Why A Dividend Cut May Be Inevitable For Transocean

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The offshore drilling industry has been facing headwinds over the last two quarters, weighed down by plummeting oil prices, an oversupply of ultra-deepwater rigs and a nebulous outlook for upstream capital spending by oil and gas companies. Last week SeaDrill, the third largest offshore driller by market cap, caught investors off guard by suspending its dividend payout in order to prune down its debt load and to help to finance possible acquisitions. [1] We believe that Transocean (NYSE:RIG), the world’s largest offshore driller, could follow suit, potentially trimming its $0.75/share quarterly dividend, since its free cash flows are likely to come under significant stress due to a weaker business outlook and also due to the company’s need to invest in upgrading its aging fleet.

See Our Complete Analysis For Transocean Here

Trefis has a $34 price estimate for Transocean, which represents a 70% premium to the current market price. We are currently updating our valuation model and price estimate for the company.

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Free Cash Flows Unlikely To Cover Current Dividend

Transocean’s operating cash flows have averaged around $2.15 billion over the last three years, and it seems likely that they will deteriorate going into next year, given the weaker dayrates and utilization rates for ultra-deepwater rigs. The dayrates on Transocean’s recent contracts have been 10-15% lower compared to previous contracts, while ultra-deepwater rig utilization rates have declined by around 7% year-over-year as of Q3 2014. The company’s capital expenditures have averaged over $1.5 billion over the last 3 years, and preliminary capital expenditure guidance for FY 2015 stands at $1.9 billion, largely related to milestone payments for the company’s newbuild program. [2] This means that the company is likely to see free cash flows (operating cash flows, less capex) of under $250 million, which would be insufficient to fund its $1.1 billion annual dividend. While the company could tap into its cash reserves ($2.87 billion as of Q3) or augment its debt load – which is already slightly above the industry average – to fund dividends, this could impact its credit rating. Transocean is just holding on to its investment grade status, with its credit rating standing at BBB- at S&P and Baa3 at Moody’s, with both firms holding a negative ratings outlook. It might make more sense for the company to prune down its dividend, while maintaining financing flexibility at this point. [3]

Even if the company remains resolute about maintaining its current level of shareholder returns, dividends may not be the best avenue. For instance, the company’s stock price is down by close to 60% year-to-date and its trailing twelve month dividend yield stands at over 15%, which is well ahead of the cost of capital. Shareholders might actually be better off if the company deploys the $1.1 billion sum on share repurchases rather than on dividends, since it could prop up the stock price and potentially be EPS accretive for shareholders in the long run.

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Notes:
  1. Seadrill Halts Dividends to Cut Debt, WSJ, November 2014 []
  2. Transocean’s (RIG) CEO Steven Newman on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, November 2014 []
  3. Oil Woes Spark Volatile High Yield Bond, Hi-Grade Trading For Energy Cos., Forbes,  December 2014 []