This week we target two investment grade, US dollar bonds from Swiss-based Transocean Ltd. (NYSE:RIG), a global provider of offshore drilling services for oil and gas wells. As an essential provider of key infrastructure for the offshore drilling industry, Transocean has the largest ultra-deepwater drilling fleet in the world, and its client list boasts icons of the oil industry including Chevron, Shell and British Petroleum (BP). The 3 year bond is currently indicating about 7¼% and the 5½ year bond about 8.8%. The company has a current backlog that amounts to USD $23.6 billion, representing multi-year contracts with its customers, with durations lasting until 2020. These contracts assure certain revenues for the duration of these bonds.
In the face of declining oil prices, Transocean has maintained its investment grade ratings from Fitch and Moody’s and has made strategic decisions to reduce its ongoing operating costs. Even at the current price for oil, the company’s cash flow from the major oil corporations will still satisfy debt payments. The company has excellent liquidity with USD $2.9 billion in cash and an additional $3.0 billion in unused revolving credit facility. Transocean is well-positioned to weather the storm in the face of the current low price oil environment. Given its healthy liquidity levels, the nature of its essential services to the offshore drilling industry and its world-class client list, we think these relatively short duration investment grade bonds offer an extremely attractive yield relative the risk typically associated with high yield, and we are adding these to our FX1 and FX2 portfolios.
About the Issuer
Transocean is a leading international provider of offshore contract drilling services for oil and gas wells. Based in Zug, Switzerland, it specializes in technically demanding sectors of the offshore drilling business with a particular focus on deepwater and harsh environment drilling services. Its mobile offshore drilling fleet is considered one of the most versatile fleets in the world. Transocean contracts drilling rigs, related equipment and work crews predominantly on a day-rate basis to drill oil and gas wells. Transocean owns or has partial ownership interests in, and operates a fleet of, 71 mobile offshore drilling units consisting of 44 high-specification floaters (ultra-deepwater, deepwater and harsh-environment drilling rigs), 17 mid-water floaters and 10 high-specification jackups. In addition, the company has seven ultra-deepwater drillships and five high-specification jackups under construction.
Transocean has a client list that includes many of the oil industry’s largest corporations, and this is reflected in the company’s high quality ratings from Fitch and Moody’s. Currently, it has active contracts with Chevron, British Petroleum (BP), Shell, Canada’s Talisman Energy, and Brazil’s Petrobras. Among these and several other oil companies, Transocean has multi-year contracts with expirations as long as March 2020. These multi-year contracts represent a total company backlog of USD $23.6 billion dollars.
In order to create additional financial flexibility, TransOcean employed several strategies in 2014, including the creation of Transocean Partners (a Master Limited Partnership or MLP) and the creation of Caledonia Offshore Drilling.
Transocean Partners was created in mid-2014 and holds roughly a 51% interest in rig companies that own and operate two ultra-deepwater drillships under contract to Chevron and one semi-submersible rig contracted to BP. These three rigs are currently located in the Gulf of Mexico with an average remaining contract life of approximately four years. The partnership also has rights over the next five years to acquire stakes in four drillships Transocean currently has under construction. The creation of this MLP provides Transocean a way to transfer assets off its balance sheet and raise liquidity to fund interest or dividend payments, while maintaining control over the assets. Transocean could sell (called “drop down” in partnership terms) rigs to the partnership, which would fund the purchase by selling additional equity units or issuing debt.
Also in 2014, Transocean created Caledonia Offshore Drilling. This separate entity now owns eight mid-water floating rigs currently in operation in the UK North Sea. The creation of Caledonia reflects Transocean’s asset strategy to improve the overall capability of its offshore drilling fleet. Transocean intends at some point in the future to either issue shares of Caledonia and/or issue debt under the Caledonia name. Net proceeds from either of these transactions would provide Transocean with additional capital.
In light of the recent declines in oil prices, Transocean has made strategic reductions in its operating costs. In 2014, it decreased its cost base by USD $700 million, from USD $5.7 billion to $5.0 billion. Also, in an effort to control costs in the current low oil price environment, the company has projected capital expenditures for 2015 at $500 million, roughly half of its annual capital expenditures the past few years. The recent decision of Transocean’s board to decrease its shareholder dividend will also help the company to retain capital. A reduced dividend translates to savings of USD $800 million per year.
Transocean has a healthy level of liquidity in consideration of the capital intensive nature of its business. As of September 30, 2014, the company had USD $2.9 billion in cash and an additional USD $3.0 billion in unused revolving credit facility, for a total of $5.9 billion. The company’s liquidity is also reflected in its current quick ratio of 1.42.
For the quarter ending September 30, 2014, the official numbers show the company registering a loss for operating income of USD $2.2 billion. A closer look at the numbers reveals an impairment charge of $2.7 billion taken for Q3 2014. Without this impairment charge, operating income was actually $612 million for the quarter and $2.049 billion for the nine months ending September 30, 2014. Using the revised operating income figure and the corresponding interest expense of $360 million for the same time frame, the interest coverage ratio is actually a healthy 5.69.
Transocean also has current shareholder equity of USD $16.691 billion, which translates to about $46 per share. With Transocean stock recently trading near the low end of its 52-week range, at around $18 per share, there is definitely still value in this company.
The default risk is Transocean’s ability to perform. Transocean provides essential services for the offshore drilling industry, to some of the biggest names in the oil industry. While the industry as a whole is currently experiencing a cyclical slowdown, the demand for oil will continue to increase as world economies continue to expand. Once the current excess supply in oil begins to decline, prices will begin to rise once again. Until then, Transocean’s cost reductions and solid liquidity levels will help meet its current expense levels.
Transocean’s revenues are affected by the price of oil, which has roughly been cut in half since last summer. Brent crude oil is currently trading at around $52 / barrel, down from around $105 per barrel in August of 2014. The decline in oil prices has been contributed to oversupply, specifically related to the United States production of shale oil. The corresponding reduced revenues should cause Transocean’s management to carefully consider the overall size of their offshore drilling fleet. This will likely lead to a smaller, albeit more effective and efficient drilling fleet, with the company retiring older, less efficient rigs in favor of newer, more efficient rigs.
Transocean is a multi-national corporation, with offices and operations around the globe. While its services are contracted with many of the leaders in the oil industry, its operations can still be affected by geopolitical events occurring within their regions of operations. This can include changes in laws and regulations that can either favor or discourage offshore drilling.
Summary and Conclusion
Transocean provides essential services to the offshore oil drilling industry. Its excellent liquidity, power client list, significant backlog of about $23 billion and healthy interest coverage ratio all point to a company that is prepared to endure the current cyclical decrease in oil prices. These investment grade bonds provide outstanding yields to investors from a quality company. With these bonds currently trading at a discount, the yields have become even more attractive for investors seeking maximum return for their investment dollar. For these reasons, we believe that these bonds make a superb addition to our FX1 and FX2 portfolios.
Issuer: Transocean Ltd.
Ratings: Baa3/ BBB-
Price: 100.3 (3/3/2015)
Yield to Maturity: ~7.25%
Ratings: Baa3/ BBB-
Price: 89.75 (2/27/2015)
Yield to Maturity: ~8.82%
Disclosure: Durig Capital and certain clients may have a position in Transocean bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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