Investment overview
As challenging times continue for offshore drilling companies, I believe medium-term investment opportunities exist in stocks that have been beaten down and still have decent fundamentals.
One of these stocks is Transocean Ltd. (RIG, Financial), which has slumped 48% year to date and currently trades at $7.6. While industry concerns are likely to persist, Transocean is oversold. I am bullish on the stock for decent returns in the next three to six months.
Backlog addition
One of the most important reasons to be bullish on Transocean is the company’s strong order backlog.
On Aug. 15, Transocean announced the acquisition of Songa Offshore (SGAZF, Financial). Prior to the acquisition, the company’s order backlog was healthy at $10.1 billion.
Further, for the remainder of fiscal 2017, the company’s order backlog is $1.2 billion. For fiscal 2018, the company’s backlog is $2 billion. In other words, the company’s near-term cash flow visibility is robust even as challenging industry trends sustain.
With the acquisition of Songa Offshore, the company’s total backlog has swelled to $14.3 billion with the remainder of fiscal 2017 and fiscal 2018's backlogs at $1.6 billion and $2.7 billion respectively. While the company’s debt profile has also changed, overall credit health remains strong.
The key point is Transocean has a backlog of $4.3 billion for the next 18 months. This will ensure smooth debt servicing and positive cash flows.
If offshore market conditions start showing gradual improvement, Transocean is well positioned for healthy financials and strong stock upside.
Balance sheet health
Including debt assumed as a result of the Songa Offshore acquisition, Transocean has $1.7 billion in maturing debt for the period between 2017 and 2019. Subsequently, $3.1 billion of the company’s debt matures between 2020 and 2022.
As of June 30, Transocean had total cash of $2.2 billion. Through 2019, the company expects operating cash flow in the range of $0.8 billion to $1.2 billion. Considering the mid-range of the guidance ($1.0 billion in operating cash flow), the company’s liquidity buffer comes to $3.2 billion.
Even if the $1.7 billion of debt through 2019 is repaid with the cash buffer, Transocean will still have liquidity of $1.5 billion. The company expects capital expenditures of $0.7 billion through 2019, which would imply a cash buffer of approximately $0.8 billion.
In addition, Transocean has a $3 billion line of undrawn revolving credit that adds to its near-term liquidity buffer. In other words, I see no balance sheet constraints through fiscal 2019 and I expect industry conditions to improve. This will ensure Transocean navigates the crisis without any credit crisis, unlike Seadrill Ltd.Ă‚ (SDRL, Financial).
Quality fleet
Over the past several years, Transocean has focused on fleet transformation. Even with the industry slump, the company is likely to emerge from the crisis with its fleet quality improving.
With the recent acquisition of Songa Offshore, the company has added four high-specification, harsh environment semisubmersibles to its fleet, increasing its total fleet of these vessels to 11, which is the biggest in the industry. Seadrill is second with eight harsh environment floaters.
Overall, the company’s fleet is well positioned for long-term contracts as industry conditions recover in the next 12 to 18 months. An important point to note is even with industry recovery, the EBITDA might remain compressed. This holds true even for high-specification floaters. I believe, however, this factor is already discounted in the current stock price.
Conclusion
Transocean’s acquisition of Songa Offshore is a bold move toward industry consolidation as challenging times sustain. While the market reaction has not be positive, I believe the deep correction is a good opportunity to accumulate Transocean for the medium term.
For Transocean or any other offshore drilling stock, however, I would advise small exposure instead of a big plunge. Broad market valuations might be a potential concern in the coming months.
Disclosure: No positons in the stocks discussed.
