A Surprising Turnaround for an Oil-Drilling Giant
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The Fiscal Times
February 29, 2012

The Dow Jones Industrial Average closed above the 13,000 level – an event last recorded before the financial crisis struck in 2008 – and among the stocks participating in the celebration was Transocean (RIG).

At first glance, you might wonder how the world’s biggest offshore oil drilling company managed to pull of this feat, given that it is still mired in legal issues arising from the 2010 Deepwater Horizon oil well disaster in the Gulf of Mexico (it owned the rig that exploded and sank, causing the worst offshore oil spill on record in the United States and killing 11 people). Moreover, the company just reported a loss of $6.12 billion, or an astonishing $18.62 a share, compared to a loss of a mere $2.51 a share for 2010.

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But financial market participants – as it never hurts to remind ourselves – don’t spend their lives gazing into the rear-view mirror. They look forward, and right now Transocean’s future is beginning to look rosier than it has since that explosion in the Gulf. Once you factor out the $6.18 billion special after-tax charges from the equation (about $1 billion of which flow from the drilling rig disaster) and look instead at the company’s operations, that loss becomes a small profit of 18 cents a share, pretty much what analysts had been expecting. That’s the first time Transocean has delivered what the market was hoping for in nearly two years – and analysts are becoming reasonably bullish about the company’s prospects.

True, the civil trial surrounding the disaster is now expected to begin next week, unless the parties agree to a settlement. (The start date was pushed back to accommodate talks between them.) But a judicial ruling in late January upheld an indemnity agreement with BP under which Transocean wasn’t liable for claims made by residents or businesses damaged by the spill or for the costs of cleaning up the mess. That doesn’t mean that the company has sailed into calm legal waters, but the possible blow to its financial resources was significantly reduced by that ruling.

Increasingly, evaluating Transocean’s business is going to come down to fundamentals – specifically, how well positioned the company is to participate in any surge in offshore drilling activity that follows the latest jump in the price of crude oil. Transoceans’ clients, analysts reported after the company’s conference call, expect to boost their spending by 12 percent to 15 percent this year. The company has been spending heavily to upgrade its aging fleet, which has meant that it has taken rigs out of service. Gimme Credit, the corporate bond research firm, notes that the rate at which out-of-service rigs are returned to active duty is expected to be very rapid throughout 2012; citing improved fundamentals and increasing free cash flow, Gimme Credit repeated its “outperform” call on the bonds.

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Equity analysts also responded favorably to the earnings report and the subsequent conference call. The stock is trading at a slight premium to the offshore drilling stocks as a group (15.6 times one analyst’s estimate for this year’s earnings), but at the low end of its own 10-year average valuation by several measures. One firm raised its recommendation to “outperform” from “market perform” yesterday. Tudor Pickering had boosted its recommendation to “accumulate” from “hold” in early January; short sellers are reducing their bearish bets.

Today, while some optimists call for the stock’s price to hit $81 this year, the median expect it will rise to at least $60.50 a share, from $54.25 currently, and there’s an even split between those analysts who rate the stock a buy and those who suggest simply holding it at current price levels.

True, Transocean is still coping with choppy seas, and the horizon won’t be completely clear until it has resolved the oil spill legal issues and the problems associated with its aging rigs. But by the time the skies clear, it’s possible the stock price will already reflect those improving fundamentals.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.