Transocean’s Results Aided By Lower Operating Expenses, Deepwater Market Concerns Remain

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Transocean (NYSE:RIG), the world’s largest offshore driller, posted a good set of Q2 2014 results that beat market expectations on both earnings and revenues. While quarterly revenues fell by around 1.5% year-over-year to about $2.33 billion due to lower utilization of the company’s high-specification rigs, adjusted earnings from continuing operations rose by around 48% to about $587 million, owing to lower operating and maintenance costs and better revenue efficiency. [1] Despite the upbeat quarterly performance, we believe that the company could encounter significant headwinds in the near term, as the ultra-deepwater rig markets are transitioning to a phase of oversupply which could dent the company’s revenues and margins going forward. Here is a brief overview of Transocean’s results for the quarter.

Trefis has a $42 price estimate for Transocean, which is slightly ahead of the current market price.

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Lower Costs And Better Revenue Efficiency Drive Profitability

Operating and maintenance costs are the single largest cost driver for Transocean. While Transocean’s O&M costs are on the higher side compared to the industry average, standing at over 50% of revenues, the company has been taking steps to bring them down by downsizing shore-based support infrastructure and eliminating some non-core functions. For this quarter, the company cut costs by roughly 11% year-over-year and around 5% sequentially to around $1.21 billion, owing to lower shipyard expenses. The company also benefited from improved revenue efficiency numbers, which rose from around 93% a year ago to about 95%. Revenue efficiency- a percentage measure of how much revenue a contracted rig earns during a period versus the maximum that it could potentially earn – is key to improving profitability for offshore drillers considering their high levels of operating leverage.

Utilization Rates Decline With Strong Ultra-Deepwater Supply

Ultra-deepwater rigs account for over half of Transocean’s revenues. The ultra-deepwater market is currently transitioning into a phase of oversupply, with the number of ultra-deepwater rigs globally expected to grow from around 120 in early 2013 to over 160 by the end of 2014, while demand (including existing contracts, options and possible contracts) is expected to stand at around 140 rigs by the end of 2014. [2] This has impacted Transocean’s overall revenues, since utilization rates for the ultra-deepwater fleet have fallen from around 96% a year ago to about 88%. Utilization rates are a ratio of the number of rigs working on contract to the total number of rigs in the fleet. This number could decline further going forward, since around 9 of the company’s 27 ultra-deepwater rigs have contracts that will expire this year, without having any new contracts lined up. [3]

Dayrates Improve Year-Over-Year, But Sequential Decline Is Worrisome

Although Transocean’s ultra-deepwater dayrates saw a 6% improvement on a year-over-year basis, they declined by about 1.5% sequentially. The year-over-year improvement is likely due to contracts that were signed previously, when contracting activity remained strong in the deepwater and ultra-deepwater market. It 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 haven’t been particularly 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 about 14% lower than 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 company’s bargaining power in new contract negotiation could also be weaker, given that it’s rigs are older on average when compared to competitors such as Seadrill.

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Notes:
  1. Transocean Ltd. Reports Second Quarter 2014 Results, Transocean, August 2014 []
  2. Howard Weil Energy Conference Presentation, Transocean, March 2014 []
  3. Fleet Status Report, Transocean, July 2014 []