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You Don't Have To Dig Deep To Find Value With Transocean Bonds

By  |  Bonds  |  Nov 20, 2012 06:15AM GMT  |   Add a Comment
 
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Transocean (RIG) is the world’s largest drilling service provider due to its presence in the market place and as evident by the number of operating rigs. RIG has over 140 rigs in its fleet, covering high specification floaters such ultra-deepwater ships, mid-water floaters, and standard jack-ups. Due to the variety of ships at its disposal, the company has a plethora of options when it comes to off shore environments. This is evident by the fact that the company has drilling presence all over the globe from the Far East, the Middle East, and in the Western world.

That said, RIG has experienced some rough waters in recent years highlighted by the Macondo Incident in the Gulf of Mexico. RIG equity has fallen more than 34% in the past two years and close to half its value from November 2009. While the stock has dropped, value in the bonds can be found that should provide certainty that investors can take comfort in.

RIG issued a bond that pays a 7.375% coupon, semi-annually and final principal at the maturity date of November 15, 2018 (CUSIP# 893830AK5). These senior notes are currently being offered at a dollar price of $121.375 which translates to a yield of 3.05%. This bond is non-callable and is rated BBB- by Standard & Poor’s and Baa3 by Moody’s which falls under the investment grade spectrum.

This is an attractive bond since it provides excellent relative value to other RIG bonds. For example, there is a RIG 6.00% Coupon Maturing on March 15, 2018 that is offered at a dollar price of $116.575 for a yield of 2.63%. This bond is yielding less simply because it trades more frequently as evident by its larger deal size ($1 billion in amount outstanding in this bond versus only $246 million in the RIG 7.375% November 15, 2018).
RIG-Yield-Curve
RIG-Yield-Curve

So for the investor who looks to own the bond until maturity, RIG 7.375% November 15, 2018 (highlighted in red in the above chart) offers a yield advantage of 42 basis points over its slightly shorter maturity counterpart. An investor can easily pickup more yield by extending the maturity. However along with greater reward comes greater interest rate risk. Given today’s low rate environment, there is balance between picking up yield while maintaining a reasonable interest risk profile with the 2018 bonds.

In addition, this RIG bond offers a significant pickup in yield versus bonds issued by its competitors with a similar maturity. Swiss based Noble Corporation (Ticker: NE) issued a bond that pays a 2.5% Coupon Maturing March 15, 2017 is currently being offered at a dollar price of $103.825 or a yield of 1.58%. So by owning RIGS over NE, an investor can add 147 basis points in yield while maintaining the same degree of interest rate risk.

Despite the lingering headwinds from the Macondo Incident, RIG has been progressing with the recent announcement of strong earnings. RIG reported an adjusted Earnings Per Share of $1.37 (unadjusted $1.39) which surprised the market since the consensus estimate called for an EPS of $0.79.

With that said and with management’s continued commitment to lower debt, the company’s debt in relation to its profitability has improved. The leverage or Net Debt to EBITDA ratio came in at 4.7x. This recent print is better than the previous quarters of 6.9x.

The Net Debt to EBITDA ratio which is represented as a multiple, measures how easily debt can be repaid using a company’s cash flow. EBITDA which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is one measure of profitability. Also, for this particular ratio, we will use the past 12 months of EBITDA. An easy way to interpret this ratio is to say that a company that has a ratio of ‘2x’ would mean that it would take two years’ worth of cash flow to repay its debt. So, a lower multiple is better.

In addition, RIG earns enough to cover its interest from the debt it owes. RIG has an Interest Coverage ratio of 2.4 based off the 3rd quarter numbers which is an increase from the previous period of 1.9.

The Interest Coverage ratio measures a company’s ability to service their debt. In other words, it shows how easily a company can pay interest expense given their profitability. A higher Interest Coverage Ratio implies better credit health since it is making enough money to stay current with their debt interest obligations. Conversely, a red flag is raised when this ratio approaches 1.5 or lower since its ability to pay the interest on their debt is questionable.

As mentioned earlier, the Macondo Incident continues to be an overhang in terms of potential liability with resolution expected to occur sometime in 2013. Currently, RIG has set aside an estimated loss contingency of $1.9 billion for any liability. The risk for RIG is for the bill to come in higher than that figure. Cash on hand jumped to $6.0 billion from $4.0 billion and should be enough to cover any shortfall. While investors should keep an eye out for the final bill, there is always the possibility it could come in lower which would be beneficial for RIG.

According to RIG from this source, they were in discussions with the U.S. Department of Justice seeking to resolve claims related to Macondo for $1.5 billion over a period of years.

Keep in mind that corporate bonds trade over-the-counter. So, prices and yields can vary depending on the broker you use. The best suggestion is to use a broker that offers the most visibility and price transparency for the corporate bond market. This can be achieved by comparing the price to buy and the sale price (aka bid-ask spread). The closer the differential usually means the better the liquidity.

As always, every investor should perform their own due diligence when making their investment decisions.

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