Hold Off on Transocean for Now

RIG offers little with a lawsuit on its plate

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AskTheEditor logo2 Hold Off on Transocean for Now“How do you feel about Transocean (NYSE:RIG). Do you see it going above its 52 week high or staying right around where it is or going lower?” — Leeor

This is a complicated question. For starters, we have to assess the weight of pending litigation on RIG stock — never an easy task. Then we have to try and make a directional call on oil, since this driller is very much tied to the ebb and flow of crude oil demand and pricing. And of course then we have to look at this specific company among its peers to see how well it’s run.

The short analysis: I think it’s too risky to chase Transocean right now because of a host of unknowns and limited short-term upside. RIG might be a decent investment later this year or in early 2013 when the dust clears, but right now investors have to follow their guts instead of the facts on a lot of things.

As a guy who prefers hard facts to hunches, count me out.

That said, Transocean is one of the largest and most well-known names in offshore drilling services, and I believe in buying the best-in-breed stocks instead of second-tier companies. Many of the risks aren’t unique to RIG, so if you truly believe in a secular recovery for energy demand and crude oil prices, then this is your best bet among all the drillers in my mind.

On to the risks:

Litigation

Transocean is infamous for the Deepwater Horizon disaster in the Gulf of Mexico. Halliburton (NYSE:HAL) and BP (NYSE:BP), of course, were the other major players in that April 2010 oil spill.

Though more than two years have lapsed since the disaster, the Gulf spill is very much a factor in RIG stock these days. In February, Transocean killed its dividend of 79 cents a quarter — a roughly 6% yield at the time — to free up cash to fund litigation related to the spill.

At the end of June, Transocean reportedly was near a final settlement with the Department of Justice. Details remain very hush-hush, but estimates are that RIG will pay between $700 million and $1.2 billion in fines — which is a lot, but much less than it could face in civil and criminal penalties if a settlement isn’t reached. Transocean has set aside $1 billion for spill-related costs.

The rumor mill indicates that a settlement is likely and that it will be digestible for Transocean. But as I mentioned before, I bristle at uncertainty. I don’t play biotechs gambling on the whims of the FDA, and I don’t trust pending lawsuits to always wind down favorably. Because if the fine is higher than expected, RIG will suffer.

And by the way, the settlement with the DoJ doesn’t guarantee this is the end of litigation. Consider that the feds are exploring charges against BP officials for allegedly making false statements to Congress about the rate at which oil was escaping from the well.

The bottom line is that there’s no way of knowing how lawyers and judges will handle this. Remember that before considering an investment.

Soft Near-Term Demand

I have written extensively about the challenges to the U.S. recovery, the economic slowdown in China and the very real threats of a prolonged and painful recession in Europe. (Check out my column “7 Reasons to Stop Trading Until Thanksgiving” for all the gory details.)

Energy is a cyclical business, and we have seen most oil stocks languish amid weak oil demand. Oil majors Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) have both lagged the Dow with a paltry 4% return in the past 12 months. Offshore drilling peers Noble Corporation (NYSE:NE) and ENSCO (NYSE:ESV) are up 3% or less in the same period. It hasn’t been a great environment for energy stocks, and shares have reflected this.


Article printed from InvestorPlace Media, http://investorplace.com/2012/07/hold-off-on-transocean-for-now/.

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