Transocean: Torque For The Coming Offshore Bull Market

Transocean Has A Wide Margin Of Safety Despite YTD Outperformance

Summary

• Transocean is a large company in the offshore sector. They have a debt heavy balance sheet, which creates additional risk, but potentially a larger reward for investors.

• The company recently reported Q1 earnings, where management confirmed their bullish outlook on the sector.

• Their refinancing in Q1 means they don’t have any significant debt maturities until 2027.

• Transocean, like other companies in the sector, are trading at a steep discount to rig replacement cost. Combined with increasing day rates, shares have a wide margin of safety for investors at $6, despite being up almost 40% YTD.

• I think we will see dividends and buybacks from Transocean in a couple years after management reduces the company’s debt load to a more reasonable level.

---

Overview

Transocean RIG 0.00%↑ is one of the largest players in the offshore sector, with a market cap of $4.7B. They have 39 rigs around the world. Approximately three quarters of these are ultra-deepwater (UDW) and the rest are classified as harsh environment (HE). They recently reported Q1 earnings, and I read the recent earnings call transcript. Management is still bullish on the sector, and they discussed some of the different regional dynamics in the offshore market. For example, they are seeing rigs start leaving the North Sea and Norway (which will probably lead to much higher day rates in the region in a couple years), along with continued demand for rigs from Petrobras in Brazil. They discussed new contracts they signed in the quarter and reported that their contract backlog has increased for the fourth consecutive quarter to $8.6B.

Transocean Investor Presentation

Of the 39 rigs, they currently have 12 rigs that are cold stacked. For the uninitiated, this means that they these rigs are available to contract but not currently operating. To bring these rigs online, they will have to be incentivized with higher day rates and the operator paying Transocean a reactivation fee (likely $75M to $125M based on the earnings call). Basically, I think we will see most of these rigs get reactivated at higher day rates which will be a huge boost for the business.

On the earnings call they predicted that we will see a $500k day rate by the end of the year. Like I said in the overview post yesterday, if the cyclical upswing continues, offshore companies will be printing cash at higher day rates. Transocean in particular has a lot of juice on the upside due to their large portfolio of assets and the deleveraging that is likely to occur over the next couple years. I also think that management is arguably the best in the sector, something I will touch on with Valaris VAL 0.00%↑ later in the week.

As I mentioned yesterday, offshore has very long cycles, with the last peak in 2014. Transocean was able to avoid the bankruptcies that hit the rest of the sector because they signed 10-year contracts with Shell at the peak of the last cycle. We can debate on if this was luck or skill, but either way, Transocean was able to navigate a brutal trough in the offshore cycle without going bankrupt. This has left them with a balance sheet loaded with debt, but I think that also gives shareholders a lot of upside as management takes advantage of the cyclical upswing to deleverage their balance sheet.