Is Transocean LTD Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Transocean LTD (RIG 2.24%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Transocean's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Transocean's key statistics:

RIG Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q4 2010.

RIG Return on Equity (TTM) data by YCharts.

Source: YCharts. *Period begins at end of Q4 2010.

How we got here, and where we're going
Transocean's scores count hasn't improved much since its prior assessment, as the deepwater oil exploration specialist only earned four out of nine possible passing grades on the test -- but that's still better than the one-of-nine score it picked up last year. One major source of that weakness is the company's falling free cash flow, which has fallen far below net income over the past few quarters, and which may be insufficient to maintain dividend payments if things don't improve soon. Transocean also carries substantial amounts of debt on its balance sheet, which makes it a rather risky stock for the long-term investor's portfolio. Let's dig a little deeper to see what Transocean is currently doing to turn around its sliding metrics and become a better company and investment going forward.

Transocean posted lower-than-expected revenue and earnings per share for its fourth quarter because of a steep decline in deepwater floater utilization as a result of slow demand. The company has also been suffering the effects of an aging deepwater fleet, which may not be competitive with newer rigs coming online at a rapid rate. Transocean and other offshore drillers, particularly Seadrill (SDRL) and Diamond Offshore (DO), have forecast reduced demand for drillships in the deepwater market, a weakness that's expected to persist for another year or two. As a result of these negatives, Transocean has lowered its full-year earnings guidance for 2014 by at least 15% from earlier estimates. Transocean also suffered a major setback in a settlement with the Department of Justice regarding the 2010 Deepwater Horizon disaster, which put a 30% dent in free cash flow in the last year.

Fellow Fool Tyler Crowe points out that Big Oil has been cutting capital expenditures because of insufficient returns from new drilling projects, which could hinder Transocean's revenue growth for some time. Day rates for ultra-deepwater drilling units are also expected to decline by approximately 16% over the next few years. As a result, Barclays downgraded deepwater drillers Transocean and Diamond Offshore, as both are more sensitive to swings in both energy prices and day rates compared to Seadrill, which has newer drillships and rigs to offer.

Transocean recently placed orders for 10 new jack-up drilling units as well as two drillships, which could help it catch up to rivals with younger fleets. Fellow Fool Rupert Hargreaves points out that the company has also implemented a restructuring plan to cut down operational expenses -- Transocean has been selling some of its non-core assets to focus on more profitable and challenging offshore drilling projects, which should help it hold the line on higher day rates. The company has also been aggressively signing new drilling contacts, resulting in an order backlog of about $30 billion. Despite its near-term challenges, Transocean foresees deepwater oil and gas drilling growing to a rate of approximately 1,250 wells per year by 2025, which is over twice the number of wells drilled last year. Transocean's board also recommended a dividend hike to $3 per share annually, which will push its yield to around 7% if approved. This could be dangerous for the company if free cash flow can't be improved, but the move does indicate that management has a strong sense of Transocean's long-term sustainability.

Putting the pieces together
Today, Transocean has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.