Finally Time To Buy This Oil Rig Contractor?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Transocean (NYSE: RIG), the largest offshore drilling rig contractor in the world, has been one of my favorite stocks to watch for years now, however I have not pulled the trigger.  When the 2007-08 oil bubble was happening and you were seeing headlines such as “Oil Going to $200 a Barrel?” Transocean was trading at up to $188 per share.  Something told me that the oil madness wouldn’t last and I was right.

After the bubble burst, and the Deepwater Horizon disaster happened, Transocean fell to a low of $38.21.  While the company has rebounded some, I was hesitant to make a call on it either way until the company had some closure in regards to that situation.  With the lawsuits and penalties pretty much settled at this point, it might finally be time to make a move on Transocean.

Profile

Transocean focuses mainly on oil rigs for deepwater drilling, which is defined as depths of over 4,500 feet.  The company currently has a fleet of 134 drilling rigs, with another six under construction. 

As of the end of the last fiscal year, Transocean had a contract backlog of $21.4 billion. This was down 10.8% from the year before, but still included $2.7 in contracts with BP (NYSE: BP), who was operating the Deepwater Horizon rig.

Deepwater Horizon Saga

Most people know the general details about the Deepwater Horizon disaster.  In April 2010, the rig (one of Transocean’s) had an explosion, burned, and sank in the Gulf of Mexico while being operated by BP. 

The reason that BP was mainly held responsible was that as the operator of the rig, the contract between the two companies provides that BP cannot hold Transocean responsible for containing a blowout, or for the cost of cleaning up the spilled oil resulting from it. 

However, Transocean was not completely absolved.  In late 2010, the Department of Justice filed a civil lawsuit against Transocean for violations of the Oil Pollution Act of 1990 and the Clean Water Act.  The company set aside a $2 billion reserve fund to deal with this and any other charges.

Just this past week, the Department of Justice approved Transocean’s $1 billion civil settlement, in addition to a $400 million settlement of criminal fines and penalties that was also recently approved.  As a condition of the settlement, Transocean also agreed to beef up its operational safety and emergency response capacities.

BP, on the other hand, has reached a settlement over its criminal fines; however, the civil trial is yet to begin.  While I do think that BP’s stock is undervalued at current levels, I cannot in good conscious recommend it as a long term investment until all of this drama is behind it.

Valuation/Competition

Now that the legal headaches are largely behind them, Transocean may be a buy again simply due to its valuation and growth potential.  When the company reports 2012’s earnings later this month, they are expected to have earned $3.48 per share for the year, meaning that the stock currently trades for 15.4 times earnings.

Earnings are expected to grow to $4.81 and $6.18 in 2013 and 2014, respectively, or annual growth rates of 38% and 28%, which more than justifies the valuation.  I believe that the company will continue to grow its earnings for the foreseeable future.  As the dust settles from the negative press that deepwater drilling has received over the past few years, I anticipate the backlog of business to grow significantly.

As far as competition, there is not much that is a real direct threat to Transocean due to its specialization in deepwater rigs, however one that is close is Diamond Offshore Drilling (NYSE: DO), which owns a fleet of 49 offshore rigs, the classifications of which are more diversified than Transocean’s with midwater, deepwater, and ultradeepwater rigs in its fleet. 

Diamond trades at a slightly lower valuation of 14.5 times earnings, however are projected to have a lower forward growth rate of 10% annually for the next 3 years, according to consensus estimates.  Don’t get me wrong, I think Diamond is a fine investment; however Transocean is perceived by the market as riskier, and with greater risk comes greater potential reward. 

Conclusion

With the depressed valuation due to both lower oil prices and the Deepwater Horizon disaster, Transocean looks like a buy right now.  Pretty much everyone agrees that the general direction of oil prices will be higher in the future; it’s just a matter of how long it takes and how high the prices go.  As oil supplies diminish over the coming decades, the big oil companies will have no choice but to contract more rigs and “drill, drill, drill”! 

 


KWMatt82 has no position in any stocks mentioned. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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