Transocean Stands Out Amid Still Soft Landscape

Summary

• Transocean could be one of the biggest winners to come out of the long and slowly unwinding crude oil bear cycle.
• The Street might have failed to fully account for Transocean's impressive October FSR in its estimates.
• I believe investors looking to dip their toes in these still-turbulent waters may want to give RIG some consideration.

Transocean (NYSE:RIG) provided further evidence that it can be one of the biggest winners to come out of the long and slowly unwinding crude oil bear cycle.

The company delivered an all-around beat on Wednesday, with revenues of $808 million growing a solid 8% sequentially and beating consensus estimates by a wide margin of over $100 million. The company looked solid on operating metrics, as every single rig type and class, from UDW to high-spec jackups, saw a sequential improvement in utilization - very meaningful in some cases. The results were partially hinted at when Transocean delivered an impressive (relative to the downcycle) fleet status update in October that was well covered by Seeking Alpha contributor Fun Trading. But the strength was possibly not fully factored into Street's estimates for the quarter.

Credit: Offshore Energy Today

Not surprisingly, however, and consistent with what peers have been reporting, dayrates continued to deteriorate. Only the much smaller portfolio of two JUs still in operation (the others having been sold to Borr Drilling) did not experience a sequential dip in pricing. I believe this metric will prove to be crucial in gauging when the offshore drilling space might be able to declare the downcycle over - not in the immediate future, in my opinion.

Non-GAAP gross profits improved as drilling expenses came down after the jackup disposition. With opex under control and decreasing sequentially, a trademark of Transocean's tight cost management practices, op margins improved substantially by nearly eight percentage points. All accounted for (revenues up, drilling and other operating expenses down), I estimate that the company's operations (i.e. excluding items below the op profit line) contributed a solid 19 cent quarter-on-quarter increase to EPS.

Source: DM Martins Research, using data from company reports

My thoughts on the offshore drilling space and RIG

I can be, and certainly have been, wrong about many stocks. But in the case of offshore drillers, I have been spot on since I shared a deep-dive report on the state of the offshore driller space with my premium community, in mid-May 2017.

Back then, I made a few statements that have played out over the past six months:

• "I have repeatedly argued that the space seems all but uninvestable at this point": offshore driller stocks in fact dipped about -30% between May and August along with weak commodity prices, just in time for crude oil (still the most important variable driving returns in this sector, in my view) to show signs of life.
• "Investors that want to approach the space as conservatively as possible and take calculated risks might have a preference for Rowan (RDC)," with RIG, the industry leader, showcasing the "most impressive operational discipline translating into the highest margins, yet trading at reasonable multiples." Both stocks have outperformed relative to their peers over the past few months (see graph below).
• "Investors who would not mind giving up some safety for a bit more 'bang' in a recovery scenario might favor Diamond (DO)." The stock has in fact been the best performer over the period, with noted strength in the back end as crude oil bounced back.
• "Ensco (ESV) and Noble (NE) are, in my view, the least appealing of the 5 names." Both stocks proved to be the worst performers of the past few months, down in the double digits since May.

Source: DM Martins Research, using chart from Yahoo Finance

Regarding the first bullet above, I continue to be very cautious about the offshore drilling space, an opinion that I supported yesterday despite decent results coming from peer Rowan. Without a more pronounced and sustainable rebound in crude prices, demand improvement might be capped, and dayrates are likely to remain under pressure.

With that caveat, I continue to find Transocean one of the most solid names in the space, and I believe it will come out the other end of the downcycle alive and well. Add to the strong fundamentals a relatively inexpensive stock (both on the basis of forward EV/EBITDA and the less-tracked market cap-to-backlog multiple), and I believe investors looking to dip their toes in these still-turbulent waters may want to give RIG some consideration.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.