Transocean Suspends Dividends – Desperate Times, Desperate Measures?

Transocean (NYSE:RIG) – the world’s largest offshore drilling contractor – which reported better-than-expected second quarter results last month, recently announced its plans to suspend the quarterly dividends for the remaining half of 2015 ^[1]. Additionally, the company is expected to recognize a non-cash impairment charge of $2 billion in the light of rapid deterioration in offshore drilling demand. While a dividend cut generally shows poorly on a company’s future prospects, we view Transocean’s decision to be a logical and much needed one, as the company needs to conserve cash given the gloomy outlook for the oil price market. Apart from this, the company has deferred the delivery of 7 of its newbuild rigs, which indicates that the company, too, sees a rough road ahead. In this article, we will discuss why Transocean is likely to face difficult times ahead which is forcing the company to take tough measures to weather this downturn.

Source: Google Finance

While Transocean managed to beat market expectations in the second quarter, one cannot rule out the fact that there has been a meaningful dip in the company’s performance, both annually as well as sequentially, owing to the oil price slump. With the growing uncertainty in the global markets driven by the fears of a potential slowdown in the Chinese economy, the outlook for oil markets is not very promising. Further, the demand for offshore drilling, which is significantly more expensive than onshore drilling, is likely to remain stagnant. Thus, being the largest offshore drilling contractor, Transocean will be the worst hit offshore driller, if the oil markets do not recover soon.

With the same thinking, the company had reduced its quarterly dividends from $0.75 per share in 2014 to $0.15 per share in 2015, in May, when the prospects of the deepwater drilling market looked bleak. However, the recent volatility in the global markets further prompted the company to take a stern action and completely eliminate the quarterly dividends for the rest of the year, saving close to $55 million per quarter. While this move may not be well received by the investors, we foresee this as a calculated risk taken by the company in order to preserve its cash flows in case the present conditions worsen. Here are the two key reasons, which according to our analysis, are likely to pull down the company’s performance in the near future.

A Diminishing Contract Backlog

Due to the prolonged weakness in crude oil prices, the demand for offshore drilling rigs has been sluggish. This, coupled with an aging fleet of rigs, has reduced Transocean’s power to negotiate new contracts at higher day rates. Consequently, the Switzerland-based offshore driller’s contract backlog which stood at $21.2 billion at the beginning of the year declined to $19.9 billion in the first quarter and fell further to $18.6 billion in the second quarter, representing a drop of more than 12% over the first six months of the year. Further, the company added a total of merely $44 million so far in this quarter, based on the fleet status report for July and August.

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

Besides, a majority of Transocean’s ultra-deepwater (UDW) and deepwater (DW) floaters are uncommitted for 2016 and 2017. This implies that while the company has not been able to win any new major contracts, most of its existing contracts are expected to expire soon. Thus, the company’s revenue visibility for the next couple of years is quite low. The company has a backlog of $3.9 billion for 2016 and $2.8 in 2017, which is less than the company’s revenue in the first half of 2015. In fact, the backlog in the future years is also on a downward trend. Hence, at the prevailing rate, the company’s top line is likely to experience a significant decline over the next two years.

Source: Barclays CEO Energy-Power Conference, 8th September 2015

A Large But Aging Rig Fleet

Transocean has one of the largest and the oldest rig fleet in the industry. With a drastic fall in the drilling activity in the overall offshore market, the company has been forced to restructure its current fleet to combat the current downturn. As a result, Transocean has scrapped 21 rigs till date, and holds 7 stacked and 12 idle rigs in its current fleet ^[2], which is the highest in the industry. In addition, the management highlighted its plans to scrap and sell some more rigs before the end of the year, during its second quarter conference call. While making some rigs idle might temporarily improve the company’s utilization rates, it results in higher downtime costs and loss of revenue. Further, it becomes difficult to find work for these rigs even after the market recovers.

Source: Barclays CEO Energy-Power Conference, 8th September 2015

To add to this, Transocean is building 12 new rigs including 7 UDW rigs with a timeframe of 2016-2020 and a capital requirement of approximately $7 billion. Building new rigs that can cater to the needs of the modern offshore drilling market would have been a smart move, if the oil prices were favorable. But in the current scheme of things, adding new rigs in a slow drilling environment may not be a sensible decision. Consequently, the company has delayed the delivery of its 7 UDW rigs to match the demand and supply in the market. However, given the aging fleet, the company does not have much choice but to bring these rigs on board in order to be able to attract more contracts when the market improves. Thus, the company would have to scrap its older rigs and invest at least $3-4 billion on these rigs to bring them to service by the second half of 2016 or early 2017.

Transocean’s Liquidity Position

Source: Barclays CEO Energy-Power Conference, 8th September 2015

As of 30th June 2015, Transocean’s debt stood at $9 billion. In addition, the company has debt obligations to the tune of $1.9 billion in the next couple of years. While the company’s CEO, Jeremy Thigpen, who presented at the Barclays CEO Energy-Power Conference earlier this week, sounded positive about the company’s liquidity position, the additional capex on building the new rigs could prove to be a burden on the company’s cash flows. Though the company seems to have provisioned well for these expenditures (see graph above), having extra cash from the eliminated dividends (though small) appears to be a reasonable move given the fluctuations in the oil price market.

In the end, it is worth mentioning that despite the aforementioned factors that could weigh on Transocean’s performance if oil prices continue to remain depressed, Transocean has held up well compared to its peers, and is leaving no stone unturned to emerge as a survivor from this downturn.

See Our Complete Analysis For Transocean Here

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1. Transocean Announces Extraordinary General Meeting, 25th August 2015, www.deepwater.com [↩]
2. Transocean provides Fleet Update Summary, 19th August 2015, www.deepwater.com [↩]