Transocean Continues to Slide

Offshore drilling giant Transocean Ltd. (RIG) reported weak first quarter 2011 results, hurt by the decline in utilization rates and average daily revenue resulting from fewer rigs in use.

Earnings per share, excluding expenses associated with the Macondo well incident, gains from asset sales and other minor items, came in at 59 cents, well short of the Zacks Consensus Estimate of 80 cents and significantly behind the year-ago adjusted profit of $2.22.

Switzerland-based Transocean, which has been in the news since the disastrous blowout and oil spill in the Gulf of Mexico, suffered from the uncertainty in the deepwater drilling market. The company has already warned investors regarding the risks associated with the Horizon rig disaster, including legal costs, government investigations and lost revenue.

As a reminder, on April 20, 2010, offshore driller Transocean’s ultra-deepwater Horizon drilling platform, contracted to British oil giant BP plc (BP), sank following an explosion while operating in the U.S. Gulf of Mexico off the coast of Louisiana. The incident killed 11 workers and spewed more than 200 million gallons of crude in what is touted as the worst oil spill in U.S. history.

Subsequently, a moratorium was imposed on offshore drilling in the region at water depths of more than 500 feet, which was lifted on October 12, 2010.

Revenue

Total quarterly revenues of $2,144.0 million missed the Zacks Consensus Estimate by 7.3% and were down 16.9% year-over-year, mainly attributable to reduction in contract drilling sales (due to lower utilization and lower average daily revenue), partially offset by contributions from newly constructed rigs and additional drilling management services activity.

Transocean’s high-spec floaters contributed approximately 60% to total revenue, while mid-water floaters and jack-up rigs accounted for 19% and 12% of the total, respectively. The remaining revenue came from other rig activities, integrated services, and others.

Operating Statistics

During the quarter, the company’s operating income totaled $372 million, down 60.5% year-over-year. Operating and maintenance expenses were $1,359.0 million, 14.6% higher than the first quarter of 2010, primarily reflecting increased drilling management services activity, somewhat offset by reduced rig-related maintenance costs.

Dayrates & Utilization

Average dayrates increased 5.7% from the December quarter to $292,600, as high-spec floater dayrates gained 6.5% and mid-water floater dayrates were up 4.9%, partially offset by a 17.9% reduction in high-spec jackup dayrates.

Compared to the first quarter of 2010, dayrates fell 2.3% (from $299,600 to $292,600), adversely affected by lower dayrates among all types of rigs. In particular, high-spec jackup dayrates were down 34.7%, while standard jackups decreased 18.0%.

Overall fleet utilization was 55% during the quarter, down from the prior quarter level of 58% and the first quarter 2010 utilization rate of 66%.

Backlog

At the end of April 14, Transocean’s contracted backlog was $24,554.0 million, up from $23,980.0 million as of February 10, reflecting the company’s ability to obtain new rig contracts to adequately replace the existing backlog as it gets consumed over time or if any contracts are terminated.

Capital Expenditure & Balance Sheet

Capital expenditures during the quarter totaled $240 million versus $369 million in the prior-year quarter, with the change primarily related to lower costs associated with the construction of new rigs. As of March 31, Transocean had cash/cash equivalents of $3,812.0 million and total debt of approximately $11,439.0 million (representing debt-to-capitalization ratio at approximately 35.0%.

Outlook

Transocean expects market utilization and dayrates for all classes to remain steady or improve over the next few quarters based on the continued favorable commodity prices and improved global economic outlook, which are also expected to create contracting opportunities for the remainder of 2011 and throughout 2012.

Our Recommendation

Transocean shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. We are also maintaining our long-term Neutral recommendation on the stock.

With its technologically-advanced and versatile offshore drilling fleet, strong backlog and considerable pricing power, Transocean offers an unmatched level of earnings and cash flow visibility.

However, the Deepwater Horizon incident is bound to create some overhang on the stock because of Transocean’s involvement and the ensuing uncertainty in the deepwater drilling market. The Swiss court order rejecting Transocean’s plea on dividend payments is also a near-term setback, in our view.