Leading offshore driller Transocean Ltd. RIG is up 30% so far this year, comprehensively outperforming the broader Oil/Energy sector and the benchmark S&P 500. The energy space has lost 7.6% during this period, while the S&P 500 has gained just 10.3%.
Lets dive into the reasons for RIG’s outperformance and analyze whether the stock can keep the momentum going.
What Led to This Price Increase?
By all accounts, the rig supplier appears to be positioned for healthy growth in the next few years. In particular, the company’s backlog of around $8.6 billion reflects steady demand from its customers and offers earnings and cash flow visibility. Further, Transocean forecasts revenue efficiency to average an impressive 96.5% in the second quarter of 2023. This is an indication of minimal loss of revenues due to downtime and Transocean’s superior efficiency in translating its industry-leading backlog into cash.
On May 2, Transocean reported first-quarter 2023 bottom line, which fell short of the Zacks Consensus Estimate by 18 cents per share. The company reported a loss of 38 cents per share versus the consensus estimate of 20 cents loss. While it was the second miss in as many quarters, there were some pockets of investor optimism. In particular, the average dayrates in the reported quarter increased to $364,100 from $334,500 in the year-ago period. The figure also beat the Zacks Consensus Estimate of $340,000.
What’s important is that management remained upbeat on the industry outlook and believes that the dayrate for leading drillships should expand to around $500,000 by the end of this year. In fact, 2023 is likely to be a good year for the company, with close to 13% revenue growth and a 50.5% increase in earnings.
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Is the Rally Overdone?
While the overall macro environment remains constructive, the company is still not out of the woods financially. Transocean’s total long-term debt is currently more than $7.3 billion, with just $955 million in cash and cash equivalents, which has seen a continued decline over several quarters. Moreover, the company's debt-to-capitalization as of the end of the first quarter, at 42.5%, is on the higher side.
Despite the relative stability in oil prices, for most upstream operators, the focus is still on sustaining the lower spending levels, further trimming breakeven costs and maintaining financial health. As a matter of fact, after bouncing strongly from the depths of the pandemic, the oil and natural gas rig count in the United States has been gradually declining since the beginning of 2023. This indicates a drop in future drilling services. This is expected to hurt the likes of Transocean.
Further, as the companies’ legacy, high-margin contracts wind down slowly, the drillers are faced with the prospect of a drop in backlog (and consequently, revenues), which is likely to accelerate over the next few quarters. This also leaves drillers vulnerable to addressing their massive debt maturities and investment in newbuilds.
Finally, Transocean doesn't pay a dividend, neither does it have a share repurchase program.
In conclusion, Transocean’s share gains look to be overdone from a fundamental point of view. Therefore, it would be prudent to wait for a better entry point as the timing is still not right for investors to hit the Buy button. Transocean currently carries a Zacks Rank #3 (Hold).
3 Energy Stocks to Buy
Investors interested in the energy space might look at operators like NOW Inc. DNOW, Murphy USA MUSA and Dril-Quip, Inc. DRQ, each carrying a Zacks Rank #2 (Buy) currently.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
NOW Inc.: DNOW beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters. NOW has a trailing four-quarter earnings surprise of 32.1%, on average.
DNOW is valued at around $958.5 million. NOW has seen its shares gain 19.6% in a year.
Murphy USA: It is valued at some $6.1 billion. The Zacks Consensus Estimate for MUSA’s 2023 earnings has been revised 2.2% upward over the past 30 days.
Murphy USA, headquartered in El Dorado, AR, beat the Zacks Consensus Estimate for earnings in three of the trailing four quarters and missed in the other. MUSA shares have gained 17.6% in a year.
Dril-Quip: It beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters. DRQ has a trailing four-quarter earnings surprise of 119.8%, on average.
Dril-Quip is valued at around $793.5 million. DRQ has seen its shares fall 20.4% in a year.
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