Transocean shares should benefit from oil company record profits

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Transoceanic (New York Stock Exchange: platform) stocks have gained substantially after the publication of my last article on this major offshore driller. But, in my opinion, the Swiss company is too cheap, since the big oil companies are doing really huge benefits. But let me explain this to you in more detail.

Transocean Earnings Release

The company released its earnings report on November 2. In general, its results exceeded expectations and were more or less in line with those reported for the previous period.

RIG results

Data is given in millions of dollars.

2T2022 3Q2022
Total Contract Drilling Revenue 692 691
Total Adjusted Contract Drilling Revenue 722 730
Operation and maintenance expenses 433 411
Net loss 68 28
Adjusted EBITDA 245 268
Contract portfolio 6200 7300

Source: Own elaboration based on company data

In some respects, RIG’s Q3 results were better compared to 2Q2022. This is particularly true for expenses, net loss and EBITDA. The results also turned out to be better than expected by analysts. Transocean’s non-GAAP EPS was -$0.06, bettered by $0.12. Meanwhile, adjusted contract drilling revenue totaled $730 million, up $64.91 million.

RIG CEO Thigpen was also positive about the company’s performance. But I don’t want to go into too much detail about the recent gains as they were pretty predictable. Instead, in my analysis, I would like to focus on the industry recovery, the company’s order book, and RIG’s valuations.

The profits of the big oil companies

A lot has happened since my last article on the Swiss-based offshore driller. The company has published its results and the status of its fleet. Many oil corporations have also released their quarterly earnings. In general, my fellow Seeking Alpha contributors are optimistic about Transocean’s latest contract additions and I totally agree with them.

Just a quick recap, the contract stack reported on October 13 when Transocean’s fleet status report was released, it totaled $7.3 billion. On its own, it might not be a very large number. However, if we look at this figure in the context of RIG’s backlog history, we see that it was quite good.

Table – Backlog history (in millions of dollars)
reported period Number of order book (in millions of dollars)
1T20 9600
2Q20 8900
3Q20 8200
4Q20 7800
1Q21 7800
2Q21 7300
3T21 7100
4Q21 6500
1Q22 6100
2Q22 6200
3Q22 7300
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Source: Own elaboration based on company data

As you can see from the table above, the order book as of October 13, 2022 is at reported levels for the second quarter of 2021. That’s really good, given that RIG’s order book has been falling for years.

Let me also illustrate this with a diagram.

RIG Backlog History

The author

All of that sounds good. There was also some very big news for RIG recently in the financial press. Many oil companies have reported their quarterly earnings. Corporations such as Chevron (CVX), Exxon Mobil (XOM), Shell (SHEL), BP (BP), many other international oil giants, and the world’s largest companies in the field, namely Saudi Aramco (ARMCO), have reported record earnings and net cash flows for the latest quarter. The last 9 months were also brilliant. The chart below compares the earnings of the major oil majors for the 9 months of 2022 with the same period a year ago.

The profits of the big oil companies have increased

guardian

You can see that the earnings doubled and in some cases tripled.

But you could say that all this extra money is going more towards buyback programs and high dividends. In fact, it does. One of the most obvious examples was that of BP, which announced a Repurchase of shares for 2,500 million dollars.

But unlike shale oil companies that spend most of their profits building up their balance sheets, large international corporations can afford to invest in exploration, new contracts and, yes, new production. After all, to take advantage of today’s reasonably high oil prices, you need to find new opportunities to increase production. It has been mentioned here many times that low-cost onshore drilling is the first choice for oil majors when commodity prices rise. However, the world has been facing power shortages since 2021. Therefore, it is the right time to turn to offshore drillers. Transocean has already demonstrated this with its strong order book growth.

drilling activity

Another perfect stimulus for new contracts that I see is the energy crisis that will clearly worsen this winter. In the northern hemisphere, especially in Europe, it is very likely that there will be a harsh winter. Many scary forecasts can be found on Oilprice.com. But I will summarize the most likely.

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Europe’s natural gas reserves are only 90% full. You might think that this is very good news. It could have been if the EU had guaranteed a stable supply of gas. But this is unlikely to happen. The G7 and the EU authorities are trying to limit natural gas prices. If they fix the price cap on Russian gas, Russia will stop supplying it. Gazprom (OTC:GZPMF) Alexei Miller confirmed it. A good alternative to natural gas is oil. Petroleum derivatives such as diesel are very useful for heating. So this news is also bullish for oil. But it is very likely that “black gold” is also very scarce. That is mainly due to the EU embargo on imports of Russian crude by sea. the the embargo will enter effective next month. That is why Europe will face very high oil prices.

The United States, for its part, is also in a situation of energy deficit. The most notable problem is the shortage of diesel. It was recently reported the distillate inventories collapsed at multi-year lows. But the US and Europe are not alone when it comes to high energy costs. Many countries around the world are facing energy shortages, especially the poorest ones.

The reason I say this is because offshore drillers may see even bigger increases in their contract activity.

risks

My bullish forecast on RIG is not without its ifs and buts. The most obvious problem with the company itself is its debt load. Transocean’s closest competitors have emerged from bankruptcy, thus shedding their high debt loads. Noble (NE) and Valaris (VAL) cannot yet compete with RIG in terms of fleet size and order book, but their absence of debt is a big advantage.

This is even more true now, given that interest rates around the world are rising. Many central bankers are getting very aggressive as inflation readings break multi-decade highs. This makes it difficult for indebted companies to pay interest and raise additional capital.

Furthermore, such a tough stance has already caused a sell-off on Wall Street. But there could be more economic pain ahead, which is not rosy for stocks overall. However, given RIG’s volatility, its shares could face additional pressure in the stock market.

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At the same time, we could end up in an energy crisis that could last for many years. A recession may not even pressure oil prices for very long. A similar situation was observed in the 1970s in the United States. At the time, many countries, including the US, suffered from energy deficits. Meanwhile, there were several recessions during a decade. Something similar can happen now.

Ratings

I decided to use the following criteria to value RIG: Transocean’s share price versus oil prices, price-to-sales (P/S) ratio, and enterprise value/EBITDA. RIG shares have traditionally moved in close correlation with oil prices.

I have decided to exclude P/E as Transocean is making a loss at the moment. The price/book value (P/B) ratio is also inappropriate because the actual value of Transocean’s fleet is likely to be different from the book value on its balance sheet.

Overall, Transocean shares should trade higher given current oil prices. In fact, the shares of the major offshore driller have been below Brent prices since 2020. I appreciate Transocean’s indebtedness and how many concerns there have been since the end of 2020, when many analysts predicted RIG’s imminent bankruptcy.

Frame
Data by YGraphics

But it appears the stock is still undervalued based on this metric.

Also, I’m considering the P/S ratio, which shows that the company’s stock is fairly valued, if not undervalued. Its shares trade at a P/S of less than 1, which is reasonable for a losing company.

Frame
Data by YGraphics

The same occurs with RIG’s EV/EBITDA ratio. Now it’s around 10, which is considered healthy.

Frame
Data by YGraphics

Overall, I would say that RIG stock is not overvalued.

conclusion

So far, RIG has shown substantial improvements when it comes to its profits and, more importantly, its order book. Transocean shares should benefit from an increase in the amount of capital spending by the oil majors. It is very reasonable that the big oil corporations increase their investments in exploration even more. The very situation of a severe energy deficit should make investment in new oil attractive. The only drawback I see is a long and uncontrolled global recession.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Top Ex-US Stock Picking Competition, which runs through November 7. This competition is open to all users and contributors; Click here to learn more and submit your article today!

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