Transocean Q3 Preview: Results Could Fall On Lower Utilization Rates

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Transocean (NYSE:RIG), the largest offshore driller, is expected to publish its Q3 2014 results on November 6, reporting on a quarter that saw the company’s stock price decline by about 30%, impacted by the increasing supply of ultra-deepwater rigs and tumbling oil prices. We expect the company’s quarterly results to decline on a year-over-year basis, impacted by weaker utilization rates and possibly lower day rates for its ultra-deepwater fleet, although this could be partially offset by better operating costs. During the second quarter, the company’s revenues fell by 1.5% year-over-year to $2.33 billion, while adjusted earnings from continuing operations rose by around 48% to about $587 million. ((Transocean Ltd. Reports Second Quarter 2014 Results, Transocean, August 2014)) Here is a brief look at what to expect when Transocean reports earnings Thursday.

We recently revised our price estimate for Transocean to about $33 to account for the weaker outlook. Our price estimate represents a premium of about 10% to the current market price.

See Our Complete Analysis For Transocean Here

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Utilizations Rates Could Fall, Impacting Revenues And Margins

Ultra-deepwater rigs account for over half of Transocean’s revenues. The ultra-deepwater rig market is currently transitioning into a phase of oversupply, with the number of ultra-deepwater rigs globally expected to grow 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. [1] The strong supply is impacting Transocean’s utilization rates, which have fallen to 88% during Q2 2014 from 96% during the year ago quarter. We believe that the decline in utilization rates could continue into next year as well. The glut of deepwater rigs is likely to make operators more selective about the rigs they deploy, and this could prove an issue for Transocean, since its rigs are older and less sophisticated, on average, compared to peers such as SeaDrill. Transocean recently announced that it would idle its Jack Ryan drillship, and the company also has another three ultra-deepwater rigs that have contracts that will end before this year. [2] Lower rig utilization rates have a direct impact on revenues and operating margins, since an idled rig typically continues to incur similar costs compared to actively working rigs, as they retain most of their crew so that they can be readily deployed as demand arises.

Operating And Maintenance Costs

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 more than 50% of revenues, 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 second quarter, the company cut costs by roughly 11% year-over-year and by around 5% sequentially to around $1.21 billion, owing to lower shipyard expenses. While we believe that operating costs as a percentage of revenues could remain high in the near term considering the revenue pressures that the company could face, we will be watching its progress in reducing operating costs on an absolute basis.

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Notes:
  1. Howard Weil Energy Conference Presentation, Transocean, March 2014 []
  2. Transocean Reveals Some Offshore Drilling Interesting Industry Trends, Seeking Alpha, October 2014 []