The extension of supply cuts by Russia and Saudi Arabia, along with a short-term dip in U.S. shale production, sent oil prices rising to new 2023 highs earlier this week. Additionally, Russia's decision to ban gasoline and diesel exports has further tightened global supplies, providing another boost to crude futures on Thursday. Against this backdrop, experts remain of the opinion that the tight supply conditions will persist till the year-end, and perhaps into the next year as well.
Taking all this into account - along with signs of economic stabilization in China - oil prices could remain at elevated levels for the foreseeable future. After surging 16% in the past month alone, crude futures for November delivery (CLX23) are trading mixed today, just below the $90 level.
This should be good news for the world's largest offshore drilling contractor, right? Let's dig in to find out whether Transocean (RIG) stock looks like a smart buy at current levels.
About Transocean
Based out of Switzerland and founded almost five decades ago, Transocean is the world's largest offshore drilling contractor in terms of revenue. The company has a fleet of over 30 rigs operating in more than 20 countries. Its customers include major oil and gas companies such as ExxonMobil (XOM), Chevron (CVX), and BP (BP). Currently, Transocean's current market cap stands at $6.095 billion.
Transocean stock has been on a tear in 2023 so far, rising more than 78% on a YTD basis. That's roughly 15x the percentage gain of the S&P 500 Energy Sector SPDR (XLE), which has added just over 5% this year.
However, just as oil prices have ramped higher, RIG's positive momentum has slowed. Over the past two-month period, XLE is up more than 8%, while RIG is off 0.7%.
Transocean's Latest Earnings Results
Transocean reported a mixed set of numbers for the second quarter, as revenue topped the consensus estimate, but the net loss was wider than expected. Additionally, third-quarter guidance came in softer than expected.
Revenues of $729 million were up 5.3% from the year-ago period, while the loss per share of $0.15 came in wider than the previous year's loss of $0.10, as well as the consensus estimate for a loss of $0.14 per share. Transocean's per-share losses have been steeper than analysts' expectations in three out of the past five quarters.
Operational numbers were also a mixed bag, marked by growth in fleet average daily revenue (up 2.5% YoY), but a decline in fleet average rig utilization levels (54.7% in Q2 2023 vs. 58.2% in Q2 2022).
Meanwhile, the company's recently released fleet status report revealed a backlog of $9.2 billion, representing the highest level since Q1 2020.
Notably, for the first six months of 2023, the company's net cash from operating activities more than doubled from the prior year to $110 million. Yet long-term debt rose 8% from the beginning of the year to $7.1 billion - a cause of concern in the prevailing high interest rate environment.
Large Contract Win
Transocean recently announced the long-awaited maiden contract for the newbuild 7th generation drillship Deepwater Aquila. The drillship is capable of operating in water depths of up to 12,000 feet and drilling wells to depths of up to 40,000 feet.
The contract is valued at $486 million, and work will begin in the third quarter of 2024. The contract is with a national Brazilian oil company for work offshore.
The company also announced that it has acquired the outstanding interest in Liquila Ventures Ltd from its JV partners, Perestroika and Lime Rock Partners. Following the transaction, Transocean will own and operate eight of the 12 ultra-deepwater, 1,400 short-ton hookload drillships in the world.
Although the initial result of these strategic moves may be short-term cash flow issues and increasing debt levels, the company remains confident that the contract margin will be enough to recoup the company's entire activation investment.
Is Transocean Overvalued?
Even though the stock's runaway momentum has stalled out recently, Transocean's valuation at current levels still looks a little rich compared to some of its industry peers.
Transocean's forward ev/sales (4.31), trailing price/sales (2.18) and price/cash flow (11.95) ratios are all above the sector medians of 2.18, 1.34 and 4.22, respectively.
Here's What Analysts Expect for RIG
Analysts remain reasonably optimistic about the earnings growth prospects for Transocean - after an expected 217% decline for the current quarter, that is. Looking ahead, Wall Street is forecasting the company's earnings to grow about 98% in the next quarter, and 23.7% in FY 2023 overall, followed by 146.5% growth in FY 2024.
Analysts are tentatively upbeat about Transocean stock overall, judging by the consensus “Moderate Buy” rating - but the mean target price of $8.65 indicates upside potential of only 6.3% from current levels.
Out of 11 analysts covering the stock, 4 have a “Strong Buy” rating, 5 have a “Hold” rating, 1 has a “Moderate Sell” rating, and 1 has a “Strong Sell” rating.
Final Takeaway
The outsized rally in Transocean shares since the start of the year has left its valuations looking a little stretched. Plus, unlike many of its peers in the oil and gas space, RIG doesn't offer any dividend to shareholders. That makes Transocean a somewhat riskier pick within the energy sector right now.
However, for those who are open to more speculative opportunities in the space, there are reasons to like RIG. The company has a huge order backlog, longer-term earnings forecasts are robust, and the stock still outperforms XLE substantially over most time frames. While the stock may be pausing to consolidate some gains for now, RIG is an under-$10 stock worth considering for investors with a longer time horizon.
On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
