Markets

Transocean Earnings: Is the Turnaround Working?

On Aug. 6, Transocean reported earnings that initially appeared very promising with soaring earnings, plummeting tax rates, and higher operating cash flows. However, further analysis shows that Transocean is still a long way off from where it needs to be to complete its turnaround.

For example, n et earnings per share were $1.61, up 92% from last year's $0.84 per share and beating analyst expectations by 44%. Operating cash flows came in at $636 million, up $500 million from last quarter and 53% from last year while the effective 12-month tax rate fell from 23.5% to just 12.6%. Capital expenditures were flat at $351 million compared to a year ago but down $780 million compared to the first quarter.

On the negative side of the ledger the fleet utilization slipped from 80% to 78%, revenues were flat at $2.328 billion, and the backlog shrank to $25.078 billion compared to $27.3 billion a year ago, and $29.7 billion at the beginning of 2013.

Drilling into the numbers

The greatly reduced taxes were due to greater rig idling in high-tax jurisdictions as seen by utilization rate; the rate was suppressed due to Transocean's aging fleet, which is mostly composed of fourth generation rigs. This is compared to younger competitors such as Seadrill and Pacific Drilling , whose fleets consist of mostly sixth and seventh generation fleets.

The age of Transocean's fleet is especially significant when it comes to ultra-deepwater, or UDW, drill ships -- which command the highest day rates in the industry. Transocean's fleet of UDWs is the second oldest in the industry at an average age of 23 years.

Source: Pacific Drilling May 2014 Investor Presentation

Source: Seadrill 42nd Annual Howard Weil Energy Conference Presentation

Source: Pacific Drilling May 2014 Investor Presentation

On a related note, the reason Transocean's operating cash flows soared this quarter compared to last is the absence of a $472 million payment made last quarter as part of the above settlement. Similarly, the decrease in capital expenditures compared to last quarter was due to timing of payments for the company's 14 new builds, which are badly needed to modernize the fleet.

Concerns going forward

The 14% decline in Transocean's backlog in the last 18 months is primarily due to the fact that Transocean is facing a major contract expiration cliff. According to the July fleet status report, Transocean has 34 rigs with contracts that expire in 2014, along with three rigs that are idled and eight that are cold-stacked (long-term storage). In 2015 an additional 39 rigs go off contract.

With only 51% of its fleet contracted through the end of next year, when day rates are expected to bottom out, Transocean faces the prospect of a significant loss of cash flows. The probability of severely reduced day rates for its rigs is made much worse because of its aging fleet, one of the oldest in the industry.

Source: Pacific Drilling May 2014 Investor Presentation

...further deterioration in the offshore drilling market as relatively flat demand is met with a relentless surge of new supply. More problematic is the increasing likelihood that a huge chunk of the existing fleet will ultimately become impaired and/ or obsolete...Over 70% of RIG's midwater fleet will come off contract by the end of 2015 in what we expect will be a very soft market for older, midwater assets and thus project weak utilization.

What to watch in the future

There are five key factors investors should closely monitor with Transocean over the next few quarters.

First, is the recently raised dividend, which now yields 7.7%. For a company undergoing such a large and expensive capital investment program and facing a 70% contract cliff, this dividend might prove unsustainable.

Second is new contracts, specifically the duration and day rates. Transocean has been able to obtain contracts for seven of its nine new build UDW drill ships for an average 8.7 year duration and $553,000 per day. However, its enormous fleet of aging, and possibly soon to be obsolete, rigs could weigh on utilization rates going forward -- which is the third key metric to watch.

Fourth and fifth are Transocean's creative financing solutions, specifically its recently announced Caledonia plans and IPOed MLP Transocean Partners .

Caledonia is Transocean's plan to carve out eight North Sea rigs into a separate company and sell them in the second half of the year. The only problem with this plan is that the average age of these rigs is 34 years, meaning that the main benefit from this deal may not be financial but rather simply an elimination of obsolete rigs.

Finally, Transocean Partners, which Transocean owns 70% of, may prove a good financing tool moving forward. Future drop downs of UDW rigs could alleviate cash flow problems, finance future new builds, and secure the dividend.

Top dividend stocks for the next decade

The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now .

The article Transocean Earnings: Is the Turnaround Working? originally appeared on Fool.com.

Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and Transocean. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story

PACD RIG

Other Topics

Stocks

Latest Markets Videos

    The Motley Fool

    Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

    Learn More