Transocean shares just plunged significantly but have upside potential (NYSE:RIG)

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Transocean Ltd. (NYSE: R.I.G.) the order book has increased considerably thanks to Wintershall Dea and OMV and their contract with Transocean Norge. RIG also announced $181 million contracts for the ultra-deepwater drillship Asgard. These two contracts were announced on 22 September 2022 and September 6, 2022respectively.

The recovery of the offshore sector is gaining ground. If there is no large-scale economic depression, it will be a success. Oil prices also have bullish catalysts. So, there is no need to worry too much. In my view, the debt swap is not the primary reason Transocean shares are not performing as well as they could. But I completely agree that there are times when RIG shares are artificially manipulated, and the market doesn’t have its best days.

Increase in order book

On September 22, the company announced that it had been awarded a long-term contract with Transocean Norge. Here’s a quote from the company’s press release:

Transocean said the total contract term is 1,071 days at an average daily rate of $408,000, which would contribute $437 million in backlog, assuming all project approvals are received. »

There is still some uncertainty, but the recent award is significant.

Transocean also stated on September 6 that:

“The ultra-deepwater drillship, Deepwater Asgard, has been awarded two contracts in the Gulf of Mexico in the United States for a total of approximately 14 months of work, adding $181 million to the firm backlog.”

In my opinion, the most notable change I noticed was in the contracted daily rates charged by Transocean. Certainly, we should take inflation into account. But contract daily rates of around $400,000 and up haven’t been announced by the company in ages. Add to that the fact that Transocean signed a $915 million contract with Petrobras on August 1. Please also check the dates. A long time ago, Transocean so frequently announced new contracts.

But the best may be yet to come.

The chart below shows that Transocean’s backlog stopped shrinking in 2Q 2022. But recent additions of $915m for Petrobras, $321m for Deepwater Conqueror, $181m for Deepwater Asgard and, if all approvals are received, the $437 million backlog for Transocean Norge makes the picture look much better (last figure is approximate).

Transocean’s statement reads: “assuming all approvals are received…“It is true that the order book is consumed quite quickly. But if we add up all these additions, we will obtain $1,854 million in the new order book. If we add to it the digit 2Q of $6,200 millionWe will get $8,054 million, or around $8 billion in the order book. I guess the current figure could be lower than that. But the very fact that Transocean’s backlog has started to grow significantly is inspiring, in my opinion.

Table – Historical backlog (in millions of dollars)

Period reported Backlog number (millions of dollars)
1T20 9600
2T20 8900
3T20 8200
4T20 7800
1T21 7800
2Q21 7300
3Q21 7100
4Q21 6500
1Q22 6100
2Q22 6200

Source: Prepared by the author based on company data.

Diagram – Backlog history (in millions of dollars)

Backlog history (in millions of dollars)

Transocean presentations

Source: Prepared by the author based on company data.

Some of my opponents and Transocean bears might say that RIG will stop receiving high value contracts thanks to falling oil prices. Allow me to explain why the current situation may not pose a significant threat to Transocean’s well-being.

The Fed, the global economy and oil prices

Don’t get me wrong, I don’t claim to have a crystal ball to predict the future. We live in a very unstable and constantly changing world. Central bankers are getting very hawkish. The biggest threat to the stock market is the Fed’s stance. Jerome Powell recently announced that many more hikes are to come as inflation figures hit multi-decade highs.

All of this is truly catastrophic for stock markets and oil prices. However, we do not know if the next recession will be long and severe. It may be short. At the same time, oil markets could still suffer from undersupply. Right now, investors and day-traders are focusing on Fed actions. At the same time, they forget that the EU is preparing the eighth package of sanctions against Russia. One of the most discussed measures in the package is the cap on oil prices. This means that EU members would refuse to buy Russian oil at market prices but impose the maximum price barrier. Russia would in turn refuse to sell oil at the prices set by European authorities. Obviously, this would leave the EU without Russian oil, thereby driving up prices.

Another bullish factor for oil is the end of Chinese lockdowns. As many of you know, China is pursuing a zero COVID policy. This means that even a very small number of Covid-19 infections discovered in a given region obliges the Chinese authorities to put the whole region under strict control. Now China is opening up and it looks like the whole Covid-19 story is over in that country. This is important since China is the largest oil importer.

Recovery at sea

Let me now tell you more about the magnitude of the recovery in the offshore sector. Many contracts advertised by Transocean had very solid daily rates. Almost all were over $400,000 a day. But more is yet to come. Transocean CFO Mark Mey says daily rates of $500,000 are entirely possible in the company’s future.

Mey even thinks high daily rates are “inevitable” if the macroeconomic environment remains unchanged. Transocean’s chief financial officer expects daily rates to reach this level within ten months. At that time, many of Transocean’s contracts would expire and new ones would be signed.

It might be easy to accuse RIG’s senior management of over-optimism, but Mey isn’t alone. The representative of Seadrill (OTCPK:SEDRF), for example, expects to hit the $500,000 mark in daily rates by the end of the year. Earlier in July, oilfield giant Schlumberger (SLB) spoke positively about the future of the offshore business, predicting that the recovery would “visibly outgrow the 2016-2019 cycle”. Schlumberger also added that offshore yields will only increase in the future.

You might disagree, given that a recession might be near. It’s a valid argument, of course. But we don’t know when it will happen and how long it will last. After all, if supply problems persist for a long time, oil prices will remain high for years. Also, recessions come and go. In my opinion, the most interesting example of poor economic performance and expensive energy sources dates back to the 1970s in Europe and the United States. There was stagflation (high inflation and mediocre, even negative economic growth) and exorbitant oil prices. A situation like this is also possible now.

It should also be remembered that offshore drilling, particularly in hostile environments and ultra-deep waters, requires long-term investment. It is therefore likely that the oil majors would sign new contracts without paying too much attention to short-term volatility.

Bondholder Speculation and the Recent Debt Swap

It was recently mentioned by my colleague Henrik Alex that the recent debt swap was the main reason for the fall in Transocean’s share price. The recent swap was announced on September 13. While this explanation is valid, I don’t think it’s entirely because of it.

Chart
Data by YCharts

On and after September 13, the oil market began to plunge, which affected energy indices and the shares of many oil companies.

Chart
Data by YCharts

This can be seen in the chart above depicting RIG’s stock price and the S&P 500 GSCI Energy Index (^SGJ). However, when it comes to Transocean shares, these are more volatile than the S&P 500 GSCI index.

Chart
Data by YCharts

Higher volatility is also typical of RIG as opposed to its close offshore rivals Noble Corp. (NE), Diamond Offshore (DO) and Valaris (VAL). In my other article, I wrote that RIG is a better company than NE, DO and VAL when it comes to order book and fleet. However, investors are more positive about RIG’s competitors than RIG itself due to the latter’s much higher leverage.

Henrik Alex also says the $300 million of new exchangeable bonds are likely subject to holders using convertible arbitrage strategies. Thus, most of the recent declines in stock prices are due to short selling. I would rather agree. But this is not the first time that RIG shares have been manipulated by the market and especially by bondholders.

The most notable time this happened was in the fall of 2020. At the time, Transocean was sued by Whitebox Relative Value Partners as a company failing to meet its obligations to bondholders. This was all due to RIG’s debt swap. As a reminder, the court ruled that Transocean’s actions did not break the law. At the same time, everyone predicted that Transocean was going bankrupt and RIG’s stock price fell to extremely low levels. So now, in my opinion, Transocean’s stock is as undervalued as it was then.

Conclusion

By all means, Transocean shares are volatile and probably not ideal for very conservative investors. At the same time, it looks like there are plenty of opportunities for growth. Don’t get me wrong – it’s very difficult to predict the future and I don’t claim to do so. Central bankers are getting very hawkish, while analysts are predicting a recession is near. However, it seems likely that energy sources will be scarce for some time as the offshore recovery is in full swing. In my view, it seems likely that patient investors will be rewarded.

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