Is Transocean Appropriately Rigged for Your Portfolio?

Typically, a company's quarterly results, and management's subsequent discussion of current initiatives and future prospects, elicit something of a conclusion regarding the degree to which the corporation in question represents a compelling investment. With Transocean (NYSE: RIG  ) , however, there are conflicting trends that render a firm stance about its shares somewhat difficult.

The numbers
For its second quarter, Transocean reported earnings of $307 million, or $0.84 per share. However, if you back out special items, the per-share figure pops up to $1.08, about in-line with analysts' expectations, and up from the year-ago adjusted number of $0.89. Revenues were up 2.9% year over year, to $2.40 billion.

It's noteworthy that, as the quarter ended, Transocean paid the first installment of its $2.24 per-share dividend, giving the company a forward annual dividend yield of 4.60%. As a neophyte dividend payer, therefore, Transocean has climbed into the upper ranks among members of the oil-field services group from a yield perspective.

With the primary objective of drilling contractors to keep as many rigs as possible working as much of the time as possible, Transocean's 93.1% total fleet revenue efficiency rate of 93.1% represented a notable improvement from 88% for the first quarter of 2013. That rate expanded throughout the quarter, with June coming in at 95.6% fleetwide.

Chopping the outlays
As is the case at Diamond Offshore, its key rival in the deepwater and ultra-deepwater, Transocean's management is in the midst of a major cost-savings program. One aspect lies in reducing shore costs, an effort that is expected to ultimately chop up to $300 million annually from the company's outlays. At the same time, rig operating costs are being attacked through an examination of the offshore rig-based headcount, rationalization of training and development spending, and tighter hold on maintenance and inspections.

And then there are the benefits of fleet rationalizations. Thus far this year, Transocean has sold three standard jack-ups, and another three sales are pending. Beyond that, the company is jettisoning "low-spec commodity" floaters. One sale has already been closed, and three more sales are in the works.

Hand in hand with Chevron
Transocean is simultaneously adding new, more sophisticated rigs to its fleet. A new jackup is now working for Chevron (NYSE: CVX  ) in Thailand, and a second is set to join it. Two new ultra-deepwater drillships will begin operations in 2014, and another four units are under construction, but already contracted to Chevron, which obviously constitutes a major customer for the largest of the offshore drilling contractors.

Thus far in 2013, $5.2 billion in new contracts have been added to Transocean's backlog. Indeed, as of mid-July, the company's total contract backlog was fully $27.3 billion.

Tempered Optimism
Nevertheless, Terry Bonno, Transocean's senior vice president for marketing, interjected a cautionary note during the company's call:

During the second quarter the market experienced a decrease in contract duration and lead times. While the near term may be a little challenging, with the large number of rollovers of existing fleet and the influx of newbuilds into early 2015, we remain confident in the long term fundamentals and our customers' willingness to continue to increase their activity levels.

He later summarized the company's various markets by noting that the ultra-deepwater market remains healthy (led by the U.S. Gulf of Mexico and sub-Saharan Africa -- read: Angola -- along with the likelihood for demand to increase in Brazil). Conversely, he also said that, "While the deepwater market utilization remains over 90% today, we're seeing some potential for incremental idle capacity in the near term."

I'll also remind Fools that Transocean remains mired in litigation stemming from its 2010 tragedy in the Gulf of Mexico, wherein it was working for BP on the Macondo well. The second phase of a trial in New Orleans will commence in late September. In addition to BP and Transocean, the trial also has the potential to affect Halliburton.

From a valuation perspective, Fools should note that Transocean trades at approximately a 8.2 times forward P/E. That, despite its new, lofty yield, and a PEG ratio of a tough-to-top 0.41. At the same time, however, it's operating margin sits below 18%, compared with nearly 34% for Diamond Offshore. Its return on equity is slightly above 6%, or 60% below Diamond's.

Foolish takeaway
All in all, with the cautionary comments regarding the company's markets rendered during the call, the lingering Macondo uncertainties, and a less-than-impressive operating margin, I'd advise Fools to watch the company closely -- albeit from a distance -- until its significant question marks are eliminated.

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