VAL - Transocean Stock: Bulls Do Not Despair

2023-11-24 23:48:18 ET

Summary

• Transocean's stock price has dropped due to factors such as debt exchange and earnings results.
• The company's liquidity and financial position improved after issuing new shares in exchange for bonds, reducing debt and interest payments.
• Despite some negative indicators, Transocean's earnings results were better than predicted, and the company's clients are willing to pay a premium for its services.

Transocean's ( RIG ) stock price has taken a hit for a number of reasons. The debt exchange and the lower-than-expected results were some of the reasons. Also, the fact that oil prices decreased also affected RIG. However, it seems the market is far too pessimistic right now. Let me explain why.

Debt exchange

In total, the company issued about 26.5 million new shares in exchange for $101 million in principal amount of the company's exchangeable bonds. I can understand that the issuance of new shares to exchange these for the company's bonds somewhat diluted the existing shareholders. In this respect, I agree with my fellow Seeking Alpha contributor Henrik Alex that it is quite a good explanation for the stock price drop. In other words, it was one of the factors making Transocean's stock trade somewhat lower than it used to a couple of months ago. However, this decision improved the company's liquidity and obviously its financial position. In other words, it reduced the company's debt and also decreased the interest payments. But there were other reasons for RIG stock's underperformance.

Quarterly earnings results

Overall, the company's earnings results were even ahead of guidance. Even the fact the margins were somewhat lower compared to the same period a year ago was due to the fact there were some rig reactivations and some new ships were built. As a result, the operating cash flow was somewhat down and the net debt increased compared to the same period a year ago.

Overall, some of the earnings indicators were worse compared to the same period a year ago but better compared to what the market had predicted. The data are provided in USD millions.

Source: Transocean's data, Daniel Jones

Source: Q3 Earnings Release

Due to reactivations and new builds and as mentioned in the earnings transcript , the company's operating cash flows were negative $44 million, mostly due to almost $135 million of contract preparation and mobilization expenses. These cash outflows were due to seven rigs starting new contracts in late 2023 and 2024, including two rigs in Brazil, two rigs being prepared for Brazil, two rigs bound for Australia, and one rig operating in the Eastern Mediterranean. The management expects to either defer or capitalize about 60% of these preparation costs. These costs will increase expenses and reduce EBITDA. However, these are temporary and will eventually translate into higher day-rate revenues and operating margins in the coming years. The management expects the contractual revenues to increase in 2024. So, nothing horrible is happening on this front. Heavy expenditures will eventually pay off in the future.

Also, in the past several quarters, the long-term debt seems to be quite moderate compared to the 2019-2020 period when the debt was around $9 to $10 billion. A very good article on the company's long-term debt history was written by my fellow Seeking Alpha contributor Fun Trading.

Transocean was also criticized by some Seeking Alpha authors for not being able to secure any day rates over the $500,000 mark. But this is not a catastrophe, indeed. The rates are still high. Key segments of the rig fleet are near 95% utilization or above, the day rates for non-harsh environment jack-up fixtures have exceeded $150,000, whilst floating rigs have been secured for contracts at or above $475,000. But the average drillship fixture across the market of 2023 is about $367,000 per day. Transocean's average, however, across the 2023 fixtures is $415,000. So, the company is 10% or 15% higher than the average. As concerns semisubmersibles, Transocean can charge $392,000 vs. the average of $336,000.In other words, Transocean's clients are willing to pay a premium to other offshore drillers for using the company's services because Transocean is the industry's leader and has the best fleet. For example, Transocean operates 8 of the 12 globally competitive 1,400 short-term hook load dual activity ultra-deepwater drillships in the world.

Just over 80% of the company's 2023 contracted backlog consists of programs of more than one year in duration. That is another clear sign that Transocean's clients believe the offshore sector's upcycle would be long. It has also been assumed that Transocean does not have any growth stimuli because no cold-stacked rigs are being reactivated. Indeed, Jeremy Thigpen has remained quite conservative in terms of reactivating cold-stacked rigs. Transocean will first use the active fleet, then the new builds, and then reactivate the cold-stacked rigs. However, if the company finds new contracts at very high rates, then it will do so. After all, cold-stacked rigs do not necessarily go to recycling. But in either case, according to Jeremy Thigpen, some of the oil majors are out for tenders. So, Transocean's management expects multi-year and multi-rig contracts to be announced in the near future.

As concerns Transocean's cash flow and balance sheet, the company ended 3Q 2023 with total liquidity of about $1.4 billion, including unrestricted cash and cash equivalents totaling $594 million, almost $183 million of restricted cash for debt service, and $600 million in the revolving credit facility. So, in this respect, the company is stable and is able to meet its day-to-day business needs.

Oil prices

The stock price decline was also partly due to the fact the oil prices were down somewhat. Not just the Fed drew investors' attention. Chinese macroeconomic indicators were also watched by the market and they disappointed . In fact, the property sector was really down, whilst the inflation readings decreased. Although the latter might look like a good piece of news, all this suggests the country's economy is experiencing a slowdown.

Oil bears also pointed out that the situation in the Middle East, namely the war between Israel and Hamas, is getting somewhat better. Hostages have been released, whilst a cease-fire has been agreed upon. But in my opinion, the war is not over, unfortunately. Anyway, the oil prices decreased, at least for now.

At the same time, if the global economy avoids a recession, the outlook for oil is positive, especially given the fact that OPEC+ is highly likely to cut output.

Risks

The risks are obvious. First, Transocean is not free of debt. Then, it is not a highly profitable company that is able to boast an excellent track record. So, its stock is quite volatile. Moreover, there is a risk that oil prices might not stay high enough. That is why the offshore sector might not recover as fast as many analysts say. However, all these risks seem to be already factored in. Then, it is important to remember that the offshore drilling industry requires long-term investments and is not subject to short-term oil price fluctuations.

Many analysts have pointed out that RIG is overvalued. But I do not personally see the company's valuations are a big problem right now. To start with, the company's stock is off its multi-year highs. Then, many authors have already compared Transocean to its close competitors, including Valaris ( VAL ) and Seadrill ( SDRL ). Sure, these businesses have lower debt levels but their backlogs, revenues, and fleets are less impressive than those of Transocean. Not to mention the fact that Transocean deserves a contract premium to its competitors.

Conclusion

Transocean's stock has just experienced a healthy correction. If there is no full-scale economic crisis and if the oil prices do not fall to all-time lows and stay there, I do not personally see RIG falling much further. All is possible, of course. However, it seems that the offshore drilling sector is still recovering well. It is highly likely the day rates and the financial results will be much better in 2024 if nothing horrible happens to the company and the oil industry in the near future. I still remain bullish.

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