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Leading offshore driller Transocean Ltd. RIG has unveiled plans for raising as much as $400 million through a large new share sale, cashing in on rising oil prices and the meme stock frenzy that has sent its stock price up more than 82% this year. The latest securities filing said that the proceeds will go toward general corporate purposes such as refinancing its debt or capital expenditures.
The Meme Madness
The so-called “meme” stocks are the favorites of retail traders, who usually trade stocks heavily discussed on social media — primarily, Reddit and Twitter. They typically buy shares of small, often struggling companies that possess high short interest and gain significantly by squeezing short sellers out of their positions. The massive rally of GameStop GME in January was the beginning of this phenomenon. While the craze waned thereafter, the buying spree appears to have picked up again in recent weeks, with an increasing number of stocks being added to the category each passing day. Blackberry BB and AMC Entertainment AMC are among the most popular ones.
RIG Stock Gaining Momentum
By all accounts, the worst may well be over for Transocean, with the rig supplier positioned for healthy growth in the next few years. In particular, the company’s backlog of $7.4 billion reflects steady demand from its customers and offers earnings and cash flow visibility. Further, Transocean forecasts revenue efficiency to average an impressive 95% in the second quarter of 2021. This is an indication of minimal loss of revenues due to downtime and Transocean’s superior efficiency in translating its industry-leading backlog into cash.
The year-to-date performance has also been driven by an improving outlook for the Oil/Energy sector. The rally in crude prices to a multi-year high of more than $70 a barrel on the back of calibrated OPEC+ cuts and an upbeat demand forecast has lifted the offshore contract drilling space and contributed to the strength in Transocean.
Apart from a better outlook, the firm’s stock price has also been propped up by its mentions on subreddit WallStreetBets. Transocean was one of the heavily shorted stocks on the speculative discussion platform in January. Coming to the present, short-sellers have increased their bets on Transocean over the last month (more than 13% of float has been sold short) despite the strong oil gains. A potential short squeeze is perhaps driving the stock’s rally.
Is the Rally Overdone?
Transocean has sought to use its share sale proceeds as another attempt to bolster its balance sheet. Last year, the company managed to get past legal challenges to conduct distressed debt exchanges that reduced its outstanding debt by an aggregate of $1.1 billion. This was after Transocean won a key default trial that averted a bankruptcy filing under chapter 11 unlike some of its peers.
While the overall macro environment has improved significantly, the company is still struggling financially, and the risk of bankruptcy is very much present. Transocean’s total debt is currently more than $7.6 billion with just $1.5 billion in cash and cash equivalents, which has seen a continued decline over several quarters. Moreover, the company's debt-to-capitalization as of the end of the first quarter, at 40.2%, is on the higher side.
Further, oil producers will likely continue with their cost-reduction efforts in 2021 despite the energy revival. With not much chance of a significant exploration and production capex cut reversal this year, drilling activity is expected to remain weak over the near-to-medium term. This expected to hurt the likes of Transocean.
For most operators, order levels have remained depressed and day rates are trending just above cash costs. This has put increasing pressure on their revenue-generating capacity. Further, as the companies’ legacy, high-margin contracts wind down slowly, the drillers are faced with the prospect of a drop in backlog (and consequently, revenues), which is likely to accelerate over the next few quarters. This also leaves the drillers vulnerable to address their massive debt maturities and investment on newbuilds.
In conclusion, Transocean’s share gains look to be overdone from a fundamental point of view. Therefore, it would be prudent to wait for a better entry point as the timing is still not right for investors to hit the Buy button. Transocean currently carries a Zacks Rank #3 (Hold).
You can see the complete list of today’s Zacks #1 Rank stocks here.
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Transocean Ltd. (RIG) : Free Stock Analysis Report
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