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Transocean (RIG) is attractive to investors due to its cheap valuations. It is trading at 1.7x to its sales, at a discount when compared to the industry average of 2.9x. RIG is trading at a low EV/Revenue of 2.6x and EV/EBITDA of 8x. Its five-year expected PEG ratio of 0.86 means that investors can buy growth cheaply. According to 37 analysts' average estimate, its earnings will grow by 52% in 2013. The Brazilian Federal Court had to overturn the ban on its off-shore drilling in Brazil, which will help RIG generate revenues from this important region.

The fact that the company was able to attain a 10-year-contract with Royal Dutch Shell (RDS.A) shows its strong future prospects. Under the contract, Transocean is to build four new ultra-deepwater drill-ships for Shell. Moreover, the recent management changes are expected to bring operational efficiencies, and enable it to better implement its strategies. The increase in fleet utilization and revenue efficiency reflects strong revenue growth prospects. Therefore, we advise investors to take a long position in the stock.

Transocean had forecasted that drilling activities would increase in the coming years due to the expected rise in oil and gas consumption. The company's acquisition of Aker Drilling last year upgraded its fleet in the ultra-deepwater segment. Furthermore, the U.S. Energy Information Administration has revealed that the global oil consumption growth rate will increase from 0.8 million barrels per day to 0.9 million barrels per day from FY2012 to FY2013. This rise in consumption will increase drilling activities and, indirectly, bring in business for the company. The total oil rig count has increased by 33% in the United States over the last one year.

Company Overview

Transocean is an offshore contract drilling company involved in the drilling of oil and gas wells all over the world. The company's business is segregated into two different segments; drilling management and contract drilling services. In its contract drilling services segment, it provides mobile drilling fleet to oil and gas companies in order to aid exploration and production activities. On the other hand, its drilling management business provides drilling engineering as well as management services on either fixed price, day-rate basis or on project completion. The company generated around 92% of its revenue from its contract drilling business, and the remaining 8% from drilling management services in the second quarter of 2012.

Contract With Shell

Despite the Macondo incident, the company has been able to get a 10-year contract from Shell. This contract was arranged, keeping in view the rising oil and gas demand in the coming period. The first shipyard will be expected to deliver in mid-2015, and the remaining three after intervals of six months thereafter. This new project is expected to bring a large amount of revenue for the company; approximately $7.6 billion from 2015-2016 onwards. Total capital investment in the development of these four rigs is estimated to be around $3 billion. The unique thing about these drill-ships is their ability to drill wells of up to 40,000 feet, and a deck load capacity of 23,000 metric tons. High environmental protection initiatives are an important feature of this project for those investors who want to invest in environmentally-friendly companies.

Management Changes

The recent management change is expected to bring improvements in the company's performance. The appointment of Ihab Toma as the Executive Vice President is important in this regard. His competence and vast experience in global supply chain management, human resource management, marketing, and information technology will add value to the organization. The company has appointed John Stobart as the new Chief Operating Officer, who has served in different capacities in well-renowned drilling companies, including BHP Billiton Petroleum (BHP), Vibrox Exploration Limited and Dome Petroleum Limited. RIG aims to utilize his experience in helping the company restore its high profit margins.

Operations in Brazil

The announcement by the Federal Court of Rio de Janeiro, instructing RIG to cease its operations in Brazil in 30 calendar days ,had raised concerns for investors. But now that the court has lifted the ban, the company has been allowed to maintain its fleet in Brazil. Already low on rig count, the shutting-down of these rigs would have caused further damage to Brazilian oil production. In total, there are 72 rigs operating in Brazil, out of which 10 are provided by Transocean.

Financial Analysis

Comp Sheet

Transocean

Ensco plc (ESV)

Noble Corp. (NE)

Rowan (RDC)

Market Cap:

16.61B

12.71B

8.99B

4.16B

Qtrly Rev Growth (yoy):

10%

90%

44%

57%

Revenue (TTM):

9.58B

4.02B

3.09B

1.19B

Gross Margin :

36%

50%

44%

44%

EBITDA :

3.13B

1.81B

1.28B

431.27M

Operating Margin :

18%

33%

23%

17%

Net Income :

-6.49B

1.03B

536.87M

170.89M

Despite a 10% increase in revenues, Transocean's operating income decreased significantly by 144% in the last quarter. The company's margins have suffered in comparison to its competitors. The main reason behind this decline is an estimated contingency loss of $750 million due to the Macondo well incident. The company's operating and maintenance expenses have increased from $1.4 billion in Q12012 to $1.6 billion in Q22012. RIG's revenue efficiency has increased significantly to 92.5% in the second quarter, from 90% in the first quarter of this year. The improvement in its fleet utilization, from 61% in Q12012 to 66% in Q22012, translated into an improvement in the company's overall performance.

Valuations

Comp Sheet

Transocean

Ensco plc

Noble Corp.

Rowan

PEG (5 yr expected):

0.86

0.64

1.1

0.71

P/S :

1.73x

3.17x

2.91x

3.48x

Forward P/E

10.25x

7.76x

7.9x

9.91x

EV/Revenue

2.61

4.33

4.26

4.18

EV/EBITDA

8

9.63

10.29

11.57

The stock is trading at an EV/ EBITDA of 8x, at a discount when compared to 9.6x, 10.2x and 11.5x of its peers Ensco plc, Noble Corp., and Rowan, respectively. RIG is trading at a P/S of 1.7x and an EV/Revenue of 2.6x, which are relatively lower than its competitors' P/S and EV/Revenue.

Previously we had a neutral rating on the stock because of two reasons 1) The uncertainty involved regarding the Mocando well incident and 2) A ban was imposed on the operations of RIG in Brazil. However, now the court has overturned its decision and allowed RIG to continue its off shore drilling in Brazil. Going forward, we believe the increasing demand of oil would enable the company to maintain its fleet in Brazil.

Source: Drill Value And Growth By Buying Transocean