Cost-Cutting Initiatives Drive Transocean’s 2Q Earnings, Outlook Remains Weak As Backlog Continues To Decline

Despite a challenging oil price environment, Transocean (NYSE:RIG) delivered strong operating results for second quarter of 2015 ^[1], comfortably beating the market revenue and EPS estimates. The offshore drilling giant’s better-than-expected results were driven by improvement in revenue efficiency and effective cost reduction measures undertaken during the quarter. The news was well received by the investors as the company’s stock price jumped by almost 11% (Source: Google Finance) during a single trading day last week when the results were announced. However, the company’s backlog has been declining sharply over the last one year. This, coupled with a weak outlook for oil prices, is likely to lead to a further drop in Transocean’s day rates, pulling down its earnings notably in the remaining half of the year. In this note, we discuss the key trends witnessed in the company’s second quarter earnings release.

Source: Google Finance

Higher Revenue Efficiency Dampens The Effect Of Lower Utilization And Day Rates

Transocean exceeded the consensus revenue estimate of $1.7 billion by reporting consolidated revenue of $1.9 billion, down 8% sequentially or 19% annually((Form 10-Q, 5th August 2015, www.deepwater.com)). The decline in revenue was driven by lower utilization rates and declining day rates, partially offset by higher revenue efficiency during the June quarter. The company’s performance on the key metrics that impact the revenue is as follows:

 Source: Form 10-Q, 5th August 2015, Transocean

Based on Transocean’s latest fleet status report, its contract backlog has been declining over the last one year. Further, 36%, 50%, and 58% of the company’s ultra-deepwater floaters are uncommitted for 2015, 2016, and 2017, respectively, while 33%, 79%, and 100% of its deepwater floaters are uncommitted for the same years respectively((Transocean Fleet Status Report July, 15th July 2015, www.deepwater.com)). This indicates that majority of the company’s existing contracts are expected to expire by the end of 2015 or early 2016. As the near to medium term outlook of the commodity markets is uncertain, the demand for drilling rigs is expected to remain stagnant. Thus, we do not expect the company’s backlog to pick up in the coming quarters, which would weigh negatively on its top line. Even if Transocean manages to re-contract some of its rigs, it would be at much lower day rates, which would translate to lower revenues for the company.

Cost Reduction Measures Drives The Earnings

The Switzerland-based company delivered an adjusted net income (excluding net favorable items) of $408 million, or $1.11 per share((Transocean Announces Second Quarter 2015 Results, 5th August 2015, www.deepwater.com)), almost double the analyst forecast of $0.51 per share. While this earnings surprise was primarily driven by a net favorable expense of $788 million (before tax) associated with Macondo-related insurance recoveries, Transocean managed to curb its operating and maintenance costs (O&M) to $985 million, 9% lower on a sequential basis, by its ongoing cost reduction initiatives. According to the July Fleet Status Report, the company has retired and sold 21 rigs till date and holds 7 stacked rigs and 7 idle rigs in its current fleet, which led to the reduction in its O&M expenses. During the conference call, the company highlighted its plans to consider scrapping and/or selling of some more rigs before the end of the year.

Since the crude oil prices continue to be depressed, we anticipate Transocean’s fleet right sizing plans to further reduce its O&M costs and enable the company’s earnings to be resilient for the rest of the year. However, Transocean has 12 new rigs under construction, some of which are expected to come on-board in 2016. With a sluggish demand for drilling rigs and declining contract backlog, we expect these new rigs to create a burden on the company’s current fleet and pull down its performance in 2016.

Strong Liquidity Despite Downturn

Transocean ended the June quarter with a cash balance of $3.8 billion, $1.1 billion higher than the previous quarter((Transocean Announces Second Quarter 2015 Results, 5th August 2015, www.deepwater.com)). While this increase includes the proceeds of a one-time settlement of Macondo-related insurance, it also reflects some improvement in the company’s ability to generate cash flows. To put this cash to efficient use, the company retired outstanding senior notes of $904 million on 30th July. However, the offshore drilling contractor has not repurchased any shares in the last six months. Given the availability of a large amount of cash, we expect the company to use it to fund the capital expenditure of $1.3 billion to be spent on its ongoing construction projects (12 new rigs). In addition, the company has accelerated certain milestone payments on these projects which will reduce the estimated capital expenditure for 2017 and 2018 by close to $1 billion, in turn improving the company’s liquidity position going forward.

See Our Complete Analysis For Transocean Here

New Management With A Vision

Despite being new to the company, the vision of Transocean’s top management appears to be quite clear and structured. Jeremy D. Thigpen, who joined as the President and Chief Financial Officer (CEO) of Transocean in late April, and Mark Anthony, who joined as the company’s Chief Financial Officer (CFO) and Executive Vice President in late May, emphasized during the second quarter conference call that the company would now be focused on managing its customer relationships, improving its cost structure, and maintaining a high quality fleet((Transocean Second Quarter 2015 Transcript, 6th August 2015, Seeking Alpha)). Overall, the management provided the following guidance for the full year 2015:

  Source: Transocean Second Quarter 2015 Transcript, 6th August 2015, Seeking Alpha

While Transocean’s earnings are highly correlated to the recovery of oil prices, we expect the new management and its strategy to enable the company to cope with the current downturn, and add value for the company and its investors in the long term.

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1. Transocean Announces Second Quarter 2015 Results, 5th August 2015, www.deepwater.com [↩]