Transocean (RIG +6.71%) just announced earnings that beat analysts' expectations -- with caveats -- in both sales and earnings per share. However, the better than expected results hide massive trouble looming over the horizon courtesy of the worst oil price crash since the financial crisis.
The numbers Wall Street cares about
Analysts were expecting the company to announce $0.77 per share in earnings derived from $2.1 billion in revenue for the quarter, and $4.79 per share and $9.02 billion in sales for the full year.
Transocean's actual results just came in 7% ahead of estimated revenue and 23% above earnings expectations for the quarter, and the company beat full-year earnings expectations by 3%, but only when goodwill impairments from rig value losses and scrapped rigs are excluded. If you include last quarter's $2.8 billion rig value writedown and this quarter's $992 million impairment charge -- then Transocean actually lost $1.9 billion for the full year, or $5.29 per share.
The numbers that really matter: some good, a lot bad
Long-term investors know that Wall Street expectations are often short-sighted, and that one quarter's or even a full year's results are less important than the underlying growth prospects going forward. On that front, Transocean's results offer a faint glimmer of good news offset by a whole lot of trouble ahead.
For example, thanks to the $3.7 billion in writedowns over the last six months, Transocean now says it has no more goodwill remaining on its balance sheet.
This means the probability of future writedowns is diminished, although not completely eliminated. That's because the company's large fleet of aging rigs, many of which are currently idle or with contracts expiring this year, will still likely decline in value if the company attempts to sell them or retire them permanently.
The only other good news was an increased rig revenue efficiency this quarter compared to the third quarter -- indicating less down time for contracted rigs -- of 95.3% compared to 92.6%. However, the overall message of this quarter's earnings release was a deeply gloomy one -- especially concerning what lies ahead in 2015.
Fleet utilization and backlog declining
Transocean's fleet utilization for the quarter came in at 72%, down from 75% in the previous quarter. The drop was due to several of its rigs coming off contract, a problem that will likely get worse in the coming year.
More troubling for long-term investors is the fact that the company's backlog of contracts crashed 22% compared to last year, and it now stands at $21.2 billion compared to $27.2 billion a year ago.
Troubles loom in 2015
There are three risks I think long-term investors need to watch in the year ahead: mounting debt, falling fleet utilization and backlog, and a suspension of the dividend.
Transocean recently slashed its dividend by 80% to preserve cash, but that wasn't enough to prevent credit rating agency Moody's from downgrading its debt to junk status.
Moody's cited Transocean's large new build program -- it has 12 rigs under construction, only five of which have contracts secured -- as the primary catalyst for the downgrade because it's expected to push the company's net debt to EBITDA, or earnings before interest, taxes, depreciation, and amortization, up to 5.5-6.0 times by 2017.
Management says it's been able to to push off delivery of five of those new rigs for six months, to the first quarter of 2016. This will allow Transocean to postpone making large final payments for delivery of those rigs, and gives it more time to hunt for contracts. However, it doesn't change the fact that eight of its 31 high-specification ultra-deepwater, or UDW, rigs -- its most profitable rig type -- are now without work, and nine more UDW rigs' contracts expire this year.
In fact, UBS analysts believe that up to 50% to 60% of Transocean's UDW fleet might be idle by the end of the year unless oil prices recover. That is terrible news, because while UDW rigs are expensive to operate at $250,000 per day, cold stacking these high-tech assets still requires $110,000 per day in maintenance costs.
Thus, should oil prices fail to recover by the end of 2015, Transocean may face a situation where 17 of its most valuable rigs are costing it $1.87 million per day to maintain -- $683 million annually -- while generating no revenue. Such a worst-case scenario, combined with Transocean's UDW new build deliveries in 2016, will likely send dayrates and cash flow plunging, potentially forcing Transocean to completely suspend its dividend in order to preserve as much cash as possible.
Investor takeaway
While Transocean may have beaten expectations this quarter and year -- if one ignores $3.7 billion in writedowns -- its declining utilization rate, shrinking backlog, and large number of idle rigs pose major hurdles for investors in 2015.
If oil prices remain low throughout the year, I think it's possible Transocean will have to completely suspend its dividend, potentially sending share prices lower still.
While long-term investors might be able to use this as an even better buying opportunity for an already undervalued stock, be aware of the risks potential long-term low oil prices pose to the industry, and adjust your diversified portfolio accordingly.
