Transocean’s Tide May Finally Be Rising

Offshore oil-drilling contractor RIG gets some needed good news

   
Transocean’s Tide May Finally Be Rising

After a long, difficult year, Transocean Ltd. (NYSE:RIG) received a double-dose of good news on Monday. The stock of this offshore oil and gas drilling contractor was upgraded to a buy with a $65 price target by BMO Capital Markets, and CEO Steve Newman bought 6,500 shares — his first such purchase in five years. The stock jumped over 5% on the news, then proceeded to hold its gain on Tuesday. Could this mark the bottom for Transocean?

It just might if the broader market holds up, but the RIG story is still extremely messy. The stock was off over 32% year-to-date through Monday, and at its current level near $45, it’s well below its March high near $86. And with good reason: The litany of bad news has been enough to send any investor headed for the exits. During 2011, Transocean has missed earnings four times, made an expensive acquisition, issued new stock and faced an increasingly unfavorable regulatory environment. Not least, Transocean remains tainted from its role in the BP (NYSE:BP) Gulf of Mexico oil spill disaster of 2009.

This has been a perfect recipe for underperformance, but it’s nearing time to start looking forward. Consider the following:

1) Overall industry demand is expected to strengthen in 2012. A recent report from Barclays predicts that exploration and production spending will rise 10% in the year ahead. Looking further out, Transocean’s focus on deepwater drilling should position it to benefit as a greater percentage of the world’s energy production moves toward more challenging deposits.

2) The capital allocation issues, while important, are likely over at this point. It’s unlikely RIG has the firepower to make another acquisition, which would preclude further share offerings. This indicates that the worst of the headline risk is out of the way, and an investment in Transocean becomes largely a question of waiting for investor confidence to return.

3) On a valuation basis, RIG has a higher P/E than many of its peers, but it’s very cheap in terms of both price-to-sales and price-to-book:

2012 P/E Price-to-Sales Price-to-Book YTD Return
Transocean RIG

12.9

1.61

0.69

-32.20%

Noble Drilling NE

8.7

3.52

1.14

0.46%

Diamond Offshore DO

12.7

2.49

2.00

-2.19%

Helmerich & Payne HP

10.7

2.49

1.94

21.27%

Atwood Oceanics ATW

8.6

4.18

1.63

12.78%

Seadrill SDRL

11.1

3.83

2.56

10.04%

 

4) The technicals are favorable, as the stock has now found support in the low-40s on three separate occasions:

Kenny rig Transocean's Tide May Finally Be Rising

5) The median estimate of the 35 analysts who cover Transocean is $64, 42% above current levels.

6) Transocean may be an attractive dividend play. It has declared a future 79-cent-per-quarter dividend that would put the current yield of the stock at about 7%. The reason for the high dividend, and the use of the word “may,” is the question of whether the company has sufficient cash flow to support the payout. But the possibility that the dividend will be suspended is largely baked into the share price at this point. If RIG proceeds as planned, investors will receive a dual benefit: a substantial yield and the share price appreciation that will occur with the removal of this cloud hanging over the stock.

Transocean shares aren’t without risk, since the management team needs to prove to shareholders that it can execute effectively and stop delivering negative earnings surprises every three months. Because of this, it’s a story that may take 6-12 months to play out.

But with so much bad news already in the rear-view mirror, the potential reward now outweighs the risk. With more positive developments such as those that occurred on Monday, RIG may well be on track to emerge as a top performer in large-cap energy during 2012.


Article printed from InvestorPlace Media, http://investorplace.com/2011/12/transoceans-tide-may-finally-be-rising/.

©2014 InvestorPlace Media, LLC

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