Transocean (RIG), which has the world’s largest rig fleet and offers a healthy dividend yield of 6.6%, is an investment worth considering for the long-term. This article discusses the key investment positives, which make a strong case for long-term investment.
Transocean Partners LLC IPO
Transocean Partners, which was formed by Transocean to own three ultra-deepwater drilling rigs in the Gulf of Mexico, filed for an IPO with the SEC this week. The company plans to raise $350 million through the initial public offering.
Seadrill (SDRL) has already tested the tax-free partnership structure successfully and the biggest advantage for Transocean in the near-term will be a healthier balance sheet. Transocean currently has 78 rigs in operation with an additional 14 rigs under construction.
The Transocean Partners IPO will allow Transocean to gradually drop-down assets to the LLC and further strengthen its balance sheet. This is one of the key initiatives, which makes me bullish on Transocean at this point of time.
Strong Contract Backlog And New Rig Deliveries
A strong contract backlog for Transocean ensures that cash inflow is stable and so is the dividend payout. As of June 2014, Transocean had an order backlog of $26.1 billion with 71% coverage for high specification floaters, 67% coverage for mid-water and 88% coverage for high specification jack-ups.
The revenue should therefore be firm and the first quarter sets the trend with a 6.9% revenue growth in a relatively challenging environment to $2.3 billion. Further, with two new ultra-deepwater drillships to commence operations in the second half of 2014, the revenue growth will be strong in the last two quarters.
Besides this, the company has 12 other new rigs for delivery in 2016 and 2017. This will ensure that revenue growth continues. Also, Transocean will have the option to drop-down contracted rigs to Transocean Partners and this will keep the company’s balance sheet strong.
High Debt, But Comfortable Coverage
As of March 2014, Transocean had a debt of $10.4 billion and a TTM EBITDA of $3.7 billion. This translates into leverage of 2.8, which is not a matter of concern considering the fact that the company has EBITDA interest coverage of 7.2 as of 1Q14.
In addition, Transocean has a comfortable debt maturity profile with $162 million debt maturing in 2014, $1.2 billion debt maturing in 2015 and $1.1 billion debt maturing in 2016.
More than 50% of the company’s total debt has maturity after 2019. With a strong new rig pipeline and robust industry dynamics, Transocean is well positioned on a debt servicing and debt repayment front. Also, given the company’s credit history, debt refinancing will also not be a matter of concern.
Positive Rig Composition
As of 1Q14, Transocean had an excellent rig composition and this adds to the bullish outlook on the stock. Of the company’s total rigs, 51% are ultra-deepwater, 11% deepwater and 12% harsh environment.
Therefore, 73% of the company’s assets are dedicated to high end operations in terms of day rates and expertise. Further, over the last few years, the biggest oil discoveries have been ultra-deepwater and deepwater and this has boosted the demand for these rigs.
Transocean is therefore well positioned to cater to the demand. Also, the company’s new rigs (under construction) are ultra-deepwater and this will add to the company’s strong fleet.
Transocean is currently trading at an EV/EBITDA valuation of 6.6. This is very attractive considering the fact that Seadrill is currently trading at an EV/EBITDA valuation of 12.5 and Ensco (ESV) is trading at an EV/EBITDA valuation of 7.4.
Transocean’s valuation will get a boost after the Transocean Partners IPO. Further, the company intends on an $800 million margin improvement by the year end-2015. This will provide another reason for valuations to improve. At current levels, Transocean can be considered to be a value buy.
Transocean has an aggressive growth pipeline in terms of new rig deliveries over the next 2-3 years. If the markets remain stable, the company stands to benefit. However, any decline in economic activity and a sharp drop in oil prices can impact the company’s fleet utilization and revenue.
I however feel that the probability of such a scenario is low considering the fact that some major oil producing regions are reeling under geo-political tensions. Oil prices should therefore remain at higher levels and this will provide support to the drilling industry.
Transocean, at an EV/EBITDA valuation of 6.6, is a value buy for the long-term. With a strong order backlog of $26 billion, cash inflows are relatively secure and so is the dividend yield of 6.6%. The company’s plan for an IPO for Transocean Partners LLC is a move in the right direction and should make the company stronger fundamentally. Overall, the stock is a good investment option to consider at current levels.