Transocean: Q4 Earnings Preview

| About: Transocean Ltd. (RIG)
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Hefty beat is in the works.

The market doesn't care one bit.

Liquidity is the paramount issue.

Transocean (NYSE:RIG) is expected to report its Q4-2015 and year-end results on February 24th and as usual I will provide a detailed preview. The upcoming results are not reflective of current industry conditions, but are necessary to evaluate balance sheet liquidity and cost structure going forward. Quarterly results have been backward-looking since 2014 and this trend will continue until new contracts will exceed current revenue run rates.

Transocean provided its comprehensive fleet status report last week, which showed new contracts totaled $500 million or 40% of the current revenue run rate. Approximately $450-500 million of existing contracts were subject to cancellation with the largest being Polar Pioneer's contract with Shell to work in the Alaska. These cancellations resulted in expedited revenue for RIG, most of which will be reported in Q4 results.

Due to large number of moving parts this is probably the most difficult quarter to estimate as revenue for Q4 will depend on the way Transocean's management decides to book it. My estimate prior to early cancellations was $1.49 billion. The estimate now is approximately $1.91 billion assuming all cancelled contracts were booked as lump-sum revenue in Q4. I suppose, RIG will provide a breakdown of revenue from continuing contracts and cancelled contracts and the street will rightfully focus on the former as a proxy going forward.

On the cost side, I had RIG spending $750 million on direct rig operating expenses and $42 million on G&A. Considering, that the company stacked an additional 6 rigs there were costs associated with these activities. Total extra costs were in the vicinity of $30-35 million.

Depreciation will decrease compared to last quarter and I also expect the company to take some impairment charges on two rigs that are currently held for sale. I believe depreciation will total $195 million for the quarter, while impairment - $150 million.

Net interest expenses should move lower by $12 million q/o/q and amount to $97 million as RIG's total debt decreased by $1.25 billion in Q3 of 2015. Taxes should come in at $54 million whereas minority interest at approximately $9 million. The projected P&L statement is as follows:

in $ millions
except EPS
Revenue 1.905
Opex + G&A 0.817
Depr 0.195
Interest 0.097
Tax 0.054
Minority 0.009
Net income 0.733
EPS 2.02

My estimate of EPS before any impairment or restructuring charges is $2.02 per share. However, this estimate includes $1.10-1.20 uplift from early cancellations. Excluding those cancellations, my projection of RIG's EPS for Q4 -2015 is $0.88 per share. I expect some hefty restructuring charges as the company downsizes its shore-based support personnel count.

On the cash flow front RIG was expected to make a final payment for Deepwater Proteus - the second Shell rig, which is about to commence its 10-year contract in Q2 - 2016. This payment along with other small items should result in total capex of nearly $700 million for the quarter. Cash generated from operating activities should exceed $900 million leaving Transocean with $2.4-2.5 billion in cash at the end of December, assuming the company did not spend any of the available liquidity on bond buybacks.

This will be yet another good quarter operationally for Transocean showing solid cash generation and resulting in 2015 adjusted EPS around $5 per share. However, over the next two years the company will face strong headwinds as contracts expire and there is little renewal work. My current 2016 EPS projection is $0.75 on revenues of $4.2 billion. I had to adjust my revenue and EPS projections downward to account for $500 million in early revenue recognition due to cancelled contracts. Basically, 2015 EPS gets a $1.10 uplift at the expense of 2016 and 2017 EPS.

From the cash flow point of view RIG will benefit as cancellations front-load cash onto the balance sheet and allow the company to possibly reduce more of its 2018-2020 debt trading at 70-75 cents on the dollar. Liquidity is at the forefront of investors' concerns and although RIG has a huge cash balance and a positive working capital position to the tune of $1 billion, at current strip prices, the market considers all oil-related companies walking zombies doubting their ability to pay off debt as it comes due.

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.