Transocean's Second Quarter Results Show A Recovering Company But Short-Term Risks Remain

Aug.14.12 | About: Transocean Ltd. (RIG)

On August 1, Transocean (NYSE:RIG) announced its second quarter 2012 results. Overall, there is quite a bit to like here, particularly the company's improving financial position and success at securing new business. The company also made further progress in resolving the legal overhang that it has suffered since the Macondo incident in 2010 and took an impairment charge of $750 million to account for an increase in its estimated loss contingency. Without this impairment charge, Transocean would have trounced the first quarter's results. Here are the highlights from the second quarter:

  • Second quarter revenues were $2,575 million. This compares favorably to the first quarter's revenues of $2,337 million.
  • Operating and maintenance expenses increased slightly from the first quarter, going from $1,463 million to $1,607 million.
  • The company saw a net loss of $304 million in the quarter. This compares unfavorably to the company's first quarter net income of $10 million. This net loss was due to the $750 million non-cash impairment that the company took due to the Macondo incident.
  • Revenue efficiency increased to 92.5% from 90.6% in the preceding quarter.
  • Fleet utilization increased to 66% from the 61% that the company had in the first quarter.
  • Operating cash flow was $459 million in the second quarter. This compares unfavorably to the $540 million of operating cash flow that the company reported in the preceding quarter.
  • Transocean secured $4.7 billion in new contracts during the period from April 18 to July 18.
  • The company increased its total contract backlog by $2.3 billion. The company's total contract backlog stood at $22.9 billion as of July 18.

At first glance, these results appear to be worse than what the company reported in the first quarter. Upon deeper examination, however, these results were significantly better than the preceding quarter and show a company that is strongly and quickly recovering from the problems that it has been facing for the past few years. As I previously mentioned, Transocean took a $750 million charge against its earnings in the second quarter due to increasing the estimated loss contingency for the Macondo spill. This increase has brought the company's total estimated loss contingency up to $1.95 billion. It is important to note that this $750 million is a non-cash charge. Here is how Steven Newman, CEO of Transocean, explains this charge (sic):

"I would tell you that the reserves we have taken are non cash reserves. They are booked through our balance sheet but would require, once we do reach agreement with the other parties in the Macondo situation, it would require us to actually fund that with cash. So that would be a use of cash that as we book reserves on our balance sheet would ultimately have to be satisfied."

Transocean further describes the loss contingency as its "current estimate under US GAAP of the low end of a range of reasonably estimable losses." Thus, this sounds as though the actual losses under the ultimate settlement for the Macondo spill could be above the $1.95 billion that Transocean has estimated. The Macondo incident could thus result in further losses going forward. However, if losses end up being less than this then Transocean would book a gain in a later period. This $750 million charge was the reason for the company's quarterly loss. When we net together all of the one-time cash and non cash items (including the increase to the Macondo Well estimated loss contingency, discrete tax benefits, and gains on the sale of rigs and other items), we learn that the company had $560 million of net unfavorable items during the second quarter. Considering these items, the company had adjusted earnings per share of $0.72 for the quarter, greatly beating analysts' expectations of $0.44 per share.

Transocean significantly improved its fleet utilization during the second and that was one of the reasons for the almost 10% increase in revenues compared to the preceding quarter. Fleet utilization was approximately 61% during the first quarter. This has risen to 66% in the second quarter. This 5% increase in utilization was responsible for $106 million of the revenue increase. The company also increased its revenue efficiency to 92.5%, up from 90.6% in the first quarter. This resulted in the company pulling in an additional $75 million in revenue compared to the first quarter.

Transocean has the potential to increase its revenues further in coming quarters by continuing to reactivate rigs, pulling them out of shipyards, and thus increasing its fleet utilization. Even with the 5% increase in the most recent quarter, Transocean still has the lowest utilization rate of any of the major offshore drilling companies. That gives the company considerable ability to grow revenues, even without building new rigs. Given the incredibly strong demand for offshore rigs that exists in the market right now, that is certainly a very realistic possibility.

Transocean management expects revenue efficiency to average approximately 92% for the 2012 fiscal year. If they are correct then there is little chance of seeing further revenue gains from improving numbers here. Overall, 92% is around the average for offshore drilling companies. It is not as good as competitor SeaDrill (NYSE:SDRL) usually achieves but it is better than what Pacific Drilling (NYSE:PACD) achieved in its most recent quarter.

Transocean could face some near-term challenges and pressure due to a recent court order in Brazil. On Wednesday, August 1, Reuters reported that a Brazilian court ordered Chevron (NYSE:CVX) and Transocean to suspend all oil production and transport operations in Brazil within thirty days. Transocean currently has ten offshore rigs producing in Brazil and so a complete shutdown and withdrawal from the Brazilian market would have a substantial negative impact on Transocean's revenues and cash flows that would persist until new assignments can be found for these rigs. Both companies intend to appeal this order and so there still exists the chance that this will be overturned. Thus, this is still an evolving risk but it is still a very real one. I intend to perform a much more in-depth analysis of this risk in a later article.

Disclosure: I am long SDRL.