What happened
Transocean (RIG +1.23%) fell 20% in July as lower oil prices soured investor sentiment on oil production and exploration stocks. No bad news came out in the month about Transocean, specifically, but lower-than-expected crude oil prices could threaten the company's financial performance in the coming quarters.
RIG Total Return Level data by YCharts
So what
The wild ride continues for energy-sector stocks. Crude oil spot prices recovered throughout the first half of 2021, and the West Texas Intermediate spot price was above $75 per barrel entering July. Things got ugly again in the middle of the month, and crude tumbled to the $65 dollar range by July 20.
Transocean provides deepwater and harsh-environment drilling services for companies that own the rights to offshore oil and natural gas wells. Low energy prices impact economics across the sector. Production volumes decrease, cash collection slows, and some companies may even fail to meet financial obligations.
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Transocean's drilling revenue has been flat or shrinking for most of the past five years. Moreover, the company's debt-heavy capital structure creates a financial health risk. The company was threatened with bankruptcy and exchange delisting as several of its bondholders contested the validity of assets pledged for a new round of bonds that were issued. The company has since improved its liquidity and seen its bond ratings improve, but it's still below investment grade with a negative outlook by rating agencies.
Now what
Transocean's stock will rise and fall with oil prices, but it brings financial risks that exaggerate these downward moves relative to its peers. The company operates a low-growth business that's extremely capital intensive. It will always need to invest large sums in heavy machinery to conduct its operations. Transocean is the opposite of nimble, and it has some real work to do before its financial health is more appealing to investors. The stock's price looks cheap relative to book value and cash flow in recent quarters. However, cash flows will be used to shore up its liquidity and cover debt obligations before shareholders see any return of capital.
Value investors might see an opportunity to get in on the ground floor of a financial health recovery story, especially if crude oil prices surge and stay elevated for several years. Outside of that scenario, clear risks to the downside remain.
