Drilling for truth about Transocean

1/19/2009


  Recent Price
$52
  Dividend
$0.00
  Yield

0.0%

  P/E Ratio
4
  Shares (millions)
321
  Long-Term Debt as % of Capital
46%
  52-Week Price Range
$163.00 - $41.95

What’s going on with Transocean ($52; RIG)? Shares of the owner of the world’s biggest fleet of offshore drilling rigs plunged 67% — nearly $100 a share — in 2008, and we can’t blame the usual suspects.

Poor operating performance? Wall Street expects 2008 per-share profits of $14.34, up 68%.

Shaky future? Transocean is expected to grow per-share earnings 4% in 2009 and 10% annually over the next five years.

Fundamentals eroding? Not at all. The balance sheet is sturdy and the backlog stout at $41 billion, or three times expected 2009 revenue.

We see two chief contributors to Transocean’s steep slide, and neither should jeopardize long-term prospects. First, Transocean was dropped from the S&P 500 Index after moving its headquarters to Switzerland. The switch should have no material effect on results, yet Wall Street responded with a 23% sell-off in the week after the announcement, in large part because S&P 500 index funds and many institutional investors bailed on the newly foreign company.

The second reason is more worrisome, but still temporary. The U.S. economy is contracting, and per-barrel oil prices are slumming in the high $30s. In a recession, companies and consumers cut down on energy use, and weakness is already visible in parts of the drilling market. However, Transocean should continue to benefit from high rig lease rates under long-term contracts. Given that most drilling projects last for years, oil companies generally take a long view, and we do not expect a sharp slowdown in deepwater drilling. Transocean is a Focus List Buy and a Long-Term Buy.

Drilling outlook
Transocean controls roughly 20% of the offshore-drilling market and operates about one-third of deepwater rigs. As land reserves dwindle, oil companies remain committed to deepwater projects. Energy research firm ODS-Petrodata projects demand for deepwater rigs will exceed supply in 2009. Transocean has booked 98% of 2009 contract days for its deepest floaters; two-thirds are contracted through 2011. Most of the company’s 10 new ultra-deepwater rigs go online in the next two years, and all already have long-term contracts.

One cause for concern is jack-ups, rigs that stand on the ocean floor in shallower waters. Two dozen of the industry’s new jack-ups slated for completion this year have no contracts, which could lead to sustained softness in the overall market. Jack-ups make up about half of Transocean’s fleet, though they contribute a much smaller portion of total revenue.

Transocean’s day rates for jack-ups have held steady since September, while deepwater rates have risen. Still, the price of oil is crucial. Transocean estimate that most clients can drill profitably with oil around $60 per barrel. While oil has dipped to the high $30s in recent days, Wall Street analysts expect prices to rally above $60 in the next few months.

Conclusion
Transocean’s long-term picture remains compelling. Its balance sheet, strong presence in deepwater drilling, and valuation (3.5 times estimated 2009 earnings) makes the stock an attractive rebound pick. An annual report for Transocean Inc. is available at 4 Greenway Plaza, Houston, Texas, 77046; (713) 232-7500; www.deepwater.com.


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