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Transocean Remains Highly Risky

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About: Transocean Ltd. (RIG)
by: Aristofanis Papadatos
Aristofanis Papadatos
Oil & gas, portfolio strategy, value, bonds
Summary

Transocean has dramatically underperformed the market in recent years.

However, the stock remains highly risky, as it has an excessive debt load.

Transocean is consuming its backlog at a fast pace.

In mid-2017, I wrote my first bearish article on Transocean (RIG). As the stock had already shed 80% off its peak in 2013, many investors might have considered my article too pessimistic. However, the stock has plunged 45% since my article, whereas S&P has rallied 36% over the same period. Despite the dramatic underperformance of Transocean, investors should not conclude that the stock has become a bargain. In this article, I will analyze why Transocean remains highly risky.

There have been some positive developments in the business of Transocean lately. The company recently secured $352.9 million of backlog from new contracts and extensions, while its management recently stated that it experiences strong demand for the high-spec ultra-deepwater floaters. In addition, in the latest conference call, in late October, management stated that it saw customer interest rise to a 5-year high level. All these positive pieces of news have helped the stock enjoy a relief rally off its 10-year lows, which were recorded in October.

Moreover, Transocean boasts of having the largest and most capable floater fleet in its peer group, with 14 harsh-environment floaters and 28 ultra-deepwater floaters. Furthermore, thanks to the high-grading of its asset portfolio in recent years, the offshore driller has reduced the average age of its floaters from 21 years in 2014 to 10 years now, while the portion of its harsh environment and ultra-deepwater floaters has surged from 45% in 2014 to 94% now. The company also boasts of a backlog that is approximately 4 times larger than the backlog of its nearest competitor.

However, investors should not be misled by this statistic of the backlog, as all the offshore drillers have been reducing their backlog at a fast pace. Transocean reduced its backlog from $11.9 billion in April to $11.4 billion in July and $10.8 billion in October, as per its most recent presentation. This means that more than half of the revenues of the company have come from its backlog in recent quarters. In other words, Transocean is consuming its backlog at a fast clip in order to compensate for the depressed revenues from new orders.

It is also hard to accept management's statement that the shale oil boom is much closer to its peak than previously expected. According to a recent study, the shale oil production will continue growing until 2030, from about 8.0 million barrels per day now to 14.5 million barrels per day in 2030. Consequently, as the vast majority of future production growth will come from shale oil, the shale oil boom will continue to exert strong pressure on the business of offshore drillers for many more years.

It is also worth noting that the offshore drillers are severely punished for their past sins. During 2012-2014, when oil was hovering around $100 per barrel, the offshore drillers were enjoying excessive profits. They thus invested hefty amounts to build new floaters and jack-ups at the most unfortunate time, near the peak of the cycle of their business. As a result, when the price of oil began to collapse in mid-2014, the offshore drilling market was caught with an excessive supply of floaters and jack-ups. Even today, more than five years after the onset of the downturn, the offshore drilling market is still oversupplied, with no tangible bottoming signs yet.

Transocean has incurred hefty losses for three consecutive years. Notably, its aggregate losses of $5.8 billion are 153% its current market cap of $3.8 billion. In addition, the company is expected to post material losses for at least another two years. As its expected losses of $1.96 per share in the next two years are 31% of its current market cap, the shareholders are running the risk of being significantly diluted. Even if they are not diluted, the company is likely to issue new debt at burdensome interest rates. It is also remarkable that the share count has jumped 60% due to acquisitions in the last three years, but the company is still far from making a profit.

Moreover, Transocean carries a huge debt load. Its net debt (as per Buffett, net debt = total liabilities - cash - receivables) stands at $9.9 billion. As this amount is 2.6 times the market cap of the stock, it is certainly excessive. Moreover, the company has posted negative operating income (-$62 million) in the last 12 months, and hence, it cannot cover its interest expense. On the one hand, as the current assets of Transocean exceed its current liabilities by a wide margin ($3.8 billion vs. $1.5 billion), the company is not likely to face liquidity problems anytime soon. On the other hand, due to its losses, the company will keep burning cash for the foreseeable future. In addition, the high debt load renders Transocean highly vulnerable to a downturn, such as a recession or a continued downturn in the offshore business for many more years.

To sum up, Transocean is still paying the price for investing hefty amounts to build new rigs at the most unfortunate time, i.e., the peak of its previous business cycle. Its shareholders have incurred devastating losses in the last six years but the stock remains highly risky, as it keeps posting losses while maintaining a leveraged balance sheet. The fact that the stock has lost 89% off its peak in 2013 does not mean that the stock has become a bargain. Overall, investors should continue avoiding the stock.

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.