You would think that, after retiring almost 40 rigs in the past four years, Transocean's (NYSE:RIG) management would be done tinkering with its fleet. This past quarter, though, it elected to retire another four rigs -- and its income statement suffered the consequences.
Let's take a look at Transocean's most recent earnings results to see what kind of impact these rig retirements had on the bottom line, why management continues to make these moves, and what investors can expect from here.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$790 million||$664 million||$751 million|
|Operating income||($917 million)||($4 million)||($1.54 billion)|
|Net income||($1.13 billion)||($210 million)||($1.69 billion)|
The headline result in this earnings report looks awful, but it is almost entirely the product of asset writedowns from rig retirements in the quarter. According to management, Transocean took a $1 billion charge to retire four of its rigs that were taken out of commission. Absent these noncash charges, the company's net income result would have been a $0.04-per-share loss, which is a stark improvement from the prior quarter.
The more promising news here is the uptick in revenue, which came from a full quarter's worth of revenue from Songa Offshore, which the company acquired in January, and the activation of a newbuild rig that started operations in the middle of the first quarter. Meanwhile, the company remains active in marketing its fleet. In its most recent fleet status report, Transocean announced that it had added $405 million in backlog revenue thanks to nine contracts either for an extension of existing contracts or for short-term work for previously idled rigs. At the end of the second quarter, Transocean had $11.7 billion in contracted backlog on the books.
What management had to say
Even though drilling activity is on the rise and companies are finding work for reactivated rigs, there are still too many rigs on the market today. So Transocean decided to retire some rigs in the quarter that it thought would be challenging to get new contracts for the coming years. Here's CEO Jeremy Thigpen going through the rationale of rig retirements this late in the cycle:
[W]e recently announced the retirement of one midwater and three ultra-deepwater floaters. With these four rigs, we have now retired 43 floaters since the start of the downturn. As a result of these retirements, the divestiture of our jackup fleet and the addition of five newbuild ultra-deepwater drillships, six semisubmersibles from Songa and the Norge, we have completely transformed our fleet over the past three years.
Our current fleet now stands at 46, including the two ultra-deepwater drillships and one harsh environment semi currently under construction, with approximately 85% of that fleet categorized as either ultra-deepwater or harsh environment. In short, we now have a smaller but far more focused and competitive fleet than when we entered the downturn.
Based on the company's fleet characteristics, I wouldn't be surprised if the company retires more rigs in the next year or so. It still has five older rigs that can only handle midwater conditions (water depths of less than 1,500 feet, drilling depths of 25,000 feet), and some ultra-deepwater (water depths of more than 8,000 feet) that are approaching 20 years old. These rigs will likely stay on the books until they're done with contracted work, but afterward, it's very likely they too will be scrapped.
Not as cheap as it looks on paper, but still cheap
Transocean looks like a compelling investment, in large part because of its valuation. At a price to tangible book value of only 0.5, the market is saying that Transocean is worth less than the liquidation value of its entire fleet.
That said, the company's price to tangible book value is a little misleading, and this past quarter was an example of why. The $1 billion in writedowns for rig retirements in Q1 implies that not all of its rigs are worth their book value. The company is going to be retiring more rigs over the next couple of years, and that means there will be more similar writedowns in Transocean's future.
With a large contract backlog and a highly capable fleet of rigs, though, the foundation is there for a rebound as drilling activity picks up again. Even if its price to tangible book value isn't wholly representative of its underlying asset values, it looks as though the market is still underestimating Transocean's ability to reap the rewards of an industry turnaround.