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Does Transocean Offer Good Value?

I have always been interested in the oil services industry, particularly offshore drilling services.

There are a couple of reasons why this industry really stands out to me as being pretty unique.

Drilling for oil and gas offshore is an incredibly skilled process, and only a handful of operators worldwide have the tools and skills required to drill for oil effectively and safely.

These qualities give the industry a sort of defensive nature. And thanks to this defensiveness, companies are relatively easy to value.

One can use a discount cash flow analysis to project how much each oil drilling asset is really worth and, in the worst-case scenario, one can use scrap values.

I should note this industry is also very cyclical. In the first half of the last decade, booming demand for offshore drilling pushed up prices for vessels and platforms. As a result, cash flooded into this sector to take advantage of these opportunities.

One of the biggest losers of this boom and subsequent bust was Seadrill (SDRLF). Founded by a Norwegian billionaire, the company borrowed heavily to expand its fleet, borrowing against future projected cash flows. These cash flows did not materialize when the market crashed and Seadrill collapsed into bankruptcy (it later emerged after restructuring its debt).

However, while the industry's cyclical nature does mean it is difficult to project future growth trends, it also throws up opportunities for astute investors to get involved at the right time.

Time to start investing?

Today might be one of those times. Since the bursting of the last bubble, operators have been scrapping older rigs and new orders have been put on hold.

Since Russia's invasion of Ukraine begain in February, the outlook for the global oil and gas market has changed completely, and so has the conversation around drilling for new prospects.

As a result of this renewed demand, the average day rate for rigs has increased from $300,000 two years ago to around $400,000. Some executives expect the rate to increase further to $500,000.

This growth is being driven by a lack of supply and increasing demand. Oil rigs take time to build, so it is unlikely there is going to be a sudden rush of supply. Moreover, shipyards are currently dealing with high volumes of orders for LNG vessels, a fuel rapidly becoming Europe's go-to choice to replace Russian supplies.

Against this backdrop, Transocean Ltd. (NYSE:RIG) looks interesting. The stock is currently trading at a price-book value of just 0.2, reflecting the market's down-beat perception of the enterprise.

To some extent, this is warranted. The business has not made any money since 2016. Billions of dollars of investment in new drilling rigs and vessels have been written off as the market has changed, and the number of shares in issue has nearly doubled as the company has come to rely on investors to keep the lights on.

Still, the environment for the company is altering. Contracted drilling revenue for the three months to the end of June increased by $106 million to $692 million as idle rigs were bought back into service.

Management is expecting further revenue growth over the coming quarters as contracted vessels roll off current agreements into the tight market. This will enable them to renegotiate contracts on more favorable terms.

Transocean's stock looks cheap, and the favorable tailwind of the improving offshore drilling market could act as a catalyst to unlock value.

This could be a value opportunity worth keeping an eye on, considering the stock's current valuation, although rising interest rates might prove to be a headache for the group and its $6.5 billion debt pile. Nevertheless, it does not seem demand for new hydrocarbon resources will start to decline anytime soon.

This article first appeared on GuruFocus.