With Brent oil surging above $100 per barrel, the energy sector has turned out to be an attractive investment theme in 2022. Oil and gas exploration stocks have surged with companies looking at significantly higher price realization. Onshore and offshore rig drilling services is another sub-sector that stands to benefit from positive tailwinds. An attractive name that’s worth considering is Transocean (NYSE:RIG) stock.
From a price-action perspective, RIG stock has trended higher by just 12% in the last 12-months. However, there has been a 16% rally in the last one-month. Clearly, higher crude oil price has translated into momentum for RIG stock after an extended period of consolidation.
It’s important to note that there are several factors that will support oil price around current levels. This includes geo-political tensions, sanctions and monetary inflation. Even if crude oil corrects on a relative basis, I don’t see a case where Brent is trading near $60 to $70 per barrel.
This is important to mention because Transocean provides offshore rig drilling services. In general, the break-even oil price for offshore projects is higher than onshore. Therefore, if there is visibility for oil remaining firm at higher levels, offshore drilling will gain traction in the coming quarters. This will be positive for Transocean.
Order Backlog and Revenue Visibility
As an overview, Transocean currently has 39 floaters that are suited for ultra-deep-water and harsh environment drilling. Since 2014, the company has pursued fleet transformation and the current age of the fleet is approximately 11 years. A modern fleet provides Transocean a competitive advantage as offshore drilling activity accelerates.
One reason to like Transocean is the current order backlog. As of March 2022, the company reported a backlog of $6.5 billion. There are two important points to note related to the backlog.
First and foremost, the backlog is front-end loaded. In simple words, the backlog provides clear revenue and cash flow visibility for 2022 and 2023. Also, with positive tailwinds, it’s likely that the backlog for the next 12-24 months will improve.
Furthermore, 90% of the backlog is with investment grade companies. This is an important consideration as the cash flows are secure.
Revenue Growth and Margin Expansion
As of February 2022, Transocean reported an operating fleet of 25. The company had two ultra-deep-water rigs under construction. Additionally, 12 rigs were cold stacked.
The cold stacked rigs provide revenue growth visibility in the coming quarters. If Brent trades around $100 per barrel, it’s likely that all the cold-stacked rigs will be operational. This will not only translate into revenue upside, but also support EBITDA margin expansion.
It’s also worth noting that new contracts for rigs are likely to come at a relatively higher day-rate. For 2021, Transocean reported an EBITDA margin of 36%. I believe that EBITDA margin expansion is due in 2022 and 2023.
Closely associated with margin expansion is the company’s cash flow potential. For fourth-quarter 2021, Transocean reported operating cash flow of $185 million. This would imply an annualized OCF of $800 million. Considering the potential for margin expansion in the coming quarters, Transocean is positioned for OCF in excess of $1 billion. This will boost the company’s financial flexibility.
The Bottom Line
As of December 2021, Transocean reported cash and equivalents of $1.4 billion. Further, the company had an undrawn credit facility of $1.3 billion. With the projected increase in operating cash flows, the company is fully financed through 2023.
Also, as EBITDA swells, the company is unlikely to face any challenges on the debt servicing front. On the contrary, Transocean is looking at debt reduction in the range of $2.3 billion to $3.9 billion through 2026. Overall, the credit profile of Transocean will improve and this will have a positive impact on RIG stock.
With these factors on consideration, RIG stock looks attractive. The current upside momentum is likely to sustain with results likely to improve on a quarter-on-quarter basis. I would bet on the stock doubling in the current break-out.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
