In June, I wrote an article in which I analyzed why Transocean (RIG) is likely to follow the fate of its peers Seadrill, Diamond Offshore, Noble Corporation and Valaris and restructure. Since then, the stock has plunged 55%. I have written many other bearish articles on this stock over the last three years, in which the stock has shed 90%. After such a prolonged downtrend, some investors may think that the stock has finally become a bargain. However, in this article, I will analyze why the stock is still excessively risky.
First of all, Transocean has repeatedly emphasized some positive factors in its business in the last several presentations it has provided to its shareholders. It has reduced the average age of its floaters from 21 years in 2014 to 9 years while it has increased the percent of its harsh environment and ultra-deepwater floaters from 45% in 2014 to 100% now. This is indeed a great improvement in the asset portfolio of the company, which is doing its best to improve the factors it can control.
Transocean also boasts of having a backlog of $8.9 billion, which is four times the backlog of the nearest competitor. However, investors should note that the company has been consuming its backlog at a fast pace due to the prolonged downturn in its business. Since June-2019, the backlog has plunged 26%, from $12.1 billion to $8.9 billion (in July-2020). Due to the fast consumption of its backlog, Transocean will not be able to continue to support its results in this way for much longer. To provide a perspective, Transocean has used $3.2 billion of backlog in the last 13 months whereas it has only $2.1 billion of backlog for 2021 and $1.6 billion of backlog for 2022.
Despite the extensive use of its backlog, Transocean has posted excessive losses in each of the last four years. During the last three years and the first half of this year, the offshore driller has posted aggregate losses of $7.3 billion. This amount is 11 times the current market cap of the stock and hence it is undoubtedly gigantic. As the results in recent years have been supported by the use of the backlog, investors should worry about the effect of a decreasing backlog on the results in the upcoming years.
The depression of offshore drillers
The immense losses of Transocean have resulted from the prolonged downturn of the offshore drilling business. This business offered outsized profits during 2012-2014, when oil was trading around $100 per barrel. However, in mid-2014, the price of oil began to collapse due to the boom in the U.S. shale oil production. Even worse, there was an excessive supply of floaters and jack-ups due to the huge investments of offshore drillers in new capacity during the boom period. While the price of oil bottomed in early 2016 and the rest of the energy market began to recover, the offshore drilling business remained depressed due to the supply glut of floaters and jack-ups. Even worse, the coronavirus crisis has now caused a severe global recession and thus it has caused a collapse in the demand for oil products and hence in the global oil production.
In other cyclical industries, such as the refining business, a bust cycle is always followed by a recovery. During a downturn, some refineries are forced to go out of business and thus the available refining capacity falls below the demand for oil products at some point. This triggers a recovery of the business. It is thus natural that many investors cannot understand why this has not occurred in the offshore drilling business. After all, most of the major offshore drillers, such as Seadrill, Diamond Offshore, Noble Corporation and Valaris, which includes three merged companies (Ensco, Atwood and Rowan), have all gone bankrupt in the last few years.
The answer is the fact that all these offshore drillers have gone bankrupt but they have restructured and thus they have not pulled their floaters out of the market. In other words, their shareholders and their bondholders were devastated but the companies are trying to operate from the beginning, with new funds. As a result, the supply glut of floaters remains in place. This is a key difference from other cyclical businesses, in which the weak players go bankrupt during a downturn and the survivors emerge stronger in the subsequent recovery.
Transocean has net debt (as per Buffett, net debt = total liabilities – cash – receivables) of $9.6 billion. This amount is approximately 15 times the market cap of the stock and hence it is undeniably excessive. Moreover, net interest expense has amounted to $605 million in the last 12 months. As this amount is nearly equal to the market cap of the stock, it raises a big red flag, particularly given that the operating income of the company has amounted to only $110 million over the same period.
Furthermore, Transocean is likely to keep posting great losses until at least the end of next year, partly due to the impact of the pandemic on its business. In fact, analysts expect the company to keep posting material losses for at least another five years. The company has posted losses of -$1.46 per share in the first half of the year. These losses exceed its current market cap by 49%. Overall, Transocean has an excessive debt pile and is far from returning to profitability. As a result, the company is likely to go bankrupt in the next few years.
It is worth noting that the stock tumbled 7% in early August, when Transocean announced that it had hired Lazard to help manage its capital structure. Lazard is specialized in restructuring the debt of companies and countries that are heavily indebted and consider “cutting” a portion of their debt at the expense of their bondholders. On the day of the announcement, the 7.5% bonds of Transocean that are due in 2031 slumped to $0.26. In other words, those who previously bought $100 of those bonds of Transocean could now sell them at only 26% of their nominal value. This is just a confirmation that the market views the debt of Transocean as unviable.
Transocean deserves to be praised for being the only major survivor in the bloodbath of offshore drillers. Its peers Seadrill, Diamond Offshore, Noble Corporation and Valaris have all restructured and thus they have wiped out their shareholders. Transocean has been doing its best to improve the parts of its business it can control but the unprecedented downturn of the offshore drilling business is beyond the control of the company. The aforementioned restructured companies have not retired their fleet and hence this business is still characterized by an excessive supply of floaters. The pandemic has only made things much worse. Given also the huge debt load of Transocean, the company is likely to follow the fate of its peers and restructure at some point in the future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.