Transocean: An Opportunity in Falling Oil

Includes: NE, RIG
by: Aidis Zunde

Crude oil's price has fallen from over $145 in July to under $115 in August and there is every indication it will fall further, at least in the short-term, as expectations of global economic growth and the associated thirst for energy are both trimmed. As irrational as was the rapid surge to nearly $150 oil, current sentiment could easily take oil to $100 or lower, despite the predicted continued growth in long-term demand. Mr. Market, as is often the case, is hardly rational or efficient in the short-term -- his wild exuberance in driving the price of black gold sky-high has now been replaced with depression, which even potential threats to supply cannot turn bullish.

This sudden fire sale of all things related to oil has created some opportunities, as various energy stocks have been brought to below fair value. Though this applies to quite a few companies, one that I like and will use as an example is Transocean (NYSE:RIG). Based in Houston, Texas, Transocean is the world's largest offshore drilling contractor. As of earlier this month, it owns and operates 137 mobile offshore drilling units, to include 39 high specification floaters (which include ultra-deepwater, deepwater, and harsh-environment semisubmersibles and drillships); it also has 10 ultra-deepwater newbuilds with ex-shipyard deliveries beginning in 2009.

Analysts' consensus growth prediction for Transocean is 22% annually over the next five years. Last Friday, RIG closed at $126.24, for a trailing twelve month P/E of 7.91. Earnings per share are expected to reach $14.43 this year (Dec 08) and $16.50 next year (though some estimates range as high as $15.31 and $18.36, respectively), resulting in a 2009 forward P/E of 7.65. Price to cash flow is also a very low 6.86. At these P/E and P/CF ratios, well below the industry average, one is buying this growth very cheaply. Prospects are good, too, with the revenue backlog growing to almost $41 billion and a new contract with Petrobras. On top of that, Transocean's profit margin, annualized from the most recent quarter, is a very respectable 44%.

The world will not quit growing its need for energy, nor the resultant demand for offshore drilling platforms, in the foreseeable future. At the moment, the market seems to be pricing Transocean for both of those events. Even if the price of oil continues to fall precipitously, deepwater drilling, by one estimate, is economical down to $60-$65. As for rigs flooding the market, Transocean estimates that 70% of new construction is already contracted.

Currently, as energy prices continue to correct -- I suspect that they will continue to do so for a while --  Transocean's share price will likely continue to experience weakness, as Mr. Market marks down everything associated with oil. Therefore, there is no need to rush into this trade -- watch the markets and, when oil regains its footing (don't know when that will be!), it will be a good time to either get into the trade or to add onto existing positions. Transocean will certainly not be the only opportunity in the oil services sector -- a little digging can bring up several more, Noble Corp. (NYSE:NE) being just one example.

Disclosure:  I am long Transocean calls, though I think it is still a little too early to jump in with significant funds.