Transocean Is Struggling With Free Cash Flow

Transocean Ltd. (NYSE:RIG) released its first-quarter 2024 results and its latest fleet status report in April. The contract backlog was $8.90 billion, down from $9 billion in the preceding quarter. However, the company has been awarded a few more contracts since then.

For instance, on June 4, the company announced that three harsh-environment semi-subs (Transocean Spitsbergen, Transocean Norge and Transocean Endurance) were contracted for $161 million. Later that month, on June 26, it revealed that Deepwater Asgard was awarded a 365-day extension for an independent operator in the U.S. Gulf of Mexico, worth $188 million.

The contracting activity, however, has been slowing down while the day rates are increasing and approaching or surpassing $500,000 per day for the best rigs, which is somewhat encouraging.

For example, the company said the Deepwater Atlas was awarded a contract extension at $505,000 per day. The contract is expected to last between 240 and 360 days, at the same rate as the Deepwater Asgard.

These high rates are for the top deep-water rigs available. Additionally, the deep-water rig Skyros, acquired from ORIG, recently secured a contract extension in Angola with TotalEnergies (EPA:TTEF) (NYSE:TTE) at a more modest rate of $400,000 daily.

Contract durations for new ultra-deep-water fixtures increased to 511 days this quarter from 302 days in 2022. This means the average daily rate will continue to rise, but at a slow pace, potentially reaching over $450,000 daily in 2025.

Transocean is well-managed. However, despite the recent substantial rise in business, it cannot generate free cash flow, which is one of my main concerns. This problem is deeply rooted in the company's business model.

The Drillships, HE Semisubmersibles and HE Jack-ups are very expensive to build, have a limited operational lifespan and require expensive maintenance and running costs.

As such, suggesting the stock as a long-term option is challenging, especially without dividend payments. As far as I can remember, the company has frequently shown negative free cash flow and has a heavy debt burden, as we will see later in this analysis.

During the conference call, the company offered the following comments about recent contracts:

"While the pace of contract awards has moderated somewhat from this time last year, demand for high-specification ultra-deepwater drillships ('UDW') and harsh environment ('HE') semisubmersibles remains extremely strong with improving day rates and lengthening terms."

First-quarter backlog and the average daily rateAs mentioned, the backlog slightly decreased to $8.90 billion this quarter but remains robust. Demand for deep-water rigs remains healthy, even far from the levels experienced six years ago.

Below is the backlog history from 2015 to the first quarter of 2024.

According to the first-quarter results, Transocean is struggling to generate revenue despite a significant increase in the average daily rate, now at $408,200 per day, and a sizable increase in backlog, now just shy of $9 billion.

This quarter, the total fleet average rig utilization was 53.70%, up from 51.90% in a year ago, which I consider poor.

Transocean's Ultra-Deepwater floater sales represent 74.60% of contract drilling revenue, or $516 million. The remaining 25.40%, or $194 million, was comprised of floaters related to harsh environments. This compares with the $536 million and $205 million reported figures from the previous quarter.

CEO Jeremy Thigpen said during the conference call:

"As we move through the next several months, we expect numerous long-term contracts to be awarded at increasing day rates, reflecting industry participants' recognition of the tightness in the market. Healthy contract durations are one of many factors supporting improved supply/demand dynamics."

It is important to note the total adjusted contract drilling revenue increased to $763 million from $741 million in the fourth quarter of 2023. The difference between revenue and contract drilling revenue is that Transocean had $4 million in contract intangible asset amortization this quarter.

Transocean's revenue was $763 million, up 17.60% from $649 million in the prior-year quarter. Total adjusted contract drilling revenue was $767 million, falling below guidance.

Revenue efficiency decreased sequentially this quarter to 92.90%, compared to 97% in the prior quarter. Net income was $98 million, or 11 cents per diluted share (however, the adjusted net loss was $22 million, or 3 cents per share).

Adjusted Ebitda was $199 million, up from $122 million in the prior quarter.

Operating and maintenance expenses were $523 million, an increase from $409 million last year.

Finally, the shares outstanding, both basic and diluted, increased to 955 million compared to 728 million, a significant increase of 31.20% year over year.

The Ultra-Deepwater segment performed better this quarter, reporting $763 million in revenue (with total adjusted revenue of $767 million), up 3% quarter over quarter.

With $767 million in adjusted contract drilling revenues, adjusted Ebitda was $199 million, yielding an adjusted Ebitda margin of roughly 26%.

In short, Transocean performed better than anticipated, but did not meet my expectations. The company reported a net income of $120 million, or 14 cents per diluted share, mainly because of $121 million in discrete tax items.

During the conference call, Chief Operating Officer Keelan Adamson said:

"As Mark will elaborate upon in his comments, the drivers behind our first quarter revenue results are primarily attributable to delays to rig start-ups in Australia and Brazil due to longer-than-anticipated mobilizations, extensive customer acceptance, processes, and operational start-up issues, as well as extended contract preparation for the KG1 in India, extreme adverse weather impacting our operations in Norway and lastly, downtime on the Deepwater Titan."

Capital expenditures decreased to $83 million from $220 million in the previous quarter, while cash from operations experienced a loss of $86 million.

Transocean's free cash flow was down from -$128 million in the year-ago quarter. Trailing 12-month free cash flow is now at -$304 million, highlighting the lack of profitability I mentioned earlier. However, we can remain hopeful for an improvement in 2025.

The main financial issue with Transocean is right in front of us. The company cannot generate free cash flow, even after receiving day rates at an almost record high. Worse, free cash flow loss has increased in the last three quarters. One possible explanation could be that total liabilities are too high and interest costs are devastating. Unfortunately, most other offshore drillers got rid of the debt after a painful restructuring under Chapter 11 a few years ago, but Transocean refused to do it and saved its shareholders from a total loss. In my opinion, it was a grave mistake at the business level, and the company is still paying for it.

As of March 31, the net debt stood at approximately $6.82 billion, down from $6.87 billion in the same period last year. The total liabilities, including current liabilities, were $9.42 billion, a decrease from $9.84 billion in the first quarter of 2023. Total liquidities are now down to $1.30 billion.

However, the total cash available was $446 million, showing a sequential decrease. This cash level is now at a record low, which is concerning.

Another concern is the diluted outstanding shares for the first quarter increased to 955 million shares, reflecting a 31.20% increase year over year.

The company recently completed refinancing transactions totaling $1.80 billion. The initial offering was $1.50 billion, but was extended by $300 million. The proceeds were used to redeem the senior notes due in 2025 and 2026 and partially redeem the 8% notes due in 2027. As a result, only $525 million of the 8% notes due in 2027 remain outstanding.

Finally, the company recently obtained an extension through mid-2028 of its revolving credit facility. It was a good financial decision, allowing the company to pay a dividend again in the future and eventually initiate a share buyback.

As Chief Financial Officer Mark May said during the conference call:

"These transactions improve our unsecured maturity profile, simplify our capital structure and combined with the recent extension of our revolving credit facility through mid-2028 enhanced our financial flexibility. On the latter point, we are pleased that the current formulation of the credit facility permits us at a point in the future the flexibility to make restricted payments, including distributions to shareholders and share repurchases."

Capex is expected to be approximately $92 million, up from $83 million last quarter.

For 2024, Transocean expects total revenue between $2.20 billion and $2.30 billion.

Stock performanceIn the past year, Transocean has performed much worse than Valaris Ltd. (NYSE:VAL) and Noble (NYSE:NE). The stock's value has decreased by 26.10%. However, this comparison is not entirely fair because both Valaris and Noble went through significant restructurings, while Transocean avoided bankruptcy.

Technical analysis and commentaryTransocean forms an ascending channel pattern, with resistance at $5.70 and support at $5. The relative strength index of 58 is ascending, indicating nothing important with a recovery after testing resistance.

Ascending channel patterns are bullish continuation patterns that form when a stock price moves between two parallel trend lines. These patterns are generally considered bullish, but end mostly with a breakdown, although this is not always true.

The chart shows a stock struggling to find meaningful support at the moment.

I suggest you hold a small long-term position in Transocean and trade LIFO for about 75% of your holdings while you wait for a higher final price target of $6.75 to $7.25 for your core position.

An important reminder, Transocean is quite volatile and has not paid a dividend in years.

Selling 50% between $5.65 (50-day moving average) and $6 and selling an extra 25% above $6.25. If resistance is crossed, which is the best strategy, I advise holding off on adding until a retracement occurs between $5.15 and $4.90. With possible lower support at $4.65.

Warning: The TA chart must be updated frequently to be relevant.

This content was originally published on Gurufocus.com