Transocean: Offshore Drilling Recovery Is Gaining Some Real Traction – Buy – Seeking Alpha

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I have covered Transocean (NYSE:RIG) previously, so investors should view this as an update to my earlier articles on the company.

On Tuesday, leading offshore driller Transocean reported first-quarter results largely in line with expectations and guided Q2 revenues above consensus estimates.

While negative free cash flow of $121 million was disappointing, management expects to return to positive cash flow from operations for the remainder of the year.

To partially offset negative free cash flow and $165 million in debt repayments, the company sold another 20.2 million shares into the open market for net proceeds of $103 million.

Remember, liquidity is going to take a major hit this year as the company faces $1.2 billion in capital expenditures for the newbuild 8th generation ultra-deepwater drillships Deepwater Atlas and Deepwater Titan which are scheduled for delivery over the next couple of quarters.

As a result, total liquidity is expected to decrease from $2.6 billion at the end of Q1 to a range of $1.4 to $1.6 billion at the end of Q2/2023 but this already includes the company's currently undrawn $1.3 billion credit facility, $350 million in secured debt anticipated to be issued next year and $315 million in restricted cash.

After last week's disclosure of Equinor's (EQNR) intention to early terminate the contract of the CAT-D rig Transocean Equinox just ahead of crucial negotiations to extend the much-needed credit facility, investors likely breathed a sigh of relief after CFO Mark Mey addressed the issue in the question-and-answer session of the conference call:

I dont foresee an issue with us getting that done. This will not be a new facility. We are looking at extending it. So, you are looking at an extension somewhere in that 2-year, maybe 2.5 year range. I think thats good for us. Its good for the banks because we do believe we are coming into a multiyear up cycle, which gives us a little more leverage down the road to be able to redo this and maybe at a larger amount or better terms.

Even better, after last week's rather disappointing fleet status report, the company announced approximately $200 million in new backlog additions:

On the conference call, management highlighted increasing offshore contract drilling demand in basically all of the world's regions with the exception of Norway which hasn't shown any signs of increasing activity as a result of the Ukraine war so far. In addition, the region is experiencing program delays due to shortages of critical subsea equipment.

That said, management expects the Norway market to improve in the second half of next year and to be sold out in 2024 which would be welcome news for the remaining three CAT-D rigs scheduled to roll off contract with Equinor over the next few quarters.

As for the Transocean Equinox, based on statements made on the conference call, the rig is likely to leave the Norway market for the UK next year which might result in some idle time for the unit.

With demand picking up across key markets, conference call participants were eager to learn about potential rig reactivations.

Unfortunately, management's commentary regarding the company's cold-stacked fleet has been somewhat inconsistent in recent quarters.

On the Q4 conference call, CEO Jeremy Thigpen expected to start reactivating cold-stacked rigs "soon" but on Tuesday walked back these comments somewhat by pointing to escalating reactivation costs and lead times of "at least twelve months" to return a cold-stacked unit to service.

In addition, the company still does not seem to have a real handle on potential reactivation costs. Remember, the company had increased its original expectations from $25 million at the time of the acquisition of Ocean Rig to a range of $60 to $100 million stated on the Q2/2021 conference call:

Based on Transoceans fleet of cold stacked assets, we estimate that the total cash cost of reactivating a cold stacked asset starts at $60 million, and could go upwards of $100 million depending on contract and location specific items.

But on Tuesday's call CFO Mark Mey surprisingly stated a lower range of $50-$75 million based on the company's engineering team 2021 assessment:

So, we have been estimating this based upon an in-depth study by our engineering team. And our estimates for our rigs are in at $50 million to $75 million. We do believe that, that number could grow higher because this is based upon a 2021 estimate. Clearly, we see that there has been inflation of somewhere around 8% to 9%. So, you can probably add that inflation impact to it as well

Quite frankly, it seems difficult to believe that Transocean would be able to reactivate an ultra-deepwater drillship that has been stacked for about six years below $100 million in the current inflationary environment.

While competitor Valaris (VAL) recently managed to reactivate a number of floaters at below $50 million per unit, these rigs had been stacked for considerably shorter periods.

Given the company's liquidity constraints, reactivating a cold-stacked drillship would likely require a long-term contract with the customer reimbursing Transocean for a meaningful part of the upfront reactivation costs.

While Transocean is still facing some challenges, the company should benefit from vastly increased demand similar to the rest of industry. New, large-scale tenders like the one issued by Petrobras (PBR) last week should further reduce available floater supply and provide another lift to dayrates next year.

That said, investors should not bet on some of the company's cold-stacked assets re-joining the active fleet anytime soon given escalating reactivation costs and long lead times.

With management being optimistic on extending the company's much-needed credit facility and some prospects for the CAT-D rigs even in case Equinor decides to release the entire quartet, I am upgrading shares back to "buy".

That said, restructured competitors like Valaris, Noble Corporation (NE) and Diamond Offshore (DO) are trading at substantially lower valuations despite not facing near-term liquidity issues and carrying no or very little net debt.

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Transocean: Offshore Drilling Recovery Is Gaining Some Real Traction - Buy - Seeking Alpha