(By Michael Vodicka) May and June were tough months for crude, pulling back from a high print above $106 a barrel to a recent low just below $78 on June 29. But June 30, the last day of the month and quarter saw a huge reversal, with prices screaming higher by 9% in just one day on news that Europe had new plans to tackle its financial problems. That kind of big spike in a weak market represents a sharp shift in sentiment and frequently triggers longer-term bull movement. So with energy stocks beaten into the ground over the last year and trading with historic low valuations, it could be a good time to take at energy stocks.
One of my favorites in the group is Transocean Ltd. (RIG), one of the largest and most well-known names in off-shore drilling services. As a diversified player in off-shore drilling services, RIG specializes in shallow, mid and deep-water exploration, providing it with more product and service diversity against weakness in one specific area. And with a market cap of $16 billion Transocean is also extremely global, operating in regions all across the world.
On the chart, Transocean was on a roll early in the year, with shares up more than 45% after topping off above $58 in mid-March. But since then, Transocean has pulled back a bit, weakening with the market in April and May and falling back to the $44 level. Although that is a sharp pullback, shares are still up a very respectable 11% on the year. Take a look at the chart below how Transocean has outperformed both the S&P 500 and its industry peers this year.
Daily Chart 2012-RIG vs. S&P500 and Energy Select Sector (XLE)
But looking forward, in spite of this year's solid gain, there are still a number of reasons to be bullish on Transocean Ltd.
Bull Case
The most bullish case an investor can make for buying a company like Transocean is driven by the fact that a lot of the "easy to extract" oil on land has already been exploited. That same principal goes for water extractions too, where most of the easy to grab oil has already been found. That means that energy companies have to pursuit exploration and production activities in more obscure and difficult areas to reach in the world. And keep in mind, 2/3's of the planet is covered in water, so there is a lot of crude in undiscovered areas that a company like Transocean will be involved in pursuing and extracting.
Transocean is also one of the largest and leading names in off-shore drilling, with a huge fleet of platforms that covers the range of shallow, mid and deep water drilling. Although demand has been a bit soft over the last few years, hurting fleet utilization rates, in a more bullish economic and demand environment this gives the company incredible operating power. Its diversification across multiple markets and regions also gives it more protection from weakness in one area.
The company has also been seeing solid gains in its backlog, providing more earnings and cash flow transparency to both management and investors. New contracts for just the 2-month period between February and April totaled $834 million, with an additional $430 million coming between April 18 and early May.
And finally, Transocean was embroiled in some serious political and regulatory issues last year with the Gulf oil spill. That created a huge cloud of uncertainty around Transocean and the entire off-shore drilling industry in general. But since then, the political climate around off-shore drilling has cooled, while Transocean itself has been resolved of any major financial responsibilities in the cleanup process.
Estimates and Valuation
On the heels of a big earnings surprise from early May and a growing backlog, estimates have been grinding higher. The full-year 2012 estimate of $2.92 is up 6 cents from 60 days ago, an extremely bullish earnings growth projection of 175% from last year. The next-year estimate is up 20 cents in the same time to $5.05, another impressive 73% growth projection.
That bullish movement has helped push the valuation picture to historic levels, with Transocean's PEG ratio of .55X well below the 10-year median of .79X and much closer to the low print of .36X than the high of 1.18X.
The Take Away
Transocean is a leader in the off-shore drilling and energy space. It has a highly diversified product offering and geographic exposure across the world. But with shares falling sharply with the market in the last two months, the valuation picture is at historically low levels, creating an opportunity to buy at a discount.