Why Pay up for Transocean?

The July fleet status report for Transocean, Ltd (NYSE: RIG  ) again provides an example of why the historical leader in the deepwater drilling sector is no longer the best investment going forward. The deepwater driller famously uses the website deepwater.com for its corporation, but it continues to struggle with old rigs in a market that demands the most modern capabilities.

Despite ongoing troubles ever since the Macondo explosion a few years back, the market actually places a sector-leading earnings multiple on Transocean. The interesting part is that the modern drillers such as Seadrill (NYSE: SDRL  ) and Ocean Rig UDW (NASDAQ: ORIG  ) with high growth profiles and longtime competitors like Diamond Offshore Drilling (NYSE: DO  ) all trade at lower earnings multiples.

Struggling fleet
Transocean operates a fleet of 77 mobile offshore drilling units consisting of 46 high-specification floaters, 21 midwater floaters, and 10 high-specification jack-ups. Also, the company is building 14 modern rigs while planning to spin off older assets, including up to eight of the midwater floaters in the UK North Sea via a company called Caledonia. The moves aren't quick enough to overcome the ongoing struggles.

The latest fleet report shows a large increase in downtime for the rest of 2014. The deepwater floater M.G. Hulme Jr. is now idle and the Transocean Amirante added 168 out-of-service days to prepare for future contracts. In addition, the contracts for two ultra-deepwater newbuild drillships were delayed by a quarter at a revenue reduction of roughly $600,000 per day for each.

Accordingly, analysts from Global Hunter cut the earnings estimates for 2014 to $4.42 and for 2015 to $3.74. While these numbers are still higher than the consensus, Global Hunter has a price target of $40 compared to the current price of around $43.

On the flip side, Ocean Rig continues to fill up the contract book. The company recently added two new contracts, including extending the length of work for the oldest rig by 260 days. The contracts secure most of the rigs with work for 2015.

High valuation
The interesting point about valuations in the sector is that companies with fleets of modern rigs actually trade at lower valuation multiples than those with older rigs. In this case, both the large Seadrill and the small Ocean Rig trade at valuation ranging from 8 to 11 times earnings estimates for 2015. For the older companies, Transocean trades at even higher valuations than the likes of Diamond Offshore, which has operations turning around to where earnings growth is expected next year.

RIG PE Ratio (Forward 1y) Chart

RIG P/E Ratio (Forward 1y) data by YCharts

Bottom line
The offshore drilling and especially deepwater-focused sector continues to trade at low earnings multiples for a stock market trading around 16x forward earnings. Within that sector, Transocean continues to trade at industry-leading earnings multiples despite continued downtime and out-of-service extensions with older rigs. Investors should consider this sector attractively valued and consider some of the newer and cheaper companies in the sector, including Ocean Rig trading at substantially lower earnings multiples.

Even for those looking for yield, Seadrill offers a higher dividend yield at 10% compared to the 6.6% yield at Transocean. Though Transocean isn't an overly expensive stock, the equation doesn't add up to paying more for it than other stocks in the industry like Seadrill, Ocean Rig, and Diamond Offshore.  

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