Last year was among the worst for the energy sector. WTI oil (West Texas Intermediate, which serves as a global oil benchmark) briefly entered into negative territory for the first time in history. The last few quarters have, however, been characterized by a slow and steady recovery in energy prices.
Exposure to oil and gas exploration companies is one way to benefit from positive industry tailwinds. The outlook also seems positive for offshore rig service providers. One stock that stands out from the crowd is Transocean (RIG).
Before discussing Transocean, it’s important to talk about the fundamental factors that are likely to support oil at higher levels. First and foremost, the IMF expects global GDP growth at 6.0% for 2021 and 4.4% for 2022. After a global recession in 2020, economic activity is accelerating. This would imply a gradual increase in demand for oil.
Furthermore, the Federal Reserve has pledged expansionary monetary policies, possibly through 2023. Artificially low interest rates, coupled with economic recovery, is a recipe for higher inflation. That's good for energy and commodity prices, which tend to perform well in times of rising inflation.
It’s also worth noting that the likely return of Iran into the oil market has not negatively impacted prices. This is an indication of the markets discounting a tighter demand-supply scenario. (See Transocean stock analysis on TipRanks)
Bullish Outlook for Transocean
It seems clear that the worst is over for Transocean. Further, the company is positioned for healthy growth in the next few years.
The first positive is the company’s current order backlog. As of March 2021, Transocean had a total backlog of $7.4 billion. The backlog is front-end loaded with $4.5 billion in revenue expected through 2023. This provides a clear cash flow visibility.
For the first quarter of 2021, Transocean reported positive operating cash flows of $96 million. Given the recovery in oil price and the possibility of higher day-rates for rigs, it seems likely that cash flows will accelerate through the year. This will help in improving the liquidity buffer.
Another important point to note is that the company’s order backlog is primarily with investment grade oil and gas companies. This reduces the risk related to potential cancellation of orders.
As offshore rig providers emerge from the worst, Transocean has another advantage compared to peers. The company has a 100% ultra-deep-water and harsh environment fleet. In the last five years, Transocean has pursued aggressive fleet transformation. With a modern fleet, the company is well positioned in a competitive market.
From a financial perspective, Transocean reported $1.2 billion in cash and $1.3 billion in undrawn credit facilities. With a total liquidity buffer of $2.5 billion, the company is well financed for capital expenditure over the next 24 months.
Further, if contract renewals are at a higher day-rate, cash flow upside will help Transocean in de-leveraging. As of March 2021, Transocean did have a total debt of $7.1 billion. However, the debt would be a concern only if oil would decline meaningfully from current levels. For now, with a robust backlog, debt servicing is likely to be smooth.
Wall Street’s Take
According to TipRanks’ analyst consensus rating, RIG stock comes in as a Hold with 4 Hold ratings assigned in the last three months.
As for price targets, the average analyst Transocean price target is $3.58 per share, implying around 11.4% downside from current levels.
Transocean has also been negotiating with shipyards for the delayed delivery of new rigs. Recently, the company announced the delayed delivery and deferred payment for two ultra-deep-water rigs. This helps preserve liquidity, and the rigs are likely to be delivered when the offshore market condition improves further.
In the last six months, RIG stock has trended higher by 61%. Given the outlook for oil prices and the possibility of EBITDA margin expansion, it’s likely that the positive momentum for the stock will sustain.
Disclosure: On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.