Transocean: Worth the Wait for a Turnaround?

An offshore rig at night. Courtesy of Wiki Commons

With 92 rigs either operational or under construction, Transocean (NYSE: RIG  ) is the largest publicly listed offshore rig operator in the world. But to the layperson, the company is often most associated with the Macondo incident, in which a Transocean rig operated by BP blew out thanks to a drilling accident on the surface. The result was the worst oil spill in U.S. history. To make things worse, in 2012 management cancelled its quarterly dividend payment due to a declining fleet-utilization rate. 

Since the Macondo incident, the company has been one of the biggest investors in new, state-of-the-art drillships. Transocean also seems to grasp the fact that the brightest future for offshore activity lies in previously untouched ultra-deepwater depths of more than 7,500 feet: Only one company currently has more ultra-deepwater drillships under construction than Transocean. Management is attempting to transform the company into a more ultra deepwater-focused name with a young fleet. But with several other excellent offshore operators, many of which already have their ducks in a row, is it worth waiting around for Transocean?

Source: Seadrill Investor Relations

Building many, replacing many
The most important thing one must understand about Transocean right now is this: The company is heavily modernizing its floaters, which are ships that operate at greater depths. Above we see that Transocean's average floater is about 23 years old -- much too old for an industry where operators are demanding safer, post 2010-built vessels. 

On the other side of the coin, however, Transocean now has nine drillships under construction, the latest of which will be operational by sometime in the second quarter of 2017. Seven of these nine already have secure contracts. Over the next few years. Transocean will also retire and stack, as needed, a good number of its older vessels. 

By 2015, Seadrill hopes to increase its net income margin by $800 million as a result of contracting newer ships at higher dayrates and retiring older ships, which command much lower dayrates. Of the $800 million in expected margin increases, $500 million will come from operational efficiencies alone.

Image courtesy of Skytruth

Late to the game
Going back to the chart above, it's clear that Transocean was a bit slow to adapt to the new reality: Both Seadrill (NYSE: SDRL  ) and Ensco (NYSE: ESV  ) were quicker to see a bifurcated market, where operators are demanding both newer and more ultra-deepwater-oriented rigs.

Is Transocean too late? Definitely not. The secular change toward deepwater drilling is a long-term one, with powerful forces behind it. By 2015 or 2016, many experts believe that demand for deepwater and ultra-deepwater rigs will overwhelm supply. By then, Transocean will be a leaner, more profitable company with a fleet that will be well suited for the new realities of the market. 

Bottom line
While Transocean is indeed turning its ship around, many retail investors may still be nervous about this one. After all, the company had to cancel its dividend once in the past few years. Right now, Transocean's generous 6.7% yield is 85% of earnings. Transocean could therefore be a nice middle ground between an aggressive Seadrill, which yields 10% but pays 100% of cash flow to shareholders and a conservative Ensco, which pays a smaller 5.5% yield, accounting for 53% of earnings. 

In any case, I believe that Transocean deserves a second look. Management is by no means too late to adapt to the new realities coming, and I believe that the company will ultimately be well suited to win in coming years.

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