The Dark Side of Transocean Inc's First-Quarter Results

Transocean's first-quarter results looked good, but there are some worrying figures.

May 30, 2014 at 8:48AM

The best investors will always weigh up the pros and cons of any argument before investing, continuing to review both sides of the argument while they are invested.

It's always interesting to know both the bull and the bear arguments, and the bears' interpretation of Transocean's (NYSE:RIG) first-quarter results triggers some interesting questions.

Glass half full
Transocean's first-quarter results, were, for the most part viewed in a positive light. The company reported a rise in revenue to $2.34 billion from $2.25 billion the previous quarter, while the company's utilization rate came in at 78% compared to 75% for the fourth quarter of 2013.

Most analysts and investors were pleased with the company's cost-cutting initiatives, which helped shave 13% off of operating expenses, and the company's effective tax rate dropped from 17.7% to 15.1% during the quarter.

Transocean's net income for the first quarter came in at $466 million, or $1.27 per share, up from $313 million, or $0.89 per share as reported during the same period of 2013. 

But some analysts still found plenty to complain about.

Glass half empty
While the majority of the market was impressed by the fact that Transocean's sales hit a level not seen since 2008, the company still has approximately 20 drilling units set to roll off contract through both 2014 and 2015.

Some Wall Street analysts believe that as these floaters roll of contract, Transocean will have a tough time renegotiating new contracts at similar, or better levels than reported previously, causing some analysts to advise caution with the company. 

What's more, there is the possibility of execution risk in Transocean's plan to divest some older drilling units to improve efficiency and cut costs. Most importantly, it's questionable what kind of prices Transocean will be able to achieve for its older units.

Key to this plan is Transocean's recent decision to place old North Sea rigs into a new entity called Caledonia Offshore. Caledonia Offshore will contain eight of Transocean's North Sea drilling units, which together have an average age of over 30 years.

Transocean's management has stated it will create Caledonia during the second quarter of this year, although the company has not yet revealed whether it will spin off the entity or sell to a buyer; with such old units making up the new entity, it's likely Transocean would get a low price if it sold off the new company. The method of disposal will be key to establishing how likely it is that Transocean will be able to sell its old units at a good price.

Not the only one
Transocean is not the only offshore driller analysts have turned negative on during recent weeks. Atwood Oceanics (NYSE:ATW) has also attracted negative attention. 

In particular, analysts at Barclays believe that, based on recent data, including lower market day rates, Atwood's earnings for 2015 could come in 45% below current estimates. At present, Atwood currently looks cheap on a 2015 forward P/E multiple of 6.1, however, after factoring in the 45% drop in earning, this ratio drops to 11.1 -- cheap, but not as cheap.

Foolish summary
Overall, Transocean's first-quarter results contained some impressive numbers, and on the face of it, the company appears to be driving forward with growth. On the other hand, however, some analysts have expressed concern that Transocean will not be able to renegotiate expiring contracts at similar, or higher rates to those currently received. Further, some analysts have speculated that Transocean's asset divestment program may fail to yield the results expected. Only time will tell if these forecasts are correct.

A bullish bet on offshore drilling
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Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends Atwood Oceanics. The Motley Fool owns shares of Atwood Oceanics 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. The Motley Fool has a disclosure policy.

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