3 Reasons Not to Buy Wall Street's Take on Transocean
Despite the S&P 500 hitting record highs, Transocean investors are not benefiting. Part of the reason may be that Wall Street has lately projected a negative view of the company. Goldman Sachs has a sell. Deutsche Bank has a sell. Citi has a sell. While other major banks have buy or hold equivalents, Wall Street banks rarely say sell.
The pessimists have been right so far, and sometimes being contrarian is hard. But, with that said, there is still reason for long-term investors to be optimistic on the offshore driller.
Wall Street's short-term focus
Wall Street banks don't like Transocean because their clients typically focus on the short term. Most mutual fund and hedge fund managers report their performance every quarter. If those managers lag the market, investors pull their money.
Goldman and Deutsche Bank don't like Transocean because they may be concerned about next quarter's numbers and guidance. Because of weak industry day-rates and Transocean's 14 still available deepwater rigs, the banks worry that Transocean may miss their expectations. Missing expectations is one sure way to send the stock lower.
The pessimists also note that Transocean has an older fleet than its competitors. They argue that having an older fleet will put significant pressure on Transocean's margins if the offshore drilling market should weaken further.
In my opinion, the older fleet is only a problem in the short term because the long-term demand is still strong. If demand for deepwater rigs is strong (such as demand was half a year ago), the day-rate differential between newer and older rigs will not be as great. At some point, Transocean will spin off the older rigs and replace them with new ones anyway.
Long-term deepwater investment still promising
Despite possibly losing over $42 billion over the Macondo oil spill, BP is still committed to drilling in the Gulf of Mexico. The company plans to spend an average of at least $4 billion a year in Gulf of Mexico for the next decade. It has also recently added two more drilling rigs to its fleet in deepwater bringing its total to a record nine rigs.
Another reason to be optimistic is that Mexico recently opened its oil and gas sector for private-sector investment. Mexico's energy ministry will launch the first bidding round for deepwater exploration of oil and gas in late 2014 or 2015.
After exploration commences, demand for offshore rigs will increase.
2014 MLP spinoff
To appease Carl Icahn, Transocean recently increased its dividend to $3 a share per year. It also agreed to do an MLP spinoff in 2014, but has yet to give a detailed plan.
In my opinion, if Transocean stock remains depressed, management will put more assets in the spinoff. I believe the MLP spinoff will be a strong upside catalyst.
The MLP strategy worked for Carl Icahn's other energy play, the refiner CVR Energy . Mr. Icahn bought 82% of CVR Energy for $30 in May 2012. After paying $25.5 in dividends, CVR Energy stock is trading at $42.64.
Part of Mr.Icahn's strategy to unlock value in CVR Energy, in addition to riding the rise in crack spreads, was to spin off assets structured as MLPs such as CVR Refining LP.
The bottom line
Long-term investors have the luxury of focusing on events that happen over broad time horizons and avoiding short-term noise. Long-term price movements are more predictable because investors are riding strong underlying trends rather than trading on the latest sentiment shifts or news. Transocean is one of the leaders in the growing market of offshore drilling. It will grow as the market grows. There is still reason for long-term investors to be optimistic.
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The article 3 Reasons Not to Buy Wall Street's Take on Transocean originally appeared on Fool.com.Jay Yao has no position in any stocks mentioned. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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