In the last few months, I have been bearish on Transocean (RIG, Financial) for two reasons. First, the decline in oil prices has impacted the offshore drilling market and second, Transocean has significant leverage and the company is likely to face challenges as oil prices sustain at lower levels.
In line with all the negative factors, Transocean stock has declined by 68% in the last year. However, I believe that there is more pain in store for the stock in the coming quarters, and Transocean remains unattractive even at current levels.
In this article, I will discuss the negative factors that come from the company’s January fleet status report. The negative factors back my bearish view for the stock in the coming months. Even if Transocean does not decline significantly from current levels, the stock is unlikely to move higher anytime soon. Therefore, my view is that investors should avoid Transocean.
The January fleet status report has no positive surprises and the report does have few negatives. In terms of new orders, Transocean has secured new contracts worth $24 million in the last one month and I believe that it is not significant when it comes to having an impact on 2015 revenue and cash flows.
Among the negatives, the company has decided to scrap the deepwater floater Discoverer Seven Seas and the rig is classified as held for sale. With the scrapping of this rig, Transocean has scrapped a total of 12 low specification rigs recently.
This might seem to be a good strategy as the company is in the process of revamping its fleet by doing away with the older fleet. However, the 12 rigs are still classified as “assets held for sale” and I believe that there will be no takers for the rigs in these difficult market conditions.
Therefore, the scrapping of the rig is lowering the cash flow forecast and it is also not adding to the company’s cash position. The rigs can be sold once market conditions improve. However, the offshore drilling market is unlikely to improve anytime soon.
Besides this, Transocean has also reported that The Discoverer Spirit, Deepwater Frontier, and Sedco 707, are idle and with several rigs going off-contract in the coming months, the number of rigs cold stacked or classified as “assets held for sale” is likely to increase.
This will have a direct impact on the company’s revenue and cash flow. The concern is that Transocean has $1.3 billion in capital expenditure that is due for 2015. With a higher number of contracts due for renewal in 2015, the cash flow outlook is very uncertain and the company might have to take further leverage to fund the new rig delivery even if the company suspends dividends.
Clearly, there are several negative factors that are lined-up for Transocean in the coming months. The market might have discounted the dividend suspension factor. However, the extent of contract coverage for 2015 still remains uncertain and if the contract coverage remains weak, Transocean will trend lower.
Transocean is currently trading at an EV/EBITDA of 3.4, which seems attractive. However, in a market where oil prices are likely to remain low, the valuations make little sense and the stock can go down further. The forward EBITDA might take the EV/EBITDA valuation to a different level.
In conclusion, my view remains that Transocean is a stock to avoid for 2015. If investors are looking for offshore drillers among value picks, my choice is Ensco (ESV, Financial) and Atwood Oceanics (ATW, Financial). Both these stocks look interesting with the medium to long-term perspective.
