When the drill bit of an offshore oil rig hits the ocean floor, it keeps drilling down through it. That's an apt metaphor for offshore rig operator Transocean (NYSE:RIG). Every time the company seems to have hit rock bottom, it just keeps heading downward. Over the last 10 years, shares have lost 95% of their value.

After a December share price pop and some good news about new contracts in early January, investors were hopeful that maybe Transocean was (finally) turning things around. But then came the company's fourth-quarter 2019 earnings report on Feb. 17, bringing a disappointing revenue miss. Here's what investors need to know.

A view of the water and drilling equipment from the platform of an offshore oil rig

Once a top performer in the oil industry, Transocean has underperformed in recent years. Image source: Getty Images.

By the numbers

The company's Q4 numbers were, frankly, terrible:

Metric Q4 2019 Q3 2019 Q4 2018 % Change (YOY)
Revenue $792 million $784 million $748 million 5.9%
Net income (loss) ($55 million) ($825 million) ($243 million) N/A
Adjusted net income (loss) ($263 million) ($234 million) ($171 million) N/A
Earnings (loss) per share, diluted ($0.08) ($1.35) ($0.48) N/A
Adjusted EPS, diluted ($0.43) ($0.38) ($0.34) N/A
Adjusted EBITDA $223 million $245 million $260 million (14.2%)

Data source: Transocean. YOY = year over year. EBITDA = earnings before interest, taxes, depreciation, and amortization.

About the only positive here is that revenue increased slightly, on a sequential and year-over-year basis.

While the company reported a smaller net loss than it did in the third quarter of 2019 or Q4 2018, that was largely due to one-time net favorable items. On an adjusted basis, which stripped out those favorables (along with some unfavorable items from the prior quarters), the net loss was much higher over the prior year. 

You can see this most clearly in the adjusted EBITDA number, which not only strips out those one-time charges and benefits, but also depreciation. EBITDA was down both sequentially and year over year. In other words, the company's making slightly more revenue, but it isn't enough to save the bottom line. Small wonder that shares took a 2.4% hit after the earnings release.

What management had to say

In a company press release, CEO Jeremy Thigpen followed a tried-and-true formula for a bad quarter: Don't focus on the worsening financials. Instead, he highlighted whatever positive numbers he could find:

I would like to recognize, and thank, the entire Transocean team for once again delivering solid operating and financial results in the fourth quarter. As utilization across our floating fleet improved for the first time in over five years, and dayrates for high‑specification ultra‑deepwater assets increased 75% over the course of the year, we believe that 2019 marked the beginning of the much-anticipated recovery in the offshore drilling industry.

While Thigpen is correct that the company's fleet utilization percentage improved, from 61.2% in Q1 2019 to 66.7% in February 2020, that statistic is misleading. In 2019, the company had a 49-ship fleet, of which 30 were being utilized. Over the course of the year, the company sent five ships to the scrapyard and put one new ship into service, which means in February 2020, it was utilizing...still 30 ships (see chart below for more details), out of 45 instead of 49.

Dayrates did indeed improve for most rig classes throughout 2019, but data from IHS Markit shows most improvement in the 10% to 20% range: nowhere close to the 75% that Thigpen cites. And even with that increase, the company is still operating at a loss. If the industry has indeed turned the corner, it may still be a long slog to profitability.

What's next for Transocean

If Transocean hopes to turn things around, it's probably going to have to see a big increase in its fleet utilization. Oil prices are now lower than at any time during Q4, and it's unlikely that dayrates will increase significantly until that changes. On Feb. 14, the company released its fleet utilization update:

A pie chart showing Transocean's fleet utilization

Data source: Transocean. Chart by author.

The green slices of the pie represent rigs that are in use: those that are generating revenue. In February, that was 66.7% of Transocean's 45-vessel fleet (not counting two vessels under construction). The orange slices are "stacked" rigs: rigs that have essentially been put into storage. These vessels represent 28.9% of the company's fleet. Transocean currently has just two idle rigs: those that are available but currently uncontracted, represented by the blue slices. 

When one-third of your fleet is sitting around doing nothing, that's a problem. Stacked rigs incur fewer costs than idle rigs, but still require maintenance and upkeep, which hurts the bottom line. But bringing a stacked rig back online requires a massive one-time outlay of cash. Estimates vary by drillship and company, but even low estimates run in the tens of millions of dollars. Transocean has estimated the cost of unstacking a seventh-generation ultra-deepwater drillship at $50 million. That's why Transocean opted to scrap four of its stacked deepwater drillships in 2019 rather than hang onto them.

In response to a question during the earnings call, Senior Vice President of Marketing, Innovation and Industry Relations Roddie Mackenzie was adamant that the company would not unstack any rigs on spec: it would wait until "the contracts support that." Part of this equation is prevailing dayrates, which are currently in the mid-$200,000s. According to Mackenzie, "I think you need to see us probably move into the kind of high-200s, low-300s before you would contemplate reactivation."

Investor takeaway

Most of Transocean's stacked rigs are ultra-deepwater rigs, which aren't currently in demand. And it's unclear how quickly -- if at all -- the company will be able to secure the additional contracts necessary to bring these rigs back online. Five of them have been stacked for more than four years now, which means they could cost a pretty penny to resurrect. But without them, Transocean's net losses -- which have been ongoing for more than two years -- seem likely to continue.

Until Transocean can show that it can generate a profit under the current energy industry conditions -- or until those conditions change -- investors are probably better off steering clear.