Transocean: Discussing The Q1 Earnings Report

Summary

• Transocean publishes its Q1 report, missing expectations.
• The stock follows the pattern seen after other drillers' reports.
• The company speculates about M&A during the earnings call.

Earnings season for offshore drillers continues, and it's high time to discuss Transocean's (NYSE:RIG) earnings report. The price action after the release of earnings reports has been universal for all drillers so far, be it Transocean, Rowan (RDC), Diamond Offshore (DO) or Ensco (ESV) - the stock price drops. In my opinion, this means that actual results don't live up to expectations after the recent rally in drillers' shares. Weaker financial results from drillers shouldn't be such a surprise for the market, but they are. As it often happens, market needs to look at the data to start adjusting prices even if something is "obvious."

As with the previous drillers' reports, we'll take a quick look at actual earnings (which impact the very short-term price action) and then proceed to the discussion of longer-term drivers that ultimately impact the stock price.

For the first quarter, Transocean reported an adjusted net loss of $210 million, or $0.48 per share. The company continued to generate cash thanks to better-era long-term contracts, but depreciation and interest expense pushed the accounting results into the red zone. Again, it's hard to tell why this is such a surprise for the market - drillers' financials will be under pressure until recovery starts happening across all segments. Anyway, the near-term reaction to a headline earnings miss is not that important. The outlook for the future and the company's plans are the things to watch. On this front, there was a surprise (at least for me) during the earnings call.

Here's what the company stated regarding potential acquisitions:

As we progress through 2018, we will continue to evaluate acquisition targets with characteristics similar to what we found in Songa including high-specification assets that will strengthen our fleet and some balance of backlog and maturity that will no significantly impact our near-term liquidity […] As we move though 2018, we will continue to evaluate our fleet, potentially acquiring high-specification assets, recycling some of our existing assets we think are no longer competitive or economically viable, and upgrading assets to meet customer demand where the economics of the investment justify the enhancement.

Frankly, I thought that Transocean was done with acquisitions after the dilution that came with the Songa purchase. The description of the potential target is even more mysterious: A company that has both a backlog and an attractive maturity profile, for which Transocean is expecting to pay with cash or mostly with cash (as was said by the company's management during the conference call). What is the name of this company?

Pacific Drilling (OTCPK:PACDQ) and Ocean Rig (ORIG) do not fall under this description due to a lack of backlog and the fact that Pacific Drilling is not out of restructuring yet. Maersk Drilling is too big for Transocean. Odfjell Drilling looks interesting, but it comes with a Well Services division, so it's not just a potential purchase of rigs. At this point, I'm confused by such plans. Songa purchase was de facto a purchase of backlog, and I'm not aware of similar opportunities in the market. Perhaps Transocean will surprise everyone and find a gem for a decent price, but it's unclear what it could be. The risk here is that the company engages in a more speculative, Ensco/Atwood-like transaction that increases the risk profile of the company with unclear benefits.

Meanwhile, Transocean stated that renewing or extending the revolving credit facility remained a priority and that it expected to complete this task in 2018. The company had publicized this intention back in 2017, so some negotiations on this front must have been going behind the scene. In my opinion, the goal of acquiring additional assets (let alone a whole company) is in conflict with the goal of a credit facility renewal (obviously, creditors want to see more cash within the company). Also, as Transocean has stated that it will be retiring some assets, so it will face the accounting consequences of such a move. Judging by the comments during the earnings call, the company is open to scrap its midwater floaters. I won't expect to see Transocean scrapping older drillships, however, despite the obvious fact that they won't see any work again due to potential writedowns.

Also on the financial front, the company stated that it expected to refinance debt associated with four Songa Cat-D rigs. This trick has already been done with newbuild drillships, and I think we can be sure of a successful execution - although the interest rate will be of great interest.

Out of all drillers' earnings calls this season, Transocean's management team was the most optimistic. This is not the first time that company management shared upbeat expectations and the market has so far proved them wrong. While Transocean is certainly one of the leading drillers and a survivor, the upcoming price action of its shares is in the hands of oil prices. So far, financial results and contracting activity failed to impress the market. Upbeat expectations and the related upside in Transocean shares are closely correlated with the recent upside in oil prices, so if Brent oil falls back below $70, we'll see a significant correction in all drillers' shares - including Transocean.

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