The Case for Transocean

Thanks to a poorly constructed stock screen, I ended up entering a bullish option spread on Transocean, Ltd (RIG). This has been quite a bad trade, but since it is inside a test portfolio, I have not divested of it to experiment on how to salvage a bad situation.

The purpose of this post is to spell out the reasons I think RIG is a good company in the middle of a cyclical bloodbath. Without going into detail of my ideas on it, here are the main reasons I think this stock will recuperate quite well once oil prices stabilize.

1. The large dividend is safe because of the financial flexibility provided to it by the MLP RIGP.
2. Transocean opened a $3B 5 year revolving credit facility on June 2014. (See 10-Q for details)
3. Also according to the 10-Q, Scheduled Maturities over the next quarters ending in 3Q16 equal $1.4B. This figure does not include the $207M redemption in November of the outstanding 4.95% Senior Notes due 2015.
4. The balance sheet is healthy as attested by Fitch in November: "Fitch views the timing of this month's impairment as a signal to the oversupplied market that, consistent with our view, industry-wide rationalization is needed ahead of scheduled newbuild deliveries to improve market balance and, ultimately, realize a cyclical improvement. Transocean has illustrated that rationalization can strengthen its cash flow and asset profile. This is evidenced by the stabilization of EBITDA and improvements in utilization and day rates following its 2011 impairment."
5. Fitch rates Transocean as Stable BBB-, the lowest of Investment grades. But the implied rating based on the CDS price is a much better BB-.
6. The $24B backlog of contracts should allow RIG to keep the fleet at work through the downturn even if it lasts into 2016. Note that in the November Fleet Summary, the expected Out of Service days actually went down by 225 for 2015.

Based on the financials, RIG should be well positioned to go up once the oil market stabilizes from its swan dive and the oil producers are able to reengage in Capital Expenditure planning.

Asset Bubble and How It May Pop...in 2016.

No. I'am not a Bear yet. Like I've said before, I see an 85% chance that the Bull market will continue into 2016. But I do think a fair amount of effort should be put in watching for the current easy money driven bubble in Bonds to burst.

US Stocks are richly valued, but not to the point of previous market frenzies. I'll be more bearish when the Trailing PE multiple of the S&P 500 is scratching 21. (e.i. the index would have to be above 2200 today).

To get there, we need more money to go into Stocks. That will have to come from the Bond Market. As interest rates rise, eventually, a Bond selloff will begin and move to stocks as the US Economy will be seen as strong to support higher stock multiples because of expected accelerating earning growth, as seen with the November Jobs numbers out today.

The Bond market has been seeing a flight to quality rotation for some time as you can see in this graph depicting the ratio of the TLT and JNK ETFs as the Proxy for the 20 yr Treasuries and the High Yield market.

The High Yield market is under threat from the marginal Oil Shale producers that are in danger of default if oil market doesn't at least stabilize soon. 

As the bond market deflates, all that money will go into the Stock market and multiples will begin to get high overall. At which time, the prudent investor should be looking for the door as the final leg up of this long bull market cycles back into a retreat. 

For now, the trend looks positive for now.