A comparative analysis shows that Transocean (RIG, Financial) has the highest order backlog among peers for 2016, but the stock has declined steeply by 30% for YTD16. Is Transocean worth buying before results for the near term?
It is important to mention here that the outlook for offshore drillers will remain challenging through 2016, but there will be medium-term trading opportunities, and there will be few long-term investment opportunities as well. In my view, Transocean presents a medium-term trading opportunity at oversold levels.
Coming to the factors to be bullish on Transocean, the stock is trading at TTM EV/EBITDA of 2.9 and this is attractive from a relative valuation perspective. Seadrill (SDRL, Financial) still trades at TTM EV/EBITDA of 5.0 and Diamond Offshore (DO, Financial) trades at TTM EV/EBITDA of 4.0. The stock is oversold in the near term, and a rally from these levels can’t be ruled out.
Coming to the order backlog for 2016, Transocean has backlog of $4.2 billion for the year and considering the company’s FY15 EBITDA margin, the EBITDA for 2016 is likely to be approximately $2.5 billion. With Transocean having $1.3 billion in capital expenditure for 2016, the company can be expected to report positive free cash flow for the year.
Considering this outlook, Transocean is well positioned to fund capital expenditure, service debt and potentially repay debt during the year.
Investors will question why the stock has steeply declined if the prospects remain bright. There are two reasons for this – First, the broad market correction and crude oil volatility has contributed to the decline in the stock. Second, Transocean has lost several contracts in the recent past and that adds to the negative sentiments and concern.
On Dec. 28, 2015, Transocean announced that the contract for Polar Pioneer (scheduled for July 2017 expiration) has been terminated. Further, on Feb. 8, Transocean announced that the contract for the ultra-deepwater drillship Discoverer Deep Seas (scheduled for November expiration) has been terminated. With trimming of the backlog, the stock declined. However, these factors have been discounted in the current price and 4Q15 results will be strong (backed by existing contracts). This will provide some near-term relief to the stock.
I must add here that Transocean has debt of $8.8 billion as of Sept. 30, 2015 and high debt is also a concern for market participants. However, considering the backlog for 2015, the company’s EBITDA interest coverage for 2016 is likely to remain above 5x and therefore debt should not be a factor. If offshore markets remain weak in 2017, there will be reasons to be concerned.
Another point that is worth mentioning here is that Transocean has cash and equivalents of $2.2 billion as of September 2015. The company’s cash buffer is sufficient to cover for capital expenditure in 2016. Transocean can potentially reduce debt by $1 billion in the coming year. Therefore, leverage metrics are well in control through 2016.
In conclusion, the steep correction in YTD16 for Transocean is a good buying opportunity for the near term. This is not a long-term investing view but a medium-term trading view. However, investors need to remain cautious and avoid any big exposure to this stock or the offshore drilling sector.
Disclosure: No position in the stock/s.
