The problem with investing in energy companies like Transocean (NYSE:RIG) is the lack of control. Energy price movements can overpower strategy and execution. With the RIG stock price bouncing off an all-time low, owners of Transocean stock are learning that lesson at the moment.
At the lows, all hope is not lost. Transocean still seems to be the leader in offshore drilling in terms of both quality and rig count. Debt on the balance sheet is a concern — but that debt is manageable. The RIG stock price was over $100 last decade; it hardly seems to take a perfect crude environment to suggest real upside from the current price of around $7.
Indeed, I argued in July that Transocean stock was an intriguing high-reward, high-risk play. Unfortunately, the risks are playing out. Plunging oil demand is lowering expectations for rig demand. The company’s acquisition of Ocean Rig looks poorly timed given that downturn. And, at best, it seems like the Transocean story is one that will require quite a bit of patience. The rewards still might be out there — but they seem likely, at best, to be a long way out.
The RIG Stock Price Follows Oil Down
The RIG stock price has dropped by 50% since early October — and the problem is oil prices. Brent crude prices are down by about one-third over that stretch; given Transocean’s financial and operating leverage, the larger declines in RIG stock make sense.
Indeed, RIG isn’t alone in falling sharply during this sell-off. Chesapeake Energy (NYSE:CHK) touched its lowest levels this century, save for a brief bankruptcy scare in early 2016. Oilfield servicer Halliburton (NYSE:HAL) is at a seven-year low. So is Exxon Mobil (NYSE:XOM). Fellow UDW plays Noble Corporation (NYSE:NE) and Seadrill (NYSE:SDRL) have performed even worse than Transocean stock.
For RIG stock, the problem is clear. Falling crude prices will limit the viability of offshore drilling projects going forward. That, in turn, lowers demand for Transocean rigs. Given that the company — and the industry — already has a surplus of idle equipment “cold-stacked” (to use industry parlance), that lower demand suggests a continuation of current conditions. That’s probably not good enough.
Transocean Stock Can Muddle Through
That said, current conditions aren’t that bad. Trailing twelve-month adjusted normalized EBITDA (which backs out termination fees) is nearly $1 billion, suggesting a sub-11 multiple. That figure actually should come down once Ocean Rig profits are tacked on. Net debt of nearly $8 billion (pro forma for Ocean Rig) is worrisome in that context. But liquidity isn’t an issue — the company has $3 billion of capacity on its undrawn credit facility — and most of the debt isn’t maturing any time soon.
There are risks here, but Transocean has time. It’s not as if low demand will send the company into bankruptcy in 2019 — or even 2021 or 2022. Any investor buying RIG stock at $10+ for most of this year was betting on a further recovery in oil prices — and increasing demand for drilling rigs. That scenario still can play out at some point, even with Brent below $60. It simply may take a little while longer. In the meantime, Transocean stock is available at half price.
How Long Do Investors Need to Wait?
That said, it’s tough to make the case for buying RIG stock right now, knowing that a recovery very well could be years off. The Ocean Rig deal wasn’t a bad one, necessarily: on this site, Aaron Levitt called it “a mixed bag“, and that seems about right. But it looks much worse at the moment, given that Transocean used cash and stock to acquire more rigs while not being able to utilize the ones it already owns.
Expectations for utilization going forward, meanwhile, have taken a huge hit. Both oil prices and stock prices are signaling an elevated risk of recession. Deepwater projects are going to be reviewed in the context of the recent decline. Even if that decline reverses in the near-term, the recent fall to a 52-week low is going to make oil company executives wonder whether another plunge is on the way.
If oil prices rise, the RIG stock price likely will follow. But that’s far from guaranteed — and the problems in the rig space aren’t going away. Capacity will be a problem for years. Day rates already are dropping and could fall further if Brent doesn’t rally. Transocean might not go bankrupt — but this still is a company valued at nearly $4 billion (including shares issued in the Ocean Rig acquisition).
That’s a big valuation for a company with muted mid-term growth prospects. Even for investors who like the long-term story, it’s hard not to believe that an investor can buy Transocean stock in 2019 or 2020 for a very similar price.
As of this writing, Vince Martin has no positions in any securities mentioned.