Transocean drills its way to the top

6/30/2008


  Recent Price
$152
  Dividend
$0.00
  Yield
0.0%
  P/E Ratio
14
  Shares (millions)
321
  Long-Term Debt as % of Capital
49%
  52-Week Price Range
$163.00 - $111.34

With the world’s largest fleet of offshore drilling rigs, Transocean ($152; NYSE: RIG) should continue to profit as energy companies step up efforts to tap underwater reserves of oil and natural gas. Transocean’s globally diverse fleet, specialization in deepwater vessels, and ability to raise rates on its rigs should help sustain rapid profit growth over the next few years.

Despite a four-year run-up in the stock price, Transocean shares appear to have a good deal further to go. Spending on deepwater exploration has been strong and should remain so as long as oil prices stay above historical norms. Transocean is a Focus List Buy and a Long-Term Buy.

Oil prices, demand high
Oilfield-services stocks have been volatile this year. Concern that an economic slowdown will reduce oil demand has weighed on shares of some energy companies. In addition, China and India have reduced gasoline subsidies, prompting a pullback in oil prices on concerns of reduced consumption. Still, prices bounced back on civil unrest in Nigeria. Despite these fluctuations, global oil demand seems likely to support efforts to boost exploration and production.

Futures markets project per-barrel oil prices of at least $130 over the next eight years, but development of reserves should remain profitable for energy companies even if oil falls below $100 per barrel.

Movements in oil prices are likely to drive Transocean shares in the near term, though the company has little direct exposure to those prices. Over the next year or two, Transocean’s operational strength should lift the stock, even if oil prices retreat substantially.

All offshore rigs are not created equal, and Transocean’s global fleet provides a competitive advantage. Jack-up rigs anchored to the ocean floor in shallow water operate under fairly long contracts, though new supply entering the market could pressure prices in the next 18 months.

Digging deep for success
Transocean’s heavy hitters — 66 deepwater rigs located in every oil-producing region of the world — benefit from strong global demand that allows for rising rental rates. Deepwater operations should provide the bulk of Transocean’s profit growth over the next few years, with several drillship contracts up for renewal in the next two years and nine new rigs slated for deployment by the end of 2010.

Earlier this month, Transocean extended a contract with BP ($67; NYSE: BP) for double its earlier rate. It also signed an agreement with Petrobras Energia ($12; NYSE: PZE), the Brazilian oil company, to operate a rig. The two contracts are worth a combined $2.74 billion over the next 10 years.

Valuation ratios for many oil stocks have declined in recent months, as some investors anticipate the end of the current spending cycle. But oil exploration and production shows no signs of slowing, and Transocean’s robust profit stream (estimated per-share-earnings growth of 67% this year, 19% in 2009, and 28% annualized over the next five years) seems undervalued.

The stock trades at just 10 times estimated year-ahead earnings, well below the drilling industry average forward valuation of 15. 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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