Transocean (RIG, Financial) reported second-quarter earnings and the company's best analyst estimates on Aug. 5. The stock surged in premarket trade, and I expect a few good days for Transocean stock on robust results. This article discusses the key numbers in the second quarter and the reasons to remain cautious on the stock.
I must point out that Transocean, Seadrill (SDRL, Financial) and Ensco (ESV, Financial) are all quality companies in the offshore drilling sector. The broad industry condition has resulted in setbacks for all these companies. However, investors can consider buying offshore drillers in small quantities over the next 6-12 months. I believe that current levels are attractive from a five-year investment horizon.
Coming to Transocean’s results, the company’s reported revenue of $1.9 billion for 2Q15 as compared to $2.3 billion in 2Q14. The revenue decline was largely expected on difficult market conditions, but EPS of $0.93 certainly came as a surprise for markets.
The second positive point is in the company’s balance sheet where cash and equivalents swelled to $3.8 billion as of 2Q15 as compared to $2.6 billion in 4Q14. Strong growth in cash position has been as a result of low capital expenditure for 1H15 and strong operating cash flow.
While the company’s capital expenditure will be around $1.3 billion in the second half of 2015, the current cash position and operating cash flows more than cover for the investments. Therefore, Transocean is likely to maintain stable debt through 2015.
Besides the results, I also see some positive in the company’s fleet status report. As of July 15, Transocean had 12 new rigs under construction. Of these, five rigs are already contracted under long-term contracts with Shell (RDS.A, Financial)(RDS.B, Financial) and Chevron (CVX, Financial).
One new rig contract will commence in 1Q16, one in 2Q16 and one in 4Q16. These contracts will offset (to some extent), lower cash flow from relatively lower contract coverage in 2016 for existing fleet.
While the company’s results are a positive surprise, there are few concerns that I have and these concerns make me cautiously optimistic on Transocean –
- First, 2016 will be a challenging year for the industry as well and rigs going off-contract in 2016 will be idle or cold stacked.
- Second, export of oil from Iran will resume in 2016 in all probability. This will keep oil prices low and can make 2017 a difficult year as well for the offshore drilling industry.
- Third, the rigs that will go off-contract and are contracted will command much lower day ate and the negative impact on cash flow will be significant.
- Fourth, seven new rigs under construction still remain un-contracted and it remains to be seen when these rigs will be contracted as offshore market conditions remain very challenging.
Considering these factors, I am still concerned and I believe that the oil price factor will continue to depress sentiments for offshore drillers even when these companies put up relatively robust performance. However, as I mentioned earlier, this is a value buying opportunity. Investors just need to avoid a big plunge in the sector as of now.
