Why Transocean Should Be on Your Watch List

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The energy industry is facing some huge, game-changing macro trends right now, with volatile oil prices and an ever-increasing shift toward greener energy. But while green energy is taking off, oil is still far from out of the game, and investors could have a lot to gain from investing in the industry today.

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In this clip, oil and gas analyst Tyler Crowe shares his pitch for offshore oil and gas rig provider Transocean (NYSE: RIG). Tune in to find out exactly what Transocean does, how it could see huge growth in the next few years, the most important risks investors need to know about before buying in, and more.

A full transcript follows the video.

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This video was recorded on Oct. 19, 2017.

Tyler Crowe: My name's Tyler Crowe, I'm an oil and gas analyst for fool.com, and we're going to talk about a stock I want to talk about today, and that's Transocean, ticker symbol RIG. Transocean is an oil and gas rig provider. Basically, they're an offshore rig company that's looking when an explorer -- say, somebody like ExxonMobil wants to go drill out on the offshore, they don't own the rigs they use. Rather, they contract a company like Transocean or some of its peers.

When you're looking at a company like this, you have to kind of think about the oil and gas market over the past couple of years. Since 2014, we've seen a very large drop in the price of oil, and as a result of that, a lot of people have been looking at the industry and saying, I don't think it's really worth it to be investing in here, especially in offshore, where the costs for production are much higher than places, say, in the Middle East, or shale, which, the price has gone down significantly over the past couple of years.

Now, that makes pretty good sense. The only thing that doesn't really consider is that shale and some of the other lower cost, like OPEC, those are a little less than half of the market. If you look at the rest of the market, there's been a massive wave of underinvestment over the past couple of years, which basically means that, as current oil production depletes, you're going to have to replace that. And we haven't really found an effective way to do that as of yet with something like shale that can absorb a little bit of the market, but not all of it.

And that's where an investment thesis in Transocean and a lot of these offshore players lies. In the next couple of years, shale is not going to be able to take up all of that, and then you get this situation where prices are going to rise, and it's going to make it much more attractive to invest in the offshore area.

Now, the reason that I'm picking Transocean in comparison to a lot of its peers is both because of its financial position and also because of the fleet of rigs it has. Over the past couple of years, CEO Jeremy Thigpen has basically gone over a massive fleet turnover. Transocean used to be one of the companies with the oldest fleets in the market. Today, over the past couple of years, Thigpen has basically turned over the fleet such that it has one of the newer fleets in the market, without really breaking the bank financially, unlike some of its other players who have gone bankrupt as a result. At the same time, when companies are going to be investing, they're going to be looking for those new rigs, especially ones with high specifications that can go into the deepest, most challenging areas. Transocean has a very large and available fleet to do that over next couple of years.

Now, on top of all of that, you also have to look at investing in the stock. And that's where, for me, Transocean looks the most compelling, because today, Transocean trades at a price-to-tangible book value of 0.3 times, which basically means that you're getting the stock at $0.30 on the dollar for the asset values of the company. As the value or the need for offshore rigs increases, and those things get deployed, it's very hard to see a situation where Transocean is going to be priced at such a low premium or discount for so long. And historically, it's a company that's traded 2 to 3 times tangible book value. So if you're looking at a situation over the next couple of years where the offshore fleet gets deployed like some people are going to expect between now and 2022, I think, over the next five years, something like Transocean could be a very interesting stock for people to look at.

Sarah Priestley: Kristine, what do you make of Tyler's RIG recommendation?

Kristine Harjes: Much like the last pitch that we heard, there are two things to consider here -- should you invest in the sub-industry, and should you invest in the stock? The sub-industry, are offshore rig companies a good investment right now? If so, is Transocean the cream of the crop? Oil prices have been rising over the past few months, and Transocean's stock has been following it pretty much in step, as it's prone to do. Industry expectations are that offshore drilling is about to kick back into gear, and I really like that Transocean has positioned itself to be ready to profit as soon as the recovery really starts up. It seems to me that this is necessarily a long-term play, and it's really not for the faint of heart. Oil is still regaining its stability, and I have to imagine that the entire subsector of offshore drillers will continue to be volatile as it does so.

Priestley: Yeah, absolutely. I think that's the key thing for people to remember. My personal opinion is that offshore drilling may not recover this decade. We may have to wait until the 2020s to see that.

There has been historically an oversupply of offshore rig. Transocean has, in the last 10 years, had to deal with the Deepwater Horizon event, the collapse of crude prices, and it's definitely taken its toll on the company. However, I do agree definitely with Tyler that it's one of the best-placed companies. It's really paid down a lot of its debt, it's rationalized its rig count, and as you said, it's poised to take advantage when things turn around. It's just a matter of when that actually happens.

The important thing for people to remember is, a lot of rig contracts were agreed on oil prices were high, so they're still relying on a lot of those rig contracts. Some of those are coming to expire soon, and the backlog of orders is something for people to be aware of and slightly concerned with. They expanded their backlog a few months ago, when they bought Songa Offshore for $4 billion, and that acquisition gives them opportunities in the strength in North Sea oil area that we're starting to see come back online after it was pretty much left for dead.

Harjes: Yeah, absolutely. That seems like it was a very smart move, because new contracts have been really hard to come by since 2014 or so. Ultimately, when I think about this pitch and whether or not I would want to invest in Transocean, I think Transocean seems like it's probably the best company from its competitors. It seems like it's really handled the situation well. Many of its competing companies have had to file for bankruptcy, whereas Transocean has been able to prune its assets and make some smart acquisitions. But the question for me is, would I want to invest in this macro-industry? And on that one, I'm not so sure.

Priestley: Yeah, I would agree with you to be hesitant. I do think, if you look at shale and OPEC, it's much cheaper to produce oil on land and from shale. But that's only half of the global supply. At some point, we're going to reach a point where the demand is outstripping shale and OPEC alone, and offshore really has to come back online in the way we'd seen it before.

I think one thing that's going to change is the rig day rates. So companies like ExxonMobil will pay per day for the operation of the rig. These day rates used to be as much as $500,000 a day. I think those days are pretty much over. One reason is, a lot of the rigs have been updated; they're much more efficient now. And the other is just a highly competitive, downtrodden market.

This week, Transocean announced a two-year contract for its Deepwater Invictus rig with BHP Billiton. This is the first sign of optimism from the market, because oil prices are rebounding. But the rumored terms of this agreement was for a $145,000-per-day rate, which is obviously a completely different environment. I still imagine that they're breaking even at those terms, but it may be harder for them to eke out some of these massive profits that we've seen before.

Anything else you would like to add? I think your bottom line was exactly right -- demand for rigs is going to be driven by the overall commodity prices. If you're bullish on the commodity, then you might be bullish on this subsector of the industry.

Kristine Harjes has no position in any of the stocks mentioned. Sarah Priestley has no position in any of the stocks mentioned. Tyler Crowe owns shares of BHP Billiton and ExxonMobil. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.