Transocean - Earnings Preview

| About: Transocean Ltd. (RIG)

Summary

Consensus estimates have gone significantly higher over the past three months as analysts adjust their P&L models to reflect lower costs.

Transocean will experience a significant revenue drop-off in Q3 due to lower fleet utilization.

Despite revenue drop-off I expect the company to generate nearly $600 million in operating cash flow in Q3 and remain cash flow positive through all of 2016.

Transocean (NYSE:RIG) reports its quarterly results on November 4th after the market close. The market has gotten used to offshore drillers routinely beating quarterly estimates over the past two years and I believe this quarter for RIG will be no different. At the same time, investors don't put much emphasis into these quarterly beats as they represent backward-looking indicators as dayrates keeps falling, while new contractual activity is at a complete standstill.

Despite these earnings reports being backward-looking, it is still important to understand changes in the dynamics of underlying operating activities and in Transocean's case it's important to project cash flow being generated as the company still has some large capex and debt obligations in the near future.

Consensus estimates have been on the rise since RIG reported its Q2 results in August. These estimates have risen substantially and currently the market expects RIG to report $0.67 of profit per share on revenues of $1.59 billion. As usual, I have my own estimates and will provide the rationale behind them in this article.

On the revenue side, RIG had ten floaters idle or stacked in Q3, which either had some sort of contribution to Q2 revenue and/or operated for only a portion of Q3. Additionally, two floaters had significant inspection-related idle time, whereas Discoverer Inspiration had 55 days of unplanned downtime due to technical problems. Revenue for Q2 was $1.88 billion based on revenue efficiency of 97% and for Q3 my estimate is $1.61 billion based on 95% fleet-wide revenue efficiency.

On the cost side, fewer days in operation and lower shipyard expenses should have their positive impact. Management stated repeatedly that operating expenses in the second half of 2015 would constitute approximately 45% of total annual operating costs. The latest fleet status report shows that RIG stacked six additional rigs. There are some upfront costs associated with stacking, so the company will see slightly elevated expenses on these stacked rigs in Q3.

I see the following breakdown of RIG's operating cost structure:

UDW segment - $410 million

DW segment - $75 million

HE segment - $100 million

MW segment - $115 million

JU segment - $70 million

Drilling support costs - $120 million

Total operating expenses - $890 million, which equates to 45% gross margin. Furthermore, G&A expenses should range between $40-45 million, resulting in EBITDA margin of 42-42.5%.

Depreciation expense should fall substantially if RIG recognizes further impairments. The company may have written off an additional $2 billion in assets in Q3, which would lower ongoing quarterly depreciation expense down to $225-235 million.

Interest expenses should be slightly lower due to early repayment of $900 million of debt, tax rate should slide below 20% in Q3, while minority interest should come in at $15 million.

Q3 projected income statement looks as follows (all numbers in $ billions):

Revenue 1.608
Operating and G&A 0.932
Depreciation 0.229
Interest 0.105
Taxes 0.051
Minority interest 0.015
Net income 0.276

EPS based on a diluted count of 363 million shares is $0.76.

RIG should generate $500 million in cash from operations. Additionally, the company will receive $43 million in the form of short-term debt repayment from Transocean Partners (NYSE:RIGP). In my personal opinion, there will be some further recalibration in working capital amount, which should generate an additional $100 million in cash.

Additionally, RIG has received $125 million from BP and $93 million from insurance companies in July as part of Macondo-related settlement. This amount will fully cover $212 million RIG has to pay, thus on cash basis the settlement is neutral for Q3 results.

The company exited Q2 with $3.77 billion in cash and depending upon the timing of the final payment for Deepwater Thalassa, RIG should have either $2.7 or $3.2 billion in cash at the end of Q3. Long-term debt should be $9 billion, while net debt should be less than $6 billion.

As a final note, RIG was expected to earn $1.3 per share at the beginning of 2015 for the entire year. The company will earn nearly $4 per share and achieve $3.2 billion in EBITDA, which is a substantial outperformance relative to initial estimates. Lately, consensus estimates have been moving in the right direction for Q3 and partly for Q4 2015, but they are still too low for 2016 and 2017.

Disclosure: I am/we are long RIG.

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.

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Tagged: , Oil & Gas Drilling & Exploration, Earnings
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