The world’s largest offshore drilling contractor and one of the leading drilling management services providers Transocean (NYSE:RIG) has joined the coveted S&P-500 Index on Monday. The company has replaced the struggling PC manufacturer Dell. This comes just a few days after Transocean announced a five-year contract with Chevron (NYSE:CVX) toconstruct a new state-of-the art ultra-deepwater drillship. The delivery of the vessel is expected in the second quarter of 2016. The vessel will require investment of $725 million and will bring $1.1 billion as revenues. The construction of the drillship is expected to begin in fourth quarter of 2014 in Okpo, South Korea, where the company has a long history of operations. It has developed five enterprise-class drill ships at that facility and it currently has six other ultra-deepwater rigs under construction.
Going Towards Efficiency
In its previous fleet status report for the month of October, Transocean revealed that since Sept. 18, it has acquired new contracts worth $2.0 billion, which includes the new Chevron contract mentioned above. Back in 2012, Transocean reported a massive backlog of $27 billion, the biggest in the industry. This has significantly improved the company’s visibility. This year, it has focused more on improving the profitability of its backlog.
Last year, Transocean started its initiative for improving its organizational efficiency by cutting costs and focusing on higher margin operations. The business has been selling non-core assets as it consolidates its operations. Last year, Transocean sold 38 older rigs for $1.05 billion as it shifted its concentration towards ultra-deepwater and high-specification rigs. The benefits from these measures will start to flow from 2014 and will translate into savings of around $300 million.
The demand for deepwater oil exploration and production has been increasing due to the two main factors. First, the onshore resources have been extensively used for decades and there simply isn’t a lot left to explore, particularly in the developed world.
Second, most of the unexplored and lucrative areas lie in the Middle East and Africa, a region which is known for its unstable business environment. For instance, Mozambique is home to enormous gas reserves and has been going on a path to prosperity over the last eight years, which is evident in its 7% GDP growth rates. Leading oil companies, such as Eni SpA (NYSE:E) and Anadarko Petroleum (NYSE:APC) have billions at stake in the country. However, the sudden termination of a peace deal by a rebel group recently has raised question marks over the country’s ability to attract investment.
Meanwhile, the global oil demand will continue to increase and is expected to touch 96.7 million barrels a day by 2018. Due to these factors, oil companies have been shifting their focus towards offshore, particularly deepwater reserves.
Transocean is in a good position to capitalize on the trend of growing demand of deepwater drilling. The business gets almost 68% of its revenues from deepwater and ultra-deepwater assets. Transocean boasts of a fleet of 29 ultra-deepwater rigs which represent more than one-fifth of the industry’s total global fleet. The company has a total backlog of nearly $30 billion, including $2 billion from new contracts mentioned earlier. Its ultra-deepwater rigs make up around 70% of its total backlog. These ultra-deepwater rigs look more promising than other deepwater rigs as they have higher revenue efficiency and utilization rates. Transocean’s nearest competitor and the world’s second largest ultra-deepwater operator, Seadrill (NYSE:SDRL), has around 15 ultra-deepwater rigs.
The Carl Icahn Factor
Transocean is also backed by Carl Icahn of Icahn Capital Management. Icahn has been pushing for a higher dividend payout. The famed activist investor has increased its stake in Transocean by 1.3 million shares from the end of last quarter to 21.5 million shares, or 6% of the company. Moreover, the company’s board also includes Icahn’s backed members.
Therefore, due to the increasing demand of ultra-deepwater drilling, which is Transocean’s core area of operation, and the company’s focus on efficiency and margin enhancement, Transocean looks poised for long-term growth. The fact that Carl Icahn yields considerable influence in the company’s board should give confidence to potential investors as the business will likely reward shareholders with dividends and buybacks. However, readers should note that Goldman Sachs has recently downgraded Transocean from Neutral to Sell with a $50 price target. This follows just a few days after Argus also downgraded Transocean from Buy to Hold.
In the last six months, Transocean’s shares have dropped by 6%, as opposed to S&P 500 ETF (SPY) and Seadrill that have risen by 11% and 23%, respectively. Due to the recent downgrades, its shares will likely remain under pressure in the short term. However, a further decline could create a buying opportunity. Its shares are certainly not expensive at the moment as they are trading 10.5 times their trailing earnings, as opposed to the industry’s average of 14 times. Moreover, at these price levels, Transocean gives an attractive yield of 4.65%, considerably above the industry’s average of 2.5%.
Transocean Fleet Status Report October 2013 (Pdf File)
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.