Transocean Downed to Underperform - Analyst Blog

We are downgrading offshore driller Transocean Inc. (RIG) shares to Underperform from Neutral, due to the potential fallout from the Gulf of Mexico (“GoM”) oil spill.

As a reminder, on April 20, Transocean’s ultra-deepwater Horizon drilling platform, contracted to British major BP Plc (BP), sank following an explosion while operating in the U.S. GoM off the coast of Louisiana . The incident killed 11 workers and caused what is touted as the worst oil spill in U.S. history.

The deepwater drilling ban invoked in the wake of the Horizon disaster (later ruled illegal by a federal judge and then replaced by a revised deepwater drilling ban) has dragged down rig count in the GoM by a whopping 65% since the week ended May 28.

For Transocean, the operator of the doomed Deepwater Horizon drill rig in the GoM spill, earnings are likely to suffer from the uncertainty in the near and medium term outlook for deepwater drilling. We further believe that Transocean − and the entire industry − will be subject to more stringent regulations in the future. The company has already warned investors regarding the risks associated with the Horizon rig disaster, including legal costs, government investigations and lost revenues.

This is reflected through a strong negative agreement among analysts regarding Transocean’s outlook. In particular, we see a notable number of estimate revisions over the past 30 days. Out of 30 analysts covering the stock, 9 have revised their estimates downward for 2010, while just 2 has gone in the opposite direction. Looking forward to 2011, the trend is more or less similar. Out of 32 analysts, 9 reduced their estimates while just a single analyst had a positive revision. As a result, the Zacks Consensus Estimates for fiscal 2010 and 2011 have gone down 9 cents (from $8.09 to $8.00) and 38 cents (from $9.09 to $8.71), respectively.

The slow pace of new contracting activity, reduced dayrates, declines in utilization and the stacking of idle equipment add to the bearish sentiment. Although Transocean has a significant backlog of $28.6 billion, we are apprehensive that it may decline if the company fails to obtain new contracts for rigs.

Given these headwinds, we expect Transocean to under perform the broader equity markets in general and the oil and gas group in particular. With the outlook for offshore contract drilling services providers remaining bleak, we see little reason for investors to own the stock.