Transocean (NYSE:RIG), one of the world’s largest offshore drilling companies, released its third quarter earnings on Monday, displaying strong operational performance. Quarterly revenues grew by about 22% y-o-y to $2.4 billion and income from continuing operations came in at $526 million. However, the company posted a net loss of $383 million due to non-cash charges relating to its shallow water rig sale.  We recently updated our model for Transocean to account for the sale of shallow water rigs. Here are a few key takeaways from the company’s release and our changes to the model.
During the quarter, the company realized a significant improvement in its operational metrics such as rig utilization and revenue efficiency. Utilization rates for continuing operations, a measure of how many of the company’s rigs are working on contracts, rose from 63% last year to 77%. The company’s ultra-deepwater floaters performed particularly well with utilization rates of around 91% on strong drilling activity in the US Gulf of Mexico. Revenue efficiency, a metric that compares revenues earned on a contract to the maximum potential revenues, was also strong at about 94%.
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Ultra-Deepwater Market Strong But Competition Could Increase
High oil prices and dwindling land reserves are pushing oil and gas companies to exploit hydrocarbon reserves that lie deep under the ocean. Recent discoveries off the coasts of West Africa, Brazil and a resurrection of drilling activity in the US Gulf of Mexico have spurred demand for ultra-deepwater rigs. This year, the industry has witnessed 46 ultra-deepwater contracts being signed, the highest level since 2008. Transocean is well-positioned in this space with over 27 ultra-deepwater floaters. During the quarter, the company added a revenue backlog of about $10.2 billion owing largely to a contract for ultra deepwater drill ships with Royal Dutch Shell.
Executing on its ultra-deepwater ambitions, the company has outlined capex spending of about $3 billion for the next year for installments toward two new deepwater drill ships under construction.
Although the outlook for ultra-deepwater drilling demand remains strong, Transocean could see increasing competition going forward due to the addition of new ultra-deepwater drilling capacity in the industry. Management estimates that 53 new ultra-deepwater ships will be commissioned globally over the next few years.  This could cause a decline in pricing power and inflation of costs, particularly relating to employee retention and training.
Impact of Jackup Rig Sale And Model Update
Transocean has been realigning its asset strategy to focus on higher specification jack-up rigs and deepwater and ultra-deepwater rigs. In September, the company entered into an agreement to divest 38 low specification jack-up rigs to a private equity backed company. The sale is expected to complete in Q4. We expect the key impacts of the rig sale to be three-fold and have updated our model accordingly.
1) Increase In Utilization Rates: According to Transocean’s recent fleet status update, the standard-jackups being divested are around 30 years old. Older rigs typically have higher maintenance downtime and lower utilization rates. Last quarter the firm’s fleet excluding the standard jack-ups stood at 77% while standard jack-ups had a utilization rate of about 66% while utilization was still lower in Q3 2011 at 49%. In keeping with the better expected overall utilization rates following the sale, we have increased our utilization rate estimate for 2013 to 70% growing gradually to 75% at the end of Trefis forecast period.
2) Increase in Average Daily Revenues: Average day rates for the divested rigs were also relatively low at around $100,000, whereas average day rates for the company’s remaining rigs stood at around $395,000. Factoring in the increase in average day rates from next year accounting for the rig sale, we have increased the rates to $390,000 for 2013 and to about $440,000 by the end of Trefis forecast period.
3) Reduced Effective Annual Rig Count: To account for the rig sale, we have reduced our effective annual rig count growth estimate for 2013 by around 30% to 92 rigs with about 2% growth through the forecast period. As a result of the sales, we expect the firm’s overall revenues to decline next year, but we expect a recovery in 2013 on better utilization and increased day rates.Notes: