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On Jun 3, 2014, we issued an updated research report on Transocean Ltd. (RIG - Analyst Report) − an offshore drilling giant. The company’s state-of-the-art mobile offshore drilling fleet worldwide can function in the most challenging environments, such as the North Sea. However, we expect Transocean shares to remain soft until it fully works its way through claims related to the BP oil spill.

Switzerland-based Transocean is the world’s largest offshore drilling contractor and the leading provider of drilling management services. As of May 15, 2014, the company owned, or had partial ownership interests in, and operated 78 mobile offshore drilling rigs. We believe that Transocean’s strong backlog, which now stands at roughly $26.1 billion, not only reflects steady demand from its customers but also offers an unmatched level of earnings and cash flow visibility.  

Transocean recently approved an annual dividend of $3.00 per share − 33.9% higher than the year-ago dividend of $2.24. We think, that the recent dividend hike reflects the company’s strong ability to allocate capital for profitable projects that generate significant returns for the shareholders.   

Moreover, during first-quarter 2014, Transocean significantly reduced its operating and maintenance expenses as compared to both the year-ago and sequential figures. This led the company to report strong first quarter results. Transocean reported earnings per share − excluding special items – of $1.43, which surpassed both the year-ago adjusted profit of 94 cents and the Zacks Consensus Estimate of $1.00.

However, the introduction of new and more stringent regulations due to the oil spill has made deepwater drilling activity prohibitively expensive for exploration and production (E&P) companies, making many projects marginal. This could hamper Transocean’s future earnings, as the demand for deepwater drilling might be hampered by the regulations.

Transocean derives its revenues from companies in the oil and gas E&P industry, a highly volatile and cyclical sector that is directly exposed to commodity prices. A potential drop in oil and gas prices could curtail deepwater drilling and dampen equipment demand, affecting bookings at Transocean.

Transocean currently holds a Zacks Rank #3 (Hold), implying that it is expected to perform in line with the broader U.S. equity market over the next one to three months.

Key Picks in the Sector

Currently, we prefer to remain at the periphery regarding Transocean. However, some top-ranked players in the energy sector such as Magellan Midstream Partners LP (MMP - Analyst Report), Ultra Petroleum Corp. (UPL - Analyst Report)  and Encana Corp. (ECA - Analyst Report), all sporting a Zacks Rank #1 (Strong Buy), are worth reckoning.

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