The challenging times for the offshore drilling industry continue, and no respite for offshore drillers is seen in the foreseeable future. However, amid challenges are opportunities, and this article discusses once such opportunity in the offshore drilling space. I am not recommending big exposure to the stock or sector, but valuations are attractive for gradual exposure with a long-term investment horizon.
Transocean (RIG, Financial) is an excellent investment for the long-term, and there are four key factors to support that.
Reason one – Solid order backlog
For offshore drilling companies, the existing order backlog is of paramount importance as it helps the company generate cash flow, service debt, make investments and sustain through these difficult times.
Transocean is well positioned from this perspective with nearly $1.3 billion in backlog for 4Q15, $3.9 billion for 2016 and $2.8 billion for 2017. Overall, the company’s order backlog stands at $18.6 billion.
For FY16, the backlog is not as high as FY15, but that was expected considering the industry scenario. The key point is how much cash can be generated from the backlog and does it suffice for debt servicing and investments.
Considering YTD15 EBITDA margin of 59%, order backlog of $3.9 billion would imply FY16 EBITDA of $2.3 billion, and this would imply smooth debt servicing. Even for 2017, order backlog of $2.8 billion would imply EBITDA of $1.6 billion and smooth debt servicing.
Reason two – Solid cash position
As of 3Q15, Transocean had total cash and equivalents of $2.2 billion. In addition, the company has $3.0 billion in undrawn credit facility, taking the total cash buffer to $5.2 billion. A strong liquidity buffer will ensure that Transocean navigates the crisis with ease.
In addition to the existing cash position, I expect 2016 and 2017 order backlog to further add to the company’s liquidity. Total EBITDA of $3.9 billion for 2016 and 2017 would imply operating cash flow well in excess of $2.0 billion. However, even if $2.0 billion operating cash flow is assumed for the next 24 months, the company’s liquidity visibility is $7.2 billion for the next 24 months.
Considering the solid cash position, Transocean is unlikely to face any challenges from a balance sheet perspective. It is true that decline in order backlog due to challenging industry conditions is a concern, but the company’s balance sheet is likely to remain healthy.
Reason three – Investments and deleveraging
Transocean has planned capital expenditure of $1.3 billion for 2016 and $323 million for 2017. Capital expenditure for the next 24 months amounts to $1.6 billion, which can be serviced through existing liquidity of $2.2 billion. Therefore, the company does not need to increase debt in the next 24 months.
Contrary to increase in debt, Transocean paid down $900 million in debt in July. With the company expecting solid cash position, I expect further reduction in debt in the next 12 to 24 months. When the industry eventually emerges from the crisis, Transocean will be well positioned to grow with strong financial flexibility.
Conclusion
Like all stocks in the offshore drilling sector, Transocean has also corrected steeply in the last year. It is difficult to predict the bottom for any stock, but Transocean looks attractive from a long-term horizon. Gradual accumulation on every decline is advised.
From a risk perspective, if oil stays depressed longer than expected, offshore drillers can witness prolonged depression, more cold stacking and continued decline in EBITDA margin. However, offshore drillers do believe that market recovery is likely in 2017.
Disclosure: No positions in the stock
