Transocean (NYSE:RIG) is scheduled to announce its Q4 2013 earnings on February 26, reporting on a quarter that saw reasonably strong drilling activity worldwide. During Q3 2013, the company’s revenues increased by around 5% year-over-year to $2.56 billion, while adjusted income from continuing operations before taxes rose by around 4% to $618 million.  For Q4, we expect the company’s revenues to be driven by strong utilization rates as well as the relatively smooth operation of the company’s fleet. However, we will be closely watching the company’s progress in improving operating margins.
Trefis will be revisiting its $53 price estimate for Transocean following the company’s earnings release.
Operating Margins Are A Key Factor To Watch
Transocean is focused on the high end of the offshore drilling market, with its fleet geared towards high-specification floaters such as ultra-deepwater, deepwater and harsh environment rigs since they typically have the highest day rates. The company has been seeing relatively strong operating metrics as well. Utilization rates have largely stood at above 80% while revenue efficiency (a measure of the actual revenues a rig earns when contracted versus its maximum potential revenues) has also held up at over 93% over the last few quarters.  However, the company’s profit margins have been something of a concern, especially when compared to competitors such as Seadrill (NYSE:SDRL). This is primarily due to the company’s higher maintenance costs and its relatively older fleet. Transocean’s typical rigs are roughly 9.5 years old, compared to Sea Drill and Ensco (NYSE:ESV), whose rigs have an average age of less than four years. 
Transocean has been taking steps to improve its profitability by scaling down its shore-based support infrastructure following the sale of its jack-up rig fleet. The company has also been streamlining and consolidating some business functions while eliminating some of its non-core operations. Transocean says that these initiatives should help raise operating income by around $800 million by the end of FY 2015. During the third quarter, the company’s operating margins stood at roughly 29% compared to around 33% during the same period last year, due to higher operation and maintenance costs. We believe that the company’s ability to improve its margins will be a key catalyst for the stock in the near term, considering that revenues could come under pressure given the looming oversupply of deepwater rigs in the market (see Why Transocean’s Stock Has Been Trending Lower).Notes: