Transocean is Missing the Mark

Oil driller Transocean (NYSE: RIG  ) has a number of broad catalysts working in its favor. The global economic recovery remains steady, and demand for energy is rising, particularly in the emerging markets. That's why many oil drillers, such as Seadrill (NYSE: SDRL  ) , had very strong results in 2013.

And yet, Transocean completely whiffed in the fourth quarter, which weighed on its full-year results. Whereas Seadrill realized improvements in key metrics for oil drillers such as utilization and fleet efficiency, Transocean couldn't keep up. Investors should be at least slightly concerned that Transocean's problems are specific to itself, which may be a case of management ineffectiveness.

Transocean's year in review
Transocean's cash flow declined from $2.71 billion in 2012 to $1.92 billion last year. In percentage terms, that represents a nearly 30% decline. To be fair, $560 million of the decrease was due to a payment associated with its settlement with the Department of Justice stemming from the 2010 Macondo rig explosion.

Still, even excluding the settlement charge, Transocean's operating cash flow declined last year, due in large part to an extremely poor fourth quarter. Transocean realized worsening utilization and fleet efficiency in the final three months of the year. Utilization stood at 75%, down eight percentage points from the third quarter. In addition, fleet efficiency dropped on a quarter-over-quarter basis as well, to 91%. The reason for this is that Transocean was forced to endure prolonged downtime on certain ultra-deep water rigs.

Transocean's poor quarter was certainly a surprise, as oil drillers are seeing strong results for the time being. While there are broad concerns over the industry's near-term future, the fourth quarter was supposed to have been strong. Indeed, Seadrill reported 6.7% growth in operating cash flow in 2013. That's thanks to excellent utilization. Seadrill's floaters and jack-ups produced utilization rates of 94% and 98%, respectively, in the fourth quarter.

Moreover, Transocean's profits were weighed down by significantly higher expenses. Capital expenditures totaled $948 million, more than double the level from the third quarter. The sharply higher capital expenditure level was due primarily to expenses associated with Transocean's newbuild program.

This is an area that can be forgiven. Oil drillers across the board are experiencing higher expenditures, as the sector continues to grapple with aging fleets. Consider that fellow driller Diamond Offshore (NYSE: DO  ) received a tepid reaction from analysts when it projected 2014 capital expenditures would double from 2013 levels. Diamond Offshore expects to allocate $2.1 billion to newbuilds and upgrades of its fleet, compared to $1 billion spent on these initiatives last year.

As a result, it's not surprising to see Transocean's capital expenditure levels increase along with its peers in the industry. However, the fact that Transocean isn't executing in its core operating activities is indeed cause for concern. Transocean's lagging metrics imply that it's losing ground to the competition.

Near-term risks for Transocean
Transocean, along with other oil drillers, is forecasting a period of softness over the upcoming months, as the pace of global drilling contracts slows down. In addition, Transocean has a unique uncertainty that still lingers from the 2010 Macondo disaster. Following the incident, Transocean was forced by the U.S. government to implement enhanced regulatory and safety measures. As a result, this has caused Transocean to experience above-average out of service time and additional maintenance costs that other drillers don't have to worry about.

Further, a broader slowdown in customer demand puts pressure on Transocean as well. Of its three key operating segments, only its high-specification jackups are expected to sustain utilization rates and contracting activity through 2014. Its two other segments, high-specification and mid-water floaters, are both expected to see diminished demand, which will have a negative effect on utilization and dayrates.

The takeaway from Transocean's 2013 report is that while the industry as a whole is forecasting a slow period up ahead, Transocean has a particular set of concerns investors should be aware of. It's still being weighed down by the 2010 rig explosion which may cause it even greater down times and lower utilization than its competitors this year.

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