Rising Star Buy: Transocean, Again

This article is part of our Rising Stars Portfolios series.

In early November, I chose Transocean (NYSE: RIG  ) as the first purchase for my Messed-Up Expectations (MUE) Portfolio. At the time, the market was expecting free cash flow (FCF) growth of 0.7% per year or less for a decade, followed by no more growth -- ever.

I purchased shares the day before the company released earnings for the third quarter. And, as expected, results weren't so hot. Free cash flow for the last four quarters dropped from $2.9 billion (ending June 30) to $2.5 billion (ending Sep 30). This was mostly the result of a drop of $342 million in net income between the two different time periods aided by the moratorium on deep water drilling in the Gulf.

Happily, despite the quarterly results, as the Gulf oil spill becomes older news, the market has actually bid the share price of Transocean up -- about 10%, in fact -- since I first purchased. So why am I buying more?

First, the market is still expecting very little out of the company. At last night's close of $69.68 per share, the market expects FCF growth to only be 6.1% per year for five years, 3% per year for the next five years, and nothing after that (at a 15% discount rate). More than a month ago, yes, but those numbers are still way below the company's 3- and 5-year average annual growth rates for FCF of 20% and 36%, respectively.

Second, as we continue to move away from all the emotion tied up in the Gulf spill, the headline risk for Transocean will decline further, making people more comfortable with the idea of investing in the company. Similar dynamics have helped shares of BP (NYSE: BP  ) -- the operator of the rig that exploded, leading to the spill -- rise nearly 60% from their nadir last July.

Finally, Transocean has signed contracts for its three newest deepwater rigs at very favorable dayrates. Plus, if Transocean is able to negotiate some sub-leasing of its idled deepwater rigs in the Gulf, like Ensco (NYSE: ESV  ) has been able to do with one of its rigs, it could earn more than the standby rates it's currently receiving.

In short, the original thesis remains intact and the risk is slowly declining, so tomorrow I'm increasing the MUE Portfolio's position from an initial investment of 2% of starting capital to 4%.

Come to the Messed-Up Expectations discussion board to tell me why I might be right (or wrong), as well as to read more behind this pick and the others I've made.