Transocean Earnings: Expectations Crushed, but 2 Massive Problems Remain

Transocean Ltd. has a great track record of crushing analyst expectations. In fact, it has crushed Wall Street expectations for the past five consecutive quarters by an average of 41%.

However, long-term investors would do well to ignore this string of analyst-topping "wins" and instead focus on two far more important factors: its rapidly shrinking contract backlog, and its massive, write-off-inducing fleet of obsolete rigs.

The numbers

Source: Transocean earnings press release.

As this table shows, Transocean was able to easily beat analyst revenue estimates -- which shrank 9% year over year -- and blow the earnings expectations out of the water. However, the painful truth is that this quarter's massive beat came not as a result of any good news regarding its business, but merely the result of Wall Street's uber-pessimistic expectations.

What really mattersIn fact, this quarter's strong earnings are valid only if you ignore the $881 million in writedowns the company had to take, $481 million of which was due to the falling value of its Deepwater Floater asset group, and $393 million in impairments for rigs held for sale.

In fact, Transocean has had to take almost $4.6 billionin writedowns over the past three quarters,as it races to scrap or sell off its older rigs, which probably won't be able to find profitable work in a market environment traumatized by crashing oil prices and a glut of new rigs hitting the market.

What really concerns me about this quarter's writedowns is that they resulted from management's having to admit that its Deepwater rigs, which are its most profitable and technologically advanced, are decreasing in value, possibly indicating that management sees little optimism that the offshore drilling industry will recover anytime soon.

Equally bleak is that so many rigs that were slated for sale are having to be scrapped instead. For example, 25% of this quarter's writedown in impairments in rigs for sale came from the April 1 decision to scrap rather than sell theGSF Aleutian KeyandSedco 707.This brings to 18 the number of rigs that Transocean is sending to the scrap yard, indicating that it's been unable to sell its older rigs, even for what is probably fire-sale prices.

Backlog continues to plummetOne of the most important things for long-term investors to pay attention to is the contract backlog, which shrank by $1.3 billion this quarter to $19.9 billion, and is down 24% -- $6.2 billion -- in the past year.

The shrinking backlog is due to Transocean's poor fleet utilization rate -- 79% this quarter -- and enormous contract cliff. For example, 10 of its rigs are already idle or cold stacked, while another 16 have contracts expiring in 2015, and another 13 expiring in 2016. All told, 60% of the company's fleet will need to find new contracts by the end of 2016, and that doesn't even include the seven new rigs the company is building that have yet to secure work.

Takeaway: A meaningless earnings beat can't make up for a painful year to comeThe offshore drilling industry may not recover before 2017 because of a combination of low oil prices and a glut of new rig deliveries.Thus, Transocean investors should be prepared for a continuation of falling day rates, a growing number of rigs set for the scrap yard, and more painful writedowns over the next few quarters.

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