Transocean 2Q Preview: Weak Day Rates And Lower Pricing Power Likely To Weigh On Profits

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Transocean

Transocean (NYSE:RIG), the world’s largest offshore drilling contractor, is scheduled to release its second quarter 2015 operating results after the market closes on Wednesday, 5th August 2015((Transocean To Announce Second Quarter 2015 Results, 24th July 2015, www.deepwater.com)). Unlike last quarter, this quarter’s results are likely to be weak as the impact of lower drilling activity is expected to be more apparent. The company is expected to witness a notable decline in its revenue, both sequentially as well as annually, as a large number of rigs remained idle or delivered lower day rates during the quarter. Further, some of the company’s existing contracts expired during the quarter and have been renegotiated at a much lower price, which is likely to create a significant dent in its bottom line. In this note, we briefly discuss the key trends that we expect to see in the company’s June quarter results.

We will be revisiting our price estimate for the company after the earnings release.

See Our Complete Analysis For Transocean Here

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Day Rates Decline While Utilization May Improve Due To Fleet Right-sizing

The Switzerland-based offshore driller delivered better-than-expected earnings in the last quarter as the company worked through older and higher value ultra deepwater contracts. However, with an aging fleet and a number of contract expirations due in the second quarter, the company did not have much bargaining power to negotiate higher day rates for newer contracts. Further, as the prolonged slump in crude oil prices continued to pull down the demand for drilling rigs, Transocean added a backlog of only $9 million((Transocean Fleet Status Report July, 15th July 2015, www.deepwater.com)) during the second quarter, for an estimated 40 day contract extension in the North Sea at a day rate of $219,000. In addition, the company witnessed a 6.3% drop in the day rates of new ultra deepwater contracts. For instance, Transocean’s Discoverer America’s rig, which operated at a day rate of $735,000 on its earlier contract, has now been re-contracted at a 20% lower day rate of $590,000.

As part of its fleet right-sizing, the company has scrapped 20 older and lower specification rigs till date. Also, the offshore driller has 7 staked rigs and 7 idle rigs in its current fleet, according to the latest fleet status report. Consequently, we expect the company’s utilization rate for the quarter to improve due to its aggressive fleet resizing initiatives. However, despite this, the company is likely to see a sizeable decline in its top line. The market anticipates Transocean to report quarterly revenue of $1.7 billion, 15% down on a sequential basis, or 26% lower on a year-on-year basis.

Earnings To Drop Despite Reduction In Operating And Maintenance Costs

Transocean’s operating and maintenance (O&M) costs are almost 55% of its total revenue, which is higher than the industry average of 40%. Consequently, to face the current downturn, the company has been working towards downsizing its offshore-based support infrastructure and eliminating non-core expenses. In the last quarter, the company managed to bring down its O&M costs by almost 15% on a year-on-year basis to $1.08 billion((Transocean Reports First Quarter 2015 Results, 6th May 2015, www.deepwater.com)) by scrapping older rigs and stacking rigs that were not economical in the present environment. This reduced the O&M expense as a percentage of revenues by about 1% to about 53% primarily due to improvements in revenue efficiency, decline in downtime on rigs, and other onshore and offshore cost reduction initiatives. Based on the last quarter’s guidance, the company expects to reduce its O&M costs to $3.8-$4.1 billion for the full year 2015, representing a 20%-25% decline annually. Even with a significant reduction in the O&M costs, the market expects the company’s earnings to drop to almost half, translating into an adjusted EPS of $0.51 per share for the second quarter.

RIG

Source: UBS Global Oil and Gas Conference, 19th May 2015

To sum it up, we expect the impact of weak demand for drilling rigs and expiration of higher-priced contracts to strongly hit Transocean’s second quarter revenues as well as earnings.

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