A Few Reasons Why This Company Can Get Better

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

With its infamously appropriate RIG ticker symbol, Transocean (NYSE: RIG) operates the world's largest fleet of offshore drilling rigs. The company has been on a whirlwind ride over the past few years, thanks to the Deepwater Horizon incident; grossly under-performing the market over the past five years.

<img alt="" src="http://media.ycharts.com/charts/999c90879813c4bc6f9ec675e5cb26a6.png" />

Thanks in part to this under-performance, billionaire activist Carl Icahn took a stake in the company during 4Q 2012, and now owns over 20 million shares -- after upping his stake by 200% during the first quarter and is now Transocean's largest shareholder.

Icahn has been pressing Transocean to shakeup its board, and he got a big win back in May when Transocean shareholders voted in favor of one of Icahn's three board nominees. However, Icahn is still pushing for a better use of cash, feeling that the company is "squandering" cash flow, which includes using it to pay down debt. 
 
In May, the company approved a $2.24 per share annual dividend, or just over $800 million annually -- compared to the company's cash on hand of $3.7 billion at the end of Q1. Icahn was pushing for a $4 per share special dividend, but the current dividend plan appears to be more financially appropriate. 

Transocean manages some 84 drilling rigs with a heavy weighting toward deepwater units. Adding to these 84 rigs will be seven high-spec rigs that are under construction. This puts Transocean well above its peers by rig count: 

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Source: Transocean
 
Distant second

Transocean is the leader driller by rig count, with Ensco (NYSE: ESV) in a distant second with 71 rigs. Ensco reached 90% utilization for its deep-water rigs in 3Q 2012, and is shooting for 95% by the end of 2013. It also posted better than expected 1Q EPS, earning $1.39, compared to $1.16 for the previous year's quarter. 
 
At the end of 2012, Ensco's backlog was $10.8 billion, up from $9.7 billion at the end of 2011, and from $3.1 billion at the end of 2010. Of that $10.8 billion backlog, $4.1 billion is expected to be realized as revenue in 2013.
 
Ensco also has an impressive balance sheet and the company recently boosted its dividend payment by 33% to $2 per share annually. This puts Ensco as the next best dividend payer (by dividend yield) behind Transocean.
 
However, one of the downsides for the company is that it generated nearly 50% of 2012 revenue from just five customers, and 24% from its largest customer, Petrobras. 

Number three

Noble (NYSE: NE) has some 68 offshore drilling rigs, plus 11 units under construction. Upon completion in 2014, the company will have 79 offshore rigs in its fleet. Noble posted 1Q EPS of $0.59 compared to $0.47 in the same quarter last year -- beating consensus by $0.08.

Noble plans to deliver a total of six new builds in 2013, which should put a strain on cash flow needs. The 2013 capital spending is expected to be $2.8 billion compared to the 2013 operating cash flow generation estimate of $1.6 billion. 
 
The smaller player

Diamond Offshore Drilling (NYSE: DO) has a fleet of 44 offshore drilling rigs. First-quarter EPS came in at $1.27 compared to the $1.22 for the same period last year, and beat consensus by $0.13. 

Recognizing the industry's transition and increase in demand for deepwater drilling, Diamond upgraded two of its mid-water floater rigs to deepwater moored units. Assuming Diamond can continue this trend, it's an innovative and low-cost way to renew its fleet. 

Diamond is also looking to boost its position in the emerging markets, including Brazil and West Africa. But what still remains as one of the key interim growth drivers for major drillers is improved drilling in the Gulf of Mexico. 
 
Hedgies love to drill

As noted, billionaire Icahn is a big believer in Transocean, but what about his major peers? Fellow billionaire Jim Simons' appears to be a big fan of Diamond Offshore, having the largest position in the company among major hedge funds, worth $171 million. However, there were only 17 hedge funds long Diamond going into 2Q; this compared to Noble's 36 hedge funds, which was a 9% increase from the previous quarter.

Bottom line

Transocean still trades well below its major peers on a price to sales basis.

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The oil and gas drilling industry should pick up over the next few years, thanks to rising awareness of "energy independence" in the U.S. As a result, all the major drillers could move higher in the coming years, but I think Transocean is investors' best bet. 

The company now offers investors the best dividend in the oil and gas drilling industry, yielding over 4.6%. With the backing of activist investor Icahn, I am in support of Transocean; the company has the top position in the drilling market and as the overhang from the Deepwater Horizon incident dissipates, the stock should move higher. 

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Marshall Hargrave 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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