We are continuously reviewing the top stocks we have under coverage in order to provide research on those that appear most promising to our analysts, and that generate the most interest among our clients. After several months of discussion, the Director of Research has concluded that Transocean no longer meet these criteria. Our policy is to continue to publish research on the company for the next 90 days, and of course retainer clients with consultation privileges can call in and speak to us about the firm on an ongoing basis.
RIG shares have underperformed over the past three months, falling 59%, while the S&P 500 has gained 8%. Over the past year, they have lost 85% while the index has risen 9%. RIG shares have significantly underperformed in the market over the past five years, falling 94% versus a gain of 68% for the S&P 500. On July 29, Transocean reported a 2Q20 non-GAAP adjusted net loss of $0.01 per share, compared to an adjusted net loss of $0.34 per share in 2Q19. Second-quarter contract drilling revenue rose to $930 million from $758 million a year earlier. As of July 2020, the backlog was $8.9 billion. In the first half, the company lost $0.31 per share. On May 8, the company announced that it would retire the semi-submersible GSF Development Driller II and the midwater floater Transocean 712. As a result, the company recorded a 2Q asset impairment of $430 million or $0.70 per diluted share. As management continues to evaluate the long-term competitiveness of its fleet, it may identify additional rigs as candidates for disposal.
EARNINGS & GROWTH ANALYSIS
The company’s 2Q rig utilization was 66%, an increase from 60% in the prior quarter and 56% a year earlier. Average daily revenue was $307,800, down from $314,900 a year earlier. The operating margin went up 9.4% from what it was the prior year. Our 2020 loss forecast is $0.97 per share, based on low oil prices and a slowdown in global GDP due to the coronavirus. We look forward another year of losses in 2021, and our loss estimate is $1.18 per share.
FINANCIAL STRENGTH & DIVIDEND
We rate RIG’s financial strength as Low, which is the lowest rank on our five-point scale. Standard & Poor’s rates the company’s debt as CCC/negative. Moody’s no longer rates Transocean’s debt. RIG had cash and cash equivalents of $1.51 billion at the end of 2Q20, compared to $2.24 billion at the end of 2Q19. At the end of 2019, the total debt/capitalization ratio was 44%. The company suspended its dividend in September 2015.
MANAGEMENT & RISKS
Jeremy D. Thigpen became Transocean’s CEO in April 2015. Mr. Thigpen previously served as CFO of National Oilwell Varco. The company’s CFO is Mark Mey. Like its peers, RIG faces risks from low commodity prices, which have shifted drilling activities away from deepwater production and toward cheaper, less risky onshore alternatives. It also faces risks from storm damage, out-of-service time, and delays in repairs and upgrades. Delays are costly, as they can stall the company from starting contracts that pay higher day rates. Offshore drilling, especially exploration-related activity, is the most complex and expensive means of accessing oil and natural gas. Given that exploration activity is unlikely to produce near-term cash flow, it may bear a disproportionately large share of any cuts to capex budgets. In addition, only a handful of firms can successfully undertake a major offshore drilling project; if they encounter difficulty or choose to pursue resources elsewhere, only a few companies could conceivably replace them.
Transocean is an offshore contract drilling company. It operates 41 mobile offshore drilling units consisting of 28 ultra-deepwater floaters, 12 harsh-environment floaters and three midwater floaters. The company also has two ultra-deepwater drillships under construction.
Transocean shares have traded between $0.76 and $7.28 over the past 52 weeks and are currently near the low end of the range. P/E valuation is not meaningful given our loss forecasts for 2020 and 2021. On price/book and price/cash flow, RIG is trading below the midpoint of its five-year historical range and below or in line with the multiples of other offshore drilling companies. RIG trades at a price/sales ratio of 0.5, above the peer average of 0.4 but below the five-year historical average of 1.1. We do not view these valuations as attractive given the weak industry outlook, and we see limited near-term upside for the shares. As such, we are maintaining our SELL rating.