Rising Star Buy: Transocean, Again

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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.

The Fool owns shares of Ensco and Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool analyst Jim Mueller owns shares in Transocean and BP. He works for the Stock Advisor newsletter service. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 08, 2010, at 11:09 PM, bucheron wrote:

    I got them at 46$ about 5 months ago :P.

  • Report this Comment On December 08, 2010, at 11:28 PM, trenton1ryan wrote:

    I got them at $44.97-


  • Report this Comment On December 08, 2010, at 11:43 PM, trenton1ryan wrote:

    7 months ago...


  • Report this Comment On December 11, 2010, at 7:29 AM, skypilot2005 wrote:

    "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%."

    Jim, my average cost is $49.09 including commissions. I've bought a lot of it. In total, about 5% of my portfolio. I am looking to hold it for at least 10 years until I retire.

    My question for you is, Do currency exchange rates effect this stock - positively? Because, it is a Swiss company and they have a relatively strong currency. Do you think this will also, add value to the stock in the future?

  • Report this Comment On December 14, 2010, at 3:55 PM, TMFTortoise wrote:

    Hi skypilot,

    Just saw your comment. Congrats on a great basis.

    Over the long term, which I'm taking from your 10-year time frame on this one, currency effects will almost assuredly net out to pretty much nothing. It's popular today to say the dollar is heading down and is doomed, but that's probably not going to be the case for the long term (especially the "doomed" part). The dollar will rise, it will fall. Short-term effects; yes, long-term, most likely not.

    Thanks for reading!


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Transocean CAPS Rating: ****