Can Transocean Send Its Problems To The Bottom Of The Sea?

May. 3.12 | About: Transocean Ltd. (RIG)

Once considered the best offshore drilling company, if not one of the best energy-related companies overall, Transocean (NYSE:RIG) has had quite the run of trouble over the last two years. Not only is Transocean still involved in the Macondo disaster mess with BP, but the company has had some very un-Transocean-like operating issues including significant unscheduled downtime.

Recent results suggest that these problems are largely behind the company. What's more, dayrates seem to be getting pretty healthy again. Though Transocean shares are already well off their late 2011/early 2012 bottom, growing EBITDA and improving investor sentiment could lift these shares higher still.

A First Quarter That Was Just What The Doctor Ordered

While a little bit better revenue growth would have been nice, this was the sort of quarter that Transocean needed. Revenue rose 9% from last year (and fell 4% from the fourth quarter), as the company saw ongoing dayrate improvement (up 2% sequentially) and higher utilization in ultra-deepwater and high-spec jack-up rigs.

Although utilization was flat overall (as a lot of jack-ups and midwater floaters are not out working) and fleet efficiency ticked down 150 basis points, these were still good enough not raise new worries.

Where Transocean really hit the mark was in its operating efficiency. Operating costs (cleaned of litigation expense) dropped 10% sequentially, and RIG posted a solid beat on operating profit and EBITDA (up 18% and 7% sequentially, respectively).

Are Downtime Problems Over And Done With?

Transocean had some pretty appalling problems with unexpected downtime in fiscal 2011, a product of both the age of its fleet and new regulations. These issues got bad enough that in January of this year BHP Billiton (NYSE:BHP) terminated the $470 million contract on Transocean's Deepwater Expedition. That was made all the worse by the strong uptimes reported by rivals Ensco (NYSE:ESV) and Seadrill (NYSE:SDRL).

Now, though, it looks like Transocean may be getting its act back together. The efficiency rate is still not where it should be for the ultra-deepwater and deepwater categories, but the company seems back on track. Moreover, the overall operating environment is looking pretty healthy - Transocean announced several jack-up contracts in its last fleet update, and not only found a new client for Deepwater Expedition, but at a slightly higher ($10,000) dayrate.

Is The Spring Coiling?

There have been plenty of signs of increasing offshore activity. Not only have companies like BP and Petrobras (NYSE:PBR) reaffirmed their commitments to large offshore projects, but equipment companies like National Oilwell Varco (NYSE:NOV), Cameron (NYSE:CAM), and General Electric (NYSE:GE) are seeing the order inflow as well.

This makes me wonder whether the market is heading to another spike in rig demand (and dayrates). Contracts for ultra-deepwater and deepwater rigs are not only getting richer, but longer as well. Given it its good downtime numbers and ultra-deepwater exposure, that's a good sign for Ensco.

It's also potentially a good sign for Noble (NYSE:NE) and Diamond Offshore (NYSE:DO) as well. Both would benefit from a tighter floater market, and Diamond and Transocean arguably have the best floater availability in the market right now.

The Bottom Line

Waxing lyrical about dayrates and downtime is all well and good, but all most investors really want to know is whether it's good time to buy Transocean shares. I lean towards a cautious "yes".

In terms of replacement value or full-cycle multiples, there's really no question that Transocean looks too cheap, and likewise little question that the company would leverage another industry-wide rig shortage into excellent profits. Where the caution creeps in is in the relatively robust current multiple to 2012 EBTIDA (an EBITDA figure which, admittedly, is probably a trough for the next few years) and the risk of further issues relating to downtime, new regulations, and/or rig acceptance.

I am most definitely a fan of the equipment stocks (NOV and Cameron in particular), Seadrill, and somewhat partial to Noble as well. But in terms of bang-for-buck potential in a deepwater bull market, it's hard to beat what Transocean could deliver if things go the right way.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.