It doesn't seem like it was that long ago when Transocean (NYSE:RIG) was considered one of the best-run energy-related companies and the leader in the offshore drilling industry. While Transocean still has far and away the largest offshore fleet, the company's issues with downtime, operational efficiency, and legacy Macondo liabilities has eroded a lot of the goodwill the company had built with the Street. Transocean's valuation doesn't appear very demanding today, and an improving deepwater market should help, but management still has to rebuild its credibility if the stock is to get the sort of valuation it used to enjoy.
SEE: Pros And Cons Of Offshore Investing
Second Quarter Results Another Step Toward Normal
Transocean's second quarter was no blockbuster, but it was the sort of result that should help build investor comfort with the state of operations.
Revenue fell 7% from the year-ago level, but rose 9% sequentially and was basically in line with expectations. Not surprisingly, more specialized/scarce equipment did better – ultradeepwater revenue rose 5% and 15%, while harsh environment revenue rose 8% and 1%.Utilization rates were better almost completely across the board, with the sequential utilization number for midwater floaters being the only negative comp. Dayrates were more scrambled, though generally up on a sequential basis (with ultradeepwater rates up 11%).
Profitability is also improving as the company puts legacy issues with GE (NYSE:GE) bolts behind it. Operating income rose 18% and 34%, while EBTIDA rose 4% and 23% and came in a little bit ahead of expectation. Fleet revenue efficiency jumped six points sequentially (to 93), and though management expected ongoing improvements (the ultradeepwater fleet is at 91.1 and still below the 94 target), those improvements aren't likely to be smooth and linear from here.
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With An Old Fleet, Can Transocean Still Be What It Once Was?
One of the hesitations I have in owning Transocean is my concern about the extent to which past results don't guarantee future performance. Transocean built a very strong operating reputation, but it's fleet has aged.
While SeaDrill's (Nasdaq:SDRL) fleet averages about four years in age, Ensco's (NYSE:ESV) 11 years, and Noble's (NYSE:NE) 17 years, only Diamond Offshore (NYSE:DO) has a higher average fleet age (28 years) than Transocean's 21. Not only does age mean less reliability and potentially higher maintenance spending, but the capabilities don't necessarily compare as favorably, as the water depth, deck load, and hook load capabilities of Transocean's fleet start to trend below average.
As has been the case with land drillers like Helmerich & Payne (NYSE:HP), newer equipment tends to attractive better terms, and I do have some concerns there with Transocean. Likewise, the maintenance burden could lead to more downtime and lower margins.
How Aggressively Should Management Act?
I'm not sure Transocean management has an abundance of choices when it comes to improving shareholder value. Although shipyards are likely looking to bargain, it would be very un-Transocean-like (and likely unpopular with the Street) for the company to commit to a meaningful number of on-spec newbuilds (that is, building new rigs without contracts in place with energy companies like Exxon (NYSE:XOM) to put them into service). Likewise, Transocean doesn't seem to have the type of fleet that would lend itself to a good master limited partnership (MLP) structure.
That may leave M&A as an option. I'm not expecting Transocean to make a move, but a deal for a company like Vantage Drilling (NYSE:VTG) or Pacific Drilling (Nasdaq:PADC) could add some growth during this cycle.
The Bottom Line
Transocean has historically traded at a multiple of 7.5x to forward EBITDA, and that would imply a fair value of almost $60 today. With the stock below $50, clearly the Street no longer believes that the old rules should apply. So the question is one of how much discount is fair. A multiple of 7x would still leave the stock more than 10% below fair value and that seems like too much of a discount given the improving dayrates and trends in the offshore drilling space. So while I'd be very careful about assuming that Transocean will ever regain former glories, the Street seems a little too down on what is still a major operator in an attractive market.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.