20 February 2008

Transocean - RIG - The Penultimate Zacks Top 10 for 2008

Here's the tenth teaser from Zacks:

Stock #8: Supplier to oil companies fueled by high prices. Recently, this brilliantly run firm acquired a competitor that broadens their already varied product line as well as their geographical footprint.

Stephen Ellis at Morningstar is intrigued by Transocean's acquisition of GlobalSantaFe. Ellis also sees RIG as a solid investment over the Zacks one-year time horizon and beyond:

The new Transocean is set to thrive in the next few years.

We like Transocean's deep-water focus, and its merger with GlobalSantaFe offers a tantalizing opportunity to deliver shareholder value. The combined 140-vessel fleet--twice the size of the next largest competitor--might be able to boost industry profitability by controlling excess capacity. As a result, we expect the combined Transocean to markedly improve on its historically poor returns on capital.

Transocean controls one of the world's largest deep-water fleets, which it contracts to oil and natural-gas companies worldwide. The combined Transocean will have nearly 40 offshore drilling vessels that can handle deep-water operations, more than 30 midwater vessels, and 68 jackup rigs. Discoveries of oil and gas thousands of feet below the surface of deep-water markets such as Brazil and India have caused a surge in Transocean's day rates and fleet utilization.

The limited supply of deep-water vessels worldwide has led to a supply-demand imbalance with operators scrambling to contract Transocean's rigs. The shift in contracting power to the offshore drillers means lengthier contracts and skyrocketing day rates. It also helps that large deep-water markets such as the Gulf of Mexico and the North Sea have little political risk for operators and offer better opportunities to retain control of the discoveries than the difficult operating environments in Russia and Venezuela. We expect day rates and fleet utilization to remain at elevated levels until new rigs are added to the market from 2010 to 2012.

We think the combined Transocean will be one of the best deep-water contractors out there. The source of its narrow moat will be its ability to control excess capacity by virtue of strong market share in several geographic regions and ship categories, such as drillships and semisubmersibles. Transocean's operational processes for employee safety, environmental concerns, and delivering quality rigs give it an advantage over established competitors. The company's industry reputation as a skilled and experienced contractor allows it to charge a premium. Further, its aggressive patent strategy has resulted in patent settlements with Pride, GlobalSantaFe, and Noble, protecting its technical leadership in the industry.

Among the oil drillers, RIG is the dominant player, but still carries a low PEG of 0.3; its peers have PEG ratios averaging closer to 0.7.

I haven't cited Jim Cramer for quite some time in this blog. Here, Cramer tossed off a mention of RIG in his second of ten predictions for 2008:

2. Oil goes much higher, maybe as much as $125 a barrel... We are running out of oil more quickly than people can imagine, and that means great returns for oil companies. Just buy the stock of the company you filled up at today or buy a driller (Transocean (RIG) is my favorite), then sit back and make money.

Cramer likes hawking "best of breed" stocks. I'm not going to contradict his favoritism. Do I think oil is running out quicker than commonly believed, and is going to climb another 25% in the next ten months?

Uh, no.

At that point, even filling up the Pig's wee beastie ('07 Honda Fit) would start looking onerous. If the Pig can't easily zoom out to DC, Boston, AC, the Hamptons, or even the Red Hook Fairway, then hopefully I'll have super-sized shares of RIG to liquidate in exchange for some precious petrol.

Oil just hit $100 again, so it's timely for me and whoever is reading this to revisit Chris Krasowski's piece on RIG:

Oil Hits $100: Time to Look at Transocean

Well its finally happened. Oil breached the triple digital per barrel threshold. It was bound to happen as the supply numbers dimished rapidly and all the civil unrest in the oil producing nations around the world.

Oil eased a bit from record levels but still managed a record close above $99.
Going into the spring, its anticipated that oil will retreat from these lofty levels, but from a technical trading standpoint, oil is still headed slightly higher. The psychological level of $100 is firmly being pushed on the commodities front.

There's a possible trade here, and I specifically like the drillers, such as Transocean (RIG), whose offshore operational rigs are plentiful and among the best in the business; the company just got another endorsement from the famous Jim Cramer. While RIG has indeed doubled over the course of a year, the important earnings metrics haven't yet flown off the handle. So there is still some room there to expand future P/E metrics. But as energy and oil related stocks reach further and further highs, it'll take rationality to not get caught up in the expected seasonal fall.

Notable Calls made its bullish call on RIG on December 19th:

Banc of America is out with a good call saying they see incremental demand for deepwater rigs from exploration success driving additional backlog and ultimately multiple expansion from the higher visibility. Among the names, the firm reits Buy on Transocean (NYSE:RIG) with a $175 target.

Stronger-for-longer. Yes it's a sell-side cliche, but with the industry's inability to keep up with growth in crude oil demand (the tyranny of geology and politics), the lack of deepwater rigs (73% of floater days are already committed over the next 36 months), and upside from a forecasted increase in exploration activity (BAC estimates Tupi alone needs an incremental 25-50 deepwater rig years), they expect the 'high' return on capital period for the oil services, equipment and drilling companies to last for the foreseeable future. While the lack of rig availability may limit 2008 EPS upside, the increase in pent-up demand, most visibly in the deepwater rig market, implicitly provides backlog for service companies as well, and should make for a multiple expansion the story for 2008.

While forward cash flow and earnings multiples have compressed for the better part of the last four years, multiples appear to have bottomed. With the pent-up demand offering unprecedented visibility, they expect the 'high' return on capital period for the oil services, equipment and drilling companies to last for the foreseeable future, and drive multiple expansion in 2008. Interestingly, multiples for the group also expanded as the cycle matured back in the 1970s cycle.

Notablecalls: BAC's comments make sense. Companies with deepwater exposure may represent a safe haven for now and we will see multiple expansion there. The chart on RIG looks good, and I think BAC's call will generate some buy interest in the name.

Finally, let's look at some charts.

Here's the daily:

And here's the weekly, for a broader view of RIG's price movement:

The middling RSI 2-day and 14-day readings on the daily chart do not currently offer up a "Buy me now!" signal. The RSI 2-day reading of 78 on the weekly chart suggests to me that I should wait for a pullback of the larger market before building up a buy-and-hold-for-a-year-or-more position in RIG.

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