Why Transocean's Transformation Is A Good Thing

| About: Transocean Ltd. (RIG)
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Transocean (NYSE:RIG) reported its 4th quarter earnings last week. The firm reported revenues of $2.332 billion or $0.73 per share. Transocean beat the EPS estimate of $0.72 per share, but came up short on revenues, missing the consensus estimate of $2.36 billion. Overall, the quarter was not terrible, but the firm did experience increased costs on several fronts which negatively affected profits and margins.

The biggest impact on revenue during the quarter was its rig utilization rate. Lowered utilization rates were something that the street knew was coming. Back in January several waves of downgrades starting rolling in anticipating the overall negative impact to the 4th quarter. In the 3rd quarter of 2013 Transocean had a rig utilization rate of 83%. That rate in the 4th quarter dropped to 75%, which was not only below the 3rd quarter's rate, but also below the 79% rate that it had the year prior.

Transocean is the largest of all the offshore drillers, but with that title also comes one of the oldest fleets in the industry. As larger integrated companies like Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Royal Dutch Shell (RDS.A) (RDS. B), and Conoco Phillips (NYSE:COP) work toward cost cutting, the demand for offshore rigs is on the decline. The majors have continued to cut exploration and production budgets to meet investor demands for higher returns.

This decrease in demand not only has hurt Transocean, but a lot of its competing firms have also been affected. Firms like Diamond Offshore (NYSE:DO), ENSCO Plc (NYSE:ESV), Seadrill (NYSE:SDRL), and Atwood Oceanics Inc (NYSE:ATW) are all susceptible to the demand volatility the offshore rig market is currently experiencing.

Now, the market has been relentlessly selling all of the above mentioned names as one giant basket of offshore drillers with the same economics, but the reality is that even in this new lowered demand environment not all drillers are created equal. There are several drillers that I mentioned above that will only see minor blimps in revenue. In the quarterly calls for both Seadrill and Atwood they all mentioned the recent slowdown in demand, but also made note of the fact that most of the slowdown is concentrated on the older deeper water rigs. Given that most of these drillers have much new fleets compared to Transocean, I do not think they will feel the as much of a pinch as Transocean might in overall fleet utilization.

Below is a chart that highlights some of the key rig utilization and revenue metrics from this past year for Transocean.

Rig Type

Number of Rigs

Average Revenue Efficiency

Average Daily Revenue 2013

Average Daily Revenue 2012

Percentage of Q413 Revenue

High Spec Floaters:







High Spec Floaters:






High Spec Floaters:






Midwater Floaters






High Spec Jackups






*Revenue efficiency is defined as actual contract drilling revenues for the measurement period divided by the maximum revenue calculated for the measurement period, expressed as a percentage

Majority of Transocean's rigs and consequently its revenue are highly tied to its high spec floaters. Given the recent pull back in demand that the industry is experiencing for high spec floaters it should come as no surprise that overall revenues are down compared to last year. Even just looking at the changes from 2012 to 2013 in the average daily rig rates that are being charged demand for high spec floaters just is not there right now. On the flip side both mid-water floaters and high spec jack-ups average daily rates have increased quite a bit, which meshes with the messaging that the other drillers have been providing this quarter.

As a comparison, when looking at one of Transocean's competitors, Seadrill, the firm reported a much higher utilization rate of 94% and 98% for its rigs. Seadrill contrary to Transocean specializes mostly in floaters, jack-ups, and tender rigs. Seadrill's floater utilization in Q4 was 94% and 98% for its jack-up fleet. This past quarter Seadrill reported net income of $281 million on earnings of $0.49 per share, which missed the street's consensus estimate of $0.77 per share.

Given the most recent numbers reported by both Seadrill and Transocean I think it is obvious that the market demand for rigs is slowing, with the only current demand being focused on the smaller floaters and jack-ups. Transocean even mentioned in its Q4 conference call that it did not expect the demand for drilling to fully recover for another 18-24 months.

None of this news sounds overly positive for Transocean for the next several quarters. The biggest surprise for the quarter came when Transocean announced that it had signed contracts to build twelve new high spec jack-up rigs and two new ultra deep-water drill ships with an estimated delivery date of 2Q17 and 1Q18. The contract also gave the firm the flexibility to add three additional drill ships with similar designs if desired. This move is rather historic for the firm given that 19 of its deep-water and ultra-deep-water rigs will be up for contracts later this year.

The move to build out additional rigs solely on speculation is not typical for the company. Since the announcement analysts have been quite critical of the move stating that Transocean taking a page out of Seadrill's playbook on speculating future demand and growth.

RBC came out shortly after earnings were released and reiterated its negative sentiment stating that they believe current market conditions will continue to put downward pressures on day rates, providing little clarity on when any upside might be seen in the stock.

I on the other hand view this move as innovative and rejuvenating for a company that has been so conservative that it sometimes is a bit behind the eight ball in terms of meeting market demand. Not all analysts are so negative of the move either, Barclays stated that they believe Transocean is going under a bit of a metamorphosis and is moving more toward becoming a more progressive driller. I view this new mindset of managements as very positive and see it aid in the future growth of the company. Especially for someone who has s more of longer term strategic time horizon in mind for their Transocean holding.

I feel confident that Transocean is making the right moves in its efforts to shore up the balance sheet, operating cash flow (thanks Carl Icahn), but to also move to where the puck is going to be by making the necessary investments in rigs now. When demand does come back online (and it will) Transocean will be ready to meet that market demand and not be scrambling to try and get new rigs built to meet demand. I personally like this new proactive management approach that Transocean is displaying and feel that longer term shareholders will be greatly rewarded.

Disclosure: I am long RIG, COP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.