Transocean: What You Need To Know

| About: Transocean Ltd. (RIG)

Summary

As earnings near, investors in Transocean need to keep an eye out for a few different things besides just sales and profits.

In particular, investors should keep a close eye on the firm's cost structure to see if they can redeem themselves from the first quarter.

Another key item would be debt and what they are planning to do with their recent liquidity addition.

After the market closes on August 3rd, the management team at Transocean (NYSE:RIG) is due to report revenue and earnings results for the second quarter of the business's 2016 fiscal year. Heading into the release, I figured that it would be a wise idea to look at the company and detail not only what analysts are expecting but also what I believe investors should be keeping an eye on in order to see whether the business truly has a good chance of surviving this oil price downturn.

Analysts expect the firm to take a beating

If analysts turn out to be correct, the picture for Transocean this quarter compared to last quarter isn't looking all that great. Based on forecasts, the business should generate revenue of around $922.82 million during the quarter, representing a roughly 50.9% falloff compared to the $1.88 billion the company saw the same quarter a year ago. This shouldn't really come as much of a surprise to investors, however, since it has been known for a while that backlog at the firm has suffered due to contracts coming offline and others being either modified or canceled outright.

On the bottom line, however, the picture is worse. If management is correct in its assumptions, Transocean should generate earnings per share of around $0.00. That's right; a big old goose egg. Due to sales falling and the fact that margins haven't been able to adjust as quickly as sales have to the energy price downturn, achieving profitability is a tough thing to do at the moment but we should also be cognizant of the fact that a sizable chunk of the pain, which I've forecasted to total about $1 billion this year (or $250 million each quarter). Although this is still most definitely an expense, it is non-cash in nature so we should be aware of that. This earnings expectation compares to a gain per share in last year's second quarter of $1.11.

It's time for management to prove itself

In the table below, you can see the historical trend that Transocean's costs have taken from 2011 through 2015 (these are costs as a percent of operating revenue so they don't factor in "other" revenue that is mostly comprised of proceeds from contract cancellations). Each and every year, operating and maintenance costs for Transocean dropped relative to those sales, falling to as low as 55% of revenue in 2015, even as revenue for the business suffered from the downturn. Even general and administrative costs fell each year, with the exception of 2015 when we can see a modest uptick.

Click to enlarge

This is rather impressive in my mind and it serves as a testament to management's skill in reducing costs considerably, without which Transocean might not be alive today. The one problem, however, is that costs came back during the first quarter. During the quarter, the firm's operating and maintenance costs hit 59.9% of sales, a meaningful increase from the 54.2% of sales seen the same quarter a year earlier. The move higher on general and administrative costs was also rather severe, soaring from 2.3% of sales last year to 3.9% this year.

Although management has recently announced some new contract awards, a great thing in my mind, I want to make sure that they are paying close attention to their cost structure. What good is a higher level of sales if those sales will lead to losses or even flat profits instead of actual gains? While I understand that it may be unreasonable for Transocean to cut its cost structure moving forward, especially as sales are likely to drop for the foreseeable future, a good goal would be for the firm to at least keep margins steady.

One other item that I will be intrigued with relates to Transocean's debt. Recently, the firm issued $1.25 billion in Unsecured Senior Notes (receiving proceeds of $1.21 billion) at a 9% interest rate that comes due in 2023. Their goal here was to reduce debt amounts due in 2020 through 2022 so that their liquidity looks better moving forward. In addition to lowering the costs on its older debt (but increasing total financing costs), the other good thing about the deal is that, if they exercise the $1 billion they plan to on reducing those debts, they will still have $210 million to play with. I believe they will either buy back other notes at a discount or they will utilize that capital toward paying for their newbuilds, but I'm not sure which (perhaps both). What management does with this increased liquidity will also give a good indication of where their heads are at but I still wonder why they did not use their untapped credit facility of $3 billion instead.

Takeaway

Based on the data provided, it's clear that Transocean's quarter isn't looking all that great according to analysts, but I do believe that, above and beyond final results, there are more important items to keep an eye out for. I'd love to see management rein in costs some more and I'd say it's certainly possible that this will happen. I'm also interested in their capital plans, something I believe management must be transparent on in this quarterly release.

Disclosure: I am/we are long RIG.

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.

Additional disclosure: I own 2017 call options, not shares.