Transocean - Still No Reversal

| About: Transocean Ltd. (RIG)

Summary

Transocean is heading back to the lows after a misplaced rally.

The key trends of earnings and backlog show no signs of improving and the company suggests dayrates are three years away from improving.

The recommendation remains to avoid the sector until trends show signs of improving.

As I wrote last week, the run up in Transocean (NYSE:RIG) appeared premature as a key trend showed no sign of reversing. The news from the deepwater driller appears to confirm that theory.

Source: Transocean website

The stock has eased off this week trading towards the lows now at $9.30. Should investors even think about owning Transocean until the earnings trend reverses?

Troubling Dayrates

Transocean introduced another issue to the offshore drilling market at the Howard Weil Energy Conference with the discussion on dayrates. The company now forecasts that dayrates won't improve until 2019 or 2020 further elongating the recovery in the sector.

The deepwater driller previously forecast that offshore drilling contracts wouldn't return until 2018, but a big difference exists between putting more rigs to work and obtaining solid dayrates for those rigs.

The well established problem in the sector is that Transocean like other deepwater drillers has limited contracts beyond 2016. Analysts forecast 2016 revenues of nearly $4 billion while the backlog for 2018 is only $2 billion. The 2019 backlog drops to only $1.5 billion.

Click to enlarge

Source: Transocean investor presentation

If the energy E&Ps start signing contracts in 2018, at least revenues will bounce off the $2 billion level. The only problem is that any new contracts will be weak with low dayrates on into 2019.

The other problem with Transocean is that the vast majority of the listed backlog beyond 2017 relates to 4 rigs with Royal Dutch Shell (NYSE:RDS.A) that are under 10-year contracts for dayrates of $519,000. Along with that, Transocean has several 5-year contracts with Chevron (NYSE:CVX).

Until the market rebounds, the reliance on a few customers adds additional risk to the story.

Liquidity To Survive

Transocean makes a compelling case that it has the liquidity to survive. With cash on hand of $2.3 billion and cash flows from operations over the next two years of at least $2.2 billion, Transocean would appear in a good position.

The projected capital spending and debt due by 2017 are roughly inline with the revolving credit facility of $3 billion. Even without refinancing the debt or reducing capital spending, Transocean wouldn't technically need to tap the credit facility.

While investors need to keep in mind that even during this severe downturn that Transocean is still discussing strong liquidity and cash flows, the trend needs to reverse before investors can turn bullish on the stock.

One prime way to view whether the trend is reversing is via EPS trends. At this point, the expectations for 2017 are still a loss of $0.69 signaling no change in the trend. Analysts forecast a loss of $0.49 only 90 days ago while expecting the driller to actual produce positive earnings this year.

The stock trades at roughly 25% of listed book value, but the books still include 21 harsh environment, deepwater and midwater floaters that are still in service. The floaters are all at least 25 years old and may offer limited value by the time the market turns around in 2018 or 2019.

Takeaway

Transocean is likely to retest the lows below $8 as the offshore drilling industry shows no signs of reversing the recent weakness. While some values exists and Transocean has the ability to survive and thrive, the stock isn't likely to mount a sustainable rebound until the underlying metrics improve.

The recommendation is to continue avoiding Transocean.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Disclosure: I/we 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.