Transocean Q2 Preview: Dayrates In Focus, Revenue Efficiency and Costs Could Improve

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Transocean (NYSE:RIG), the world’s largest offshore drilling contractor, is scheduled to report its Q2 2014 earnings on August 6. We expect the company’s earnings to rise year-over-year, driven by higher revenue efficiency and lower operation and maintenance (O&M) costs, although rig utilization rates could continue to remain under pressure due to excess supply in the offshore drilling markets. Global rig supply has risen by around 10% over the last year, although demand has remained relatively flat, which has caused global offshore rig utilization rates to decline from levels of around 87% a year ago to around 80%. [1] During Q1, Transocean’s quarterly revenues grew by about 7% year-over-year to $2.34 billion, while income from continuing operations rose by about 49% to $474 million. Below is a quick take of what to expect and what we will be watching when Transocean publishes earnings.

Trefis has a $46 price estimate for Transocean, which is slightly ahead of the current market price.

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Cost And Efficiency Improvements Should Drive Earnings

Operating and maintenance costs are the largest cost driver for Transocean. While Transocean’s O&M costs are on the higher side compared to the industry average, at around 60% of revenues (FY’13), the company has been taking steps to bring them down by downsizing its shore-based support infrastructure and eliminating some non-core functions. During the last quarter, the company cut costs by roughly 6.5% year-over-year to $1.27 billion, and we believe that there could be a sequential improvement during Q2. Revenue efficiency could also be a driver of quarterly earnings. Revenue efficiency is a percentage measure of how much revenue a contracted rig earns during a period versus the maximum that it could potentially earn. During Q1, revenue efficiencies (considering all rig types) improved to around 96% from about 88% a year ago, due to a smoother operation of the fleet with less downtime. Maintaining high revenue efficiency is key to improving profitability for offshore drillers given their high operating leverage.

Watching Average Day Rates

During Q1 2014, the average day rates for Transocean’s fleet rose by around 14% year-over-year to about $413,100. [2] This increase was largely attributable to the company’s fleet of deepwater and ultra deepwater rigs, which saw their rates rise by over 20% year-over-year. However, it’s possible that the rates the firm recorded were due to contracts that were signed previously, when contracting activity remained strong in the deepwater and ultra deepwater market. Tt will be important to see the rates that the company garners on new contracts that it signs. Indicators from the company’s  recent fleet status reports don’t seem very encouraging. For instance, the Dhirubhai Deepwater KG1 drillship was recently awarded a three-year contract for work in Brazil at a rate of around $440,000, which is almost 14% below the previous contract rate. The Cajun Express semi-submersible rig will also see rates that are nearly 24% lower than current rates on a contract expected to start in October this year. The lower contract rates could prove a threat to Transocean, since about 9 of the company’s 27 ultra-deepwater rigs have contracts that will expire this year, without having any new contracts lined up. [3] Additionally, the company has two idle rigs, which could also weaken its bargaining power in contract negotiations.

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Notes:
  1. Offshore Rig Utilization Reports, RigZone, July 2014 []
  2. Transocean Q1 2014 Earnings Press Release, Transocean, May 2014 []
  3. Fleet Status Report, Transocean, July 2014 []