Strong Fundamentals and Oil Ties Make Transocean a Great Long-Term Buy 11 comments
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I forgot to post this up on Friday since there was so much going on. Amidst all that news, we saw that Transocean (RIG) was added to Goldman Sachs Conviction Buy List.
Goldman removed Halliburton (HAL) and swapped RIG in its place. Goldman's new price target on RIG is $178 due to its tie to oil, where it sees strong long-term fundamentals (obviously).
I definitely agree with them on this call, as I believe oil will face big supply/demand issues as we go forward many years into the future. In addition, I believe Transocean is an excellent proxy for this (besides just owning oil in the commodities markets or the United States Oil Fund ETF (USO) for the long term). The reason I say that is there is an increasing demand for deepwater rigs. As evidenced by Petrobras' desire to lock up nearly 80% of offshore rigs, the demand for RIG's services is very strong. As oil companies shift from shallow water searches to deep water finds, RIG becomes all the more attractively positioned.
The only problem I have with RIG right now is with its technicals. The chart looks horrible right now and the name looks to be breaking down. I've drawn a line in the sand at $120. If RIG can hold onto this level (typically past support), then I think it’s safe to enter RIG here. However, if it begins to trade lower yet again, I think it would be safer to stay away as it will have broken down on the technicals. RIG trading lower is a real possibility simply because it is tied to the price of crude. I
In addition, since crude has been selling off recently, it doesn't look good. As crude approaches the very important psychological level of $100 a barrel, things could get interesting. Add in the speculation regarding hedge fund liquidations and you have a recipe for a wild ride. The point is that both crude oil and RIG are around significant levels in terms of technicals. As you can see from the chart below, $120 has typically been an area of support for RIG. If it breaks through this support level, it looks to be heading lower.
click to enlarge
This is a simple case of "trade the perception, not the reality." In reality, Transocean is poised to rake in major dollars as its new rigs come out of production down the road. In addition, the company is constantly seeing rising day rates on its existing deepwater rigs. However, everyone seems to be concerned with the "here and now" and as a result, the technicals are on the verge of a major breakdown. Therefore, you have to respect the action and step aside if you get stopped out below $120. Long term, this should be an excellent name to own. So, if you're one of those Buffett-buy-and-hold investors, then go for it. I am simply painting a picture for those who like to take a more active role in their positions.
Fundamentally, RIG is one of the best buys out there. Its trailing P/E of 7.8 and forward P/E of 7.4 are very compelling, especially considering that despite being one of the largest companies, it trades at some of the cheapest multiples in the drilling sector. It has a PEG ratio of 0.55, indicating the company is primed for earnings growth. Where the company really becomes attractive though, is in its operating margins and returns on equity. I like to call this the "bread and butter" of any given company.
With operating margins of 46.17% and a return on equity of 38.54%, Transocean is cranking out some of the highest numbers out there. Its merger with Global Santa Fe has certainly paid off in terms of increasing its fleet and extending its dominant market share. The only real negative with Transocean would be its massive debt. Currently, the company has $976 million in cash and over $15.2 billion in debt. The majority of this debt is from financing the merger of Global Santa Fe and Transocean and a special dividend that the company paid shareholders upon completion of the merger. Therefore, the massive debt load is a concern. However, when you think about how much money the company is making, it becomes less of a worry.
Essentially, RIG looks very strong. However, since this name is tied to oil's price fluctuations, you also have to worry about oil. If we are indeed seeing a global slowdown, then the price of oil will obviously suffer, thereby affecting RIG's shares in a negative manner. Despite this, RIG still remains attractive due to its dominant market share and positioning, rising day rates, the rising demand for its deepwater rigs, and the fact that the company has several new rigs scheduled to be completed in the coming years.
This is a great long-term buy (3-5 years +). However, if you want to save yourself some money in the near term, watch the $120 level as the technicals have really dictated this volatile and whacky market as of late. As long as you have a stop just below $120, call it good. Alternatively, you can take the Buffett-buy-and-hold approach with this name, as the company stands to benefit over the long haul.
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This article has 11 comments:
RIG appears to be a great buy, but I would appreciate some input on the following questions:
1) If the price of oil drops to X ($80, $60, $40) at what point do RIG's contracted day rates, and thus revenue, adjust per the terms of their contracts? Has anyone analyzed this?
2) If their revenue drops, as the first question ponders, then at what oil price would they be unable to service their debt?
3) Has anyone considered the risks of non-payment or contract abandonment by RIG's customers if oil prices continue to plummet towards historical means?
A star does not teach...but a good astrologer learns from the star.
1) If the price of oil drops to X ($80, $60, $40) at what point do RIG's contracted day rates, and thus revenue, adjust per the terms of their contracts? Has anyone analyzed this?
Their contracts are not cancellable. A lesson learnt from previous down turns. Most new contracts have cost escalation clauses meaning costs will be passed to oil companies.
2) If their revenue drops, as the first question ponders, then at what oil price would they be unable to service their debt?
Current backlog is $40.7 billion which will leave almost $10 bn in spare after paying back all debts. You need to worry about what they are going to do with the cash flooding in.
3) Has anyone considered the risks of non-payment or contract abandonment by RIG's customers if oil prices continue to plummet towards historical means?
See No1.
OPEC is defending $100 oil (a level that got passed just this April) whereas Petrobras is contracting all deepwater rigs it can find for the next 10 years. Their projects require $100-$115 oil to be sustainable. Do you think they go ahead if they think oil will be at $80, $60 a barrel?
which only adds to the real value.
RIG is not alone as a pummeled 5 * equity...(See US Steel for
another) which gives the investor one heck of an opportunity
to add some names where before the price was an obstacle
to some.
I would hasten to add that I have averaged down on RIG, a
tactic that over the years has cost the investor too much
in too many instances.Often this occured when a party
"fell in love" with a stock while that emotion is simply a
Venus Fly Trap waiting to make those folks a lot poorer.
The simple fundamentals of RIG make it a compelling buy
at a much higher price.Now unless this episodic event
wherein people simply bail out despite the rewriting of
P:E etc.,etc.
I firmly believe that oil will continue to go higher long term.
But...
Contracts can only be paid if the company has the money to pay. In the event that oil went back to historical levels, some companies would run out of cash, may have trouble getting financing, and therefore default on contracts. This is not unheard of.
I would hope that they pay down their debt substantially before offering a dividend.