Transocean Ltd (RIG, Financial) is a third-party offshore oil company that provides rigs along with the equipment and manpower to drill for heavy oil. Oftentimes, the company will get contracted due to complex drilling processes, which has served it well over the years.
The stock has traded up along with the prices of heavy oil and has experienced gains in excess of 210% year-over-year. However, I think the stock remains undervalued even at current levels. Its true value is hiding in plain sight, and it's only a matter of time before the market sees it.
Oil prices and capital allocation
Many oil exploration firms will be piling cash into new projects after they've profited from the surge in global oil prices. Whether it be greenfield or brownfield projects, Transocean is in a good position to facilitate drilling services and equipment to large projects as it's the market leader in the drilling contractor space.
Backlog and buyouts
The company is sitting on a massive backlog of $7.1 billion, which is worth more than two-quarters of its historical revenue.
In addition to its own backlog, the firm has increased its non-organic capacity via acquisitions through the recent buyouts of Songa and Ocean Rig. These acquisitions add significant cost-saving synergies and bring a client base with them. Transocean will be able to lower its prices and become even more dominant in the industry.
Reverting to fossil fuels
The zero-emissions target by 2050 is a good thing for all of us. However, many countries have experienced slower and more expensive implementation of their clean energy policies due to an underestimation of the capital required and resistance from fossil fuel producers, many of which have gained entrenched political power.
The result of fossil fuels still not only staying but growing as part of our energy mix not only sustains business for Transocean but gives it enough time to pivot toward renewable projects.
Key valuation metrics
Although the stock has surged year-to-date, the stock price is still lagging the diluted earnings per share based on a close historical correlation. I expect convergence to the upside with the cash flows remaining robust.
Levered free cash flow has increased by 79.34% year-over-year, and operating cash flow growth is anticipated to reach 12.61% over the next year after growing by 150.19% year-over-year.
Finally, the stock's RSI is trading low at 44.18 and is probably due for renewed momentum after some investors have cashed out their profits. According to 13-F filings, hedge funds have increased their holdings of Transocean by a total of 1.3 million shares over the past quarter with noticeable names such as Joel Greenblatt (Trades, Portfolio) and Rob Citrone adding the stock to their portfolios.
Final word
Transocean's stock is still overlooked by the market at this time, despite the recent rise. As the backlog rolls in, we could expect upside in the stock. Key acquisitions have contributed to increased capacity and are expected to add to cost-saving synergies.
Key stock valuation metrics indicate that we've yet to see the stock reach its peak with the RSI signaling a possible momentum period ahead.
