Nearly every investor, long, short or indifferent, is aware of the numerous downgrades analysts have issued on Transocean Ltd. (RIG) and on the offshore drilling industry as a whole over the past few months. I'll avoid the recap. Last week Transocean issued their February fleet status update. Neither bull nor bear received the guidance they were expecting. Instead, the market received mixed guidance from Transocean. Resulting from the mixed guidance is a few near term binary events investors, both long and short, should be aware of. Aside from the near term binary events, I would like to shed some light on what was missing from the February Fleet Status Update and will likely appear in next month's fleet status update. Although guidance was mixed, it leans more in the direction of bullish news rather than bearish.
The Good News First:
Transocean has announced a 66 million dollar increase in new contract value. This addition is primarily due to Inpex opting to exercise their option to extend the Discover Seven Seas' contract to drill an additional well off the coast of Indonesia. Aside from the single well extension, the Discover Seven Seas was contracted by an undisclosed customer to drill a single well after the Inpex contract expires. Basically, The Discover Seven Seas was contracted to drill two wells and the rig is contracted until September of 2014.
Aside from the contract value increase, Transocean announced a contract for the GSF Galaxy 1, which will begin in April. The rig is contracted to Total SA, (TOT) but will not operate in the first quarter. They're expecting 91 days of additional downtime from the GSF Galaxy 1 and will receive compensation from Total for the downtime because Total wants to upgrade the rig before a long term contract begins.
Transocean also expects 45 days of compensated downtime from the M.G. Hulme Jr. The rig is being upgraded before it begins a new contract. Although Transocean has not released the identity of the client or the stipulations of the contract, 45 days of "substantially reimbursed" downtime to make upgrades suggests the contract will be long term.
Lastly, The GSF Monitor has been sold. That rig was removed from the fleet status report in January when the intension to sell the rig was announced. No further details were announced.
The Bad News:
The company still has nearly the same amount of rigs with contracts expiring in 2014. Now they just expire in a more narrow period of time. Contracts for all other Rigs, aside from the GSF Development Driller 2 and the M.G. Hulme Jr. have not been re-negotiated. With that said, there are four rigs which had contracts expiring at the end of February and only three were mentioned in the fleet status update. Since there is no mention of the GSF Development Driller 1, it's status remains unchanged as of February 18th 2014. As of January 16th, the company was not expecting any down time for that rig. This rig is still at risk of going un-contracted.
Aside from the issues mentioned above, there were some statements made on the February fleet status update which appear to be inaccurate. In the press release and on the Fleet status report the company stated:
"Estimated 2014 out-of-service time increased by a net 150 days, including 91 days primarily associated with customer-requested and substantially reimbursed upgrades on the GSF Galaxy I; and 45 days on the M.G. Hulme, principally for preparation in advance of anticipated contracts."
-Transocean Fleet Status Update
These statements indicate that they are only expecting 14 days of additional unpaid downtime because after the 136 days of compensated downtime are deducted from the 150 total days, we are left with 14. The rig from which they were expecting 14 days of downtime was not identified. As far as I can tell they are expecting downtime from numerous rigs which will equal 14 days total. Unfortunately, there's a problem with that. The increase in the amount of unpaid downtime expected in 2014 drastically exceeds 14 days. In fact it more than doubles that. As opposed to a mere 14 days of downtime, Transocean will actually suffer 34 days of unpaid downtime since 136 subtracted from 170 equals 34 days.
(click to enlarge)
Binary Events in the Near Term:
- 2013 Earnings: Transocean reports earnings on February 26th, the RSI is increasing which means the stock is gaining momentum going into earnings.
- March Guidance: Should come in the beginning of the Third Week of March. Investors should look for information pertaining to the sale of the GSF Monitor and any information pertaining to the GSF Development Driller 1.
- April Guidance: April Guidance is going to be important for Transocean because it has 3 rigs with contracts expiring. The one rig investors should pay particular attention to is the Sedco 706. It was built in 1973, making it the second oldest rig in Transocean's active fleet.
Conclusion:
All in all, February guidance was mixed, but slightly leaning in the bullish direction. Despite two rigs being contracted, there is still roughly the same amount of rigs with contracts expiring in 2014; they will just expire in a narrower period of time and there is still one rig at risk going un-contracted in March. RSI continues to increase which indicates the stock is gaining momentum going to the 2013 earnings call on February 26th.
The amount of downtime seems to decrease in the second half of the year. I would like to caution investors and remind them that the amount of downtime will likely continue to increase in the third and fourth quarters. It is just difficult to forecast downtime over 6 months in advance. Consequently, the 48 dollar price target is also misleading. There is a saying in the off shore drilling industry that appears, in some shape or form, in financial statements across the industry and is appropriate in this particular instance.
"The dayrates set forth in the report are estimates based upon the full contractual operating dayrate. However, the actual average dayrate earned over the course of any given contract will be lower and could be substantially lower."
-Seadrill Ltd.
In regards to the discrepancy on the fleet status update, I'm uncertain if all other information contained within the report is accurate or if there is other inaccurate information. I'll give Transocean the benefit of the doubt. They weren't trying to deceive their investors, they just made mathematical error and that happens from time to time. The company needs spend additional time reviewing the information they intend to release to their shareholders to ensure it's accurate.
On a positive note, they aren't expecting nearly as much unpaid downtime in first quarter and it has all basically been rolled over into second and third quarter. We should see a bull run after earnings because the EPS estimates for 1st quarter should become significantly higher. How long the bull run continues for depends on future guidance.
Disclosure: I am long RIG. 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. (More...)
Additional disclosure: I'm long calls at the $46 strike march expiration and puts at the $40strike may expiration This is not a buy or sell recommendation. All readers should conduct their own research and use the information contained within this article as a starting point for their own research.
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