charts below give some technical analysis information.
The RIG stock price is 5.29% below its 20-day simple moving average, 8.63% below its 50-day simple moving average and 10.45% below its 200-day simple moving average. That indicates a short-term, mid-term, and a long-term downtrend.
Chart: TradeStation Group, Inc.
The weekly MACD histogram, a particularly valuable indicator by technicians, is negative at -0.28 and descending, which is a bearish signal (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 35.69 and approaching oversold conditions.
Many analysts are covering the company but their opinion is extremely divided. Among the thirty-two analysts, only one analyst rates it as a Strong Buy, two rate it as a Buy, seventeen analysts rate it as a Hold, six rate it as an Underperform, and six analysts rate it as a Sell.
TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering RIG stock there are only eight analysts who have the four or five star rating, one of them recommends the stock, five analysts have a Hold rating on the stocks, and two top analysts rate it as a Sell.
According to NASDAQ news-item of July 22, Transocean Partners LLC, an LLC formed by Transocean to own three deepwater rigs in the Gulf of Mexico, announced terms for its IPO. Transocean planned to raise $350 million by offering 17.5 million units (100% insider) at a price range of $19 to $21. At the midpoint of the proposed range, Transocean Partners LLC would command a fully diluted market value of $1.4 billion.
Transocean Partners LLC, which was formed in 2014 and booked $558 million in historical sales for the 12 months ended March 31, 2014, trades at the NYSE under the symbol RIGP since August 01.
Transocean is the world leader in ultra‐deepwater market segment with 27 existing rigs and 9 under construction.
Source: Mitsubishi UFJ Securities Oil & Gas Conference Presentation
According to SeaDrill Limited (NYSE:SDRL), it has the second largest ultra‐deepwater fleet in the world after Transocean.
According to Rowan Companies plc (NYSE:RDC) presentation, Transocean has the highest number of high- specification ultra‐deepwater drillships equipped with 2 BOP Stacks and 1250 Hookload.
Source: Investor Presentation May 2014
Currently this market segment is oversupplied and rental prices have remained at a depressed level ($375,000-$500,000 daily rate). However, since a greater percentage of oil is being discovered in extremely deep waters, as shown in the charts below, exploration success indicates significant long‐term ultra-deepwater demand.
Source: Mitsubishi UFJ Securities Oil & Gas Conference Presentation
Oil price has been rising from the beginning of the year which should promote an increase in the demand for new explorations. WTI crude price has risen 8.1% from its low of $90.02 per barrel on January 09, 2014, to $97.32 per barrel on August 13. Moreover, the turmoil in these days in Iraq can put in the danger Iraq's 2.5 million barrels a day of exports and to cause another rise in the price of oil.
WTI crude September 2014 leading contract
Charts: TradeStation Group, Inc.
Transocean has been able to show significant earnings per share surprise in three of the last four quarters, as shown in the table below.
Since the company has succeeded to significantly beat analysts' expectations in three of the last four quarters, there is a good chance, in my opinion, that Transocean will continue to surprise by reporting better than estimated results also in the future.
Due to oversupply of ultra‐deepwater rigs, Transocean's stock has significantly underperformed the market this year and in 2013. Since the start of the year, RIG's stock is down 21.9% while the S&P 500 index has risen 5.3%, and the Nasdaq Composite Index has increased 6.2%. Moreover, since the beginning of 2013, RIG's stock has dropped 13.6%, while the S&P 500 index has increased 36.5%, and the Nasdaq Composite Index has risen 46.8%. However, in my opinion, the drop in RIG's stock price has been exaggerated, and considering its compelling valuation metrics, strong earnings growth prospects, and its leading position in the ultra‐deepwater market, it is now an excellent opportunity to buy a good stock at a cheap price.
Transocean, the world leader in ultra‐deepwater market segment, will benefit from significant long‐term ultra-deepwater demand. Transocean has compelling valuation metrics and strong earnings growth prospects; its EV/EBITDA ratio is extremely low at 5.82. Furthermore, RIG's stock is ranked second among all S&P 500 stocks yielding more than 4%, according to Portfolio123's "All-Stars: Graham" powerful ranking system. All these factors lead me to the conclusion that RIG stock is a smart investment right now. Moreover, the very rich dividend represents a gratifying income.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in RIG over the next 72 hours. 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.