Transocean (NYSE:RIG) recently reported its Q1 financial results and held a conference call, providing an update that is especially interesting given the recent share price performance of all offshore drilling stocks including Transocean. I assume that the majority of readers have had the time to read the earnings press release, so I want to immediately jump to key numbers and comments.
Source: Transocean Q1 press release
Operating cash flow swings to the negative territory. This had to happen with all of Transocean’s big activity. Ultimately, mergers, reactivations and upgrades cost money in the near term, and no legacy higher-margin backlog is a perfect shield if the company constantly engages in new activities. I believe that this is a sobering number for those who believed that Transocean’s upscale fleet and industry-leading backlog were a magic bullet against everything.
Liquidity projections call for $300 million-$500 million cash position at the end of 2020, but there are major questions. This is the most important issue so I’ll give the corresponding quote from the conference call in full:
“Turning now to projected liquidity at December 31, 2020, including our $1 billion revolving credit facility which matures in June 2023, our end-of-year 2020 liquidity forecast is estimated to be between $1.3 billion and $1.5 billion. This liquidity forecast includes an estimated 2019 capex of $470 million and 2020 capex of $800 million. The 2020 capex includes $600 million related to the two newbuild drillships and $86 million for the two Ocean Rig newbuilds at Samsung, and maintenance capex of $115 million. Please note that our capex guidance excludes any speculative rig reactivations”.
Let’s start by identifying the changes to liquidity guidance in comparison with the company’s statements made in the Q4 2018 earnings call. Back then, the company expected to have $900 million-$1.1 billion at the end of 2020, which meant that the company was supposed to run out of money as this number included the credit facility. Capex projections for 2019 were $440 million ($30 million lower than the new forecast), while capex projections for 2020 were $1.3 billion ($500 million higher (!) than the new forecast). Given the fact that capex projections decreased by $470 million while liquidity projections increased by $400 million, the company’s business outlook worsened in comparison with the previous quarter.
What’s even more interesting is that capex for one newbuild drillship is obviously pushed further into 2021. Also, the continued modest capex projections for Ocean Rig newbuild drillships mean that either the company does not expect to take their delivery or it will simply rely on yard financing (the terms of Ocean Rig's agreement with the yard allow this; in this case, the principal will be due in June 2023 for Ocean Rig Santorini and January 2024 for Ocean Rig Crete). A picture is better than a thousand words here:
Source: Transocean 10-K
Above, you can see the remaining capex for newbuilds, including TBN2 (the rig is now named Deepwater Titan according to the conference call) which has received a major contract from Chevron (CVX) at the end of 2018 but will accrue a total cost of more than $1 billion and easily become the most expensive rig in the whole fleet.
While Transocean has cut its 2020 capex expectations by as much as $500 million, it will still have to incur this expense (or fail to deliver a drillship) later. The starting point of $300 million-$500 million of cash at the end of 2020 does not look great, so I’d expect Transocean to take even more debt to improve the cash position. The balance sheet situation is challenging, and the company needs a timely recovery to succeed. Meanwhile, reactivation costs are rising…
Transocean admitted that reactivating Ocean Rig’s drillships will cost more than planned. Back in 2018, when the Transocean-Ocean Rig deal was announced, the company stated that reactivating Ocean Rig drillships will cost $25 million per rig. That number looked artificially low right from the start. In the previous conference call, Transocean admitted that it had not done the proper homework on the rigs. Suddenly, the company changed its mind and finally did the exercise, coming with double the original cost: “We have recently conducted a thorough analysis on these rigs, and excluding any contract-specific requirements or contract mobilization, we estimate costs ranging from $45 million to $50 million”.
So, no upgrades for cold stacked rigs (an impossible scenario, in my view), no mobilization, and the cost is still $45 million-$50 million per rig, or $180 million-$200 million for all four stacked Ocean Rig drillships. In addition, drillships Discoverer Champion, Discoverer Luanda, Discoverer Americas and Discoverer Clear Leader have not seen any work for a long time, being stacked from February 2016 (Champion) to February 2018 (Luanda). How much will it cost for these rigs to get back to the market and will they ever see the light of day again?
Transocean is playing a risky game and needs a timely recovery. The balance sheet situation is not looking good at this point. The company does not have the finances to reactivate cold stacked rigs, and the scenario when all eight above-mentioned drillships continue rusting without work for some years to come is possible. Just like other offshore drilling stocks, Transocean's shares remain a good trading vehicle – should they drop lower or stabilize at support around $8.00 level, a momentum long bet will surely be on the table. Speaking about the longer term, the company faces material risks despite the fact that offshore drilling recovery is slowly unfolding because it has amassed a fleet and a capital structure that need a robust recovery. I’m sure that some readers will call me too bearish and negative on Transocean, but I believe that the company’s own liquidity projections, together with the number of stacked rigs and costs to bring them back to work, speak for themselves.
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