Transocean (RIG) Added to Goldman Sachs Conviction Buy List ~ market folly

Monday, September 8, 2008

Transocean (RIG) Added to Goldman Sachs Conviction Buy List

I forgot to post this up on Friday since there was so much going on. Amidst all that news, we saw that Transocean (RIG) was added to Goldman Sachs Conviction Buy List. They removed Halliburton (HAL) and swapped RIG in its place. Goldman's new price target on RIG is $178 due to its tie to oil, where they see strong long term fundamentals (obviously).

I definitely agree with them on this call as I believe oil will face big supply/demand issues as we go forward many years into the future. And, I believe Transocean (RIG) is an excellent proxy for this (besides just owning oil in the commodities markets or the etf USO for the long term). The reason I say that is because there is an increasing demand for deepwater rigs. As evidenced by Petrobras' desire to lock up nearly 80% of offshore rigs, the demand for RIG's services is very strong. As oil companies shift from shallow water searches to deep water finds, RIG becomes all the more attractively positioned.

The only problem I have with RIG right now is the technicals. The chart looks horrible right now and the name looks to be breaking down. I've drawn a line in the sand at $120. If RIG can hold onto this level (typically past support), then I think its safe to enter RIG here. But, if it begins to trade lower yet again, I think it would be safer to stay away as it will have broken down on the technicals. RIG trading lower is a real possibility simply due to the fact that it is tied to the price of crude. And, since crude has been selling off recently, it doesn't look good. As crude approaches the very important psychological level of $100 a barrel, things could get interesting. Add in the speculation regarding hedge fund liquidations and you've got a recipe for a wild ride. The point is that both crude oil and RIG are around pretty significant levels in terms of technicals. As you can see from the chart below, $120 has typically been an area of support for RIG. If it breaks through this support level, it looks to be heading lower.

(click to enlarge)

This is a simple case of "trade the perception, not the reality." In reality, Transocean (RIG) is poised to rake in major dollars as their new rigs come out of production down the road. And, they are constantly seeing rising day rates on their existing deepwater rigs. But, everyone seems to be concerned with the "here and now" and thus the technicals are on the verge of a major breakdown. So, you've got to respect the action and step aside if you get stopped out below $120. Long term, this should be an excellent name to own. So, if you're one of those Buffett-buy-and-hold investors, then go for it. I am simply painting a picture for those who like to take a more active role in their positions.

Fundamentally, RIG is one of the best buys out there. Their trailing PE of 7.8 and forward PE of 7.4 is very compelling, especially considering that they trade at some of the cheapest multiples in the drilling sector, despite being one of the largest companies. They have a PEG ratio of 0.55, indicating they are primed for earnings growth. Where the company really becomes attractive though, is in its operating margins and returns on equity. I like to call this the "bread and butter" of any given company. With operating margins of 46.17% and a return on equity of 38.54%, Transocean is cranking out some of the highest numbers out there. Their merger with Global Santa Fe has certainly paid off in terms of increasing their fleet and extending their dominant market share. The only real negative with Transocean fundamentally would be its massive debt. They currently have $976 million in cash and over $15.2 billion in debt. The majority of this debt is from financing the merger of Global Santa Fe and Transocean and a special dividend that the company paid shareholders upon completion of the merger. So, the massive debt load is a concern. But, when you think about how much money the company is making, it becomes less of a worry.

Fundamentally, RIG looks very strong. But, you've got to worry about oil too since this name is tied to the price fluctuations of the underlying commodity. If we are indeed seeing a global slowdown, then the price of oil will obviously suffer, affecting RIG's shares in a negative manner. Still though, RIG remains attractive due to their dominant market share and positioning, their rising day rates, the rising demand for their deepwater rigs, and the fact that they have many new rigs scheduled to be completed in the coming years. This is a great long term buy (3-5 years +). But, if you want to potentially save yourself some money in the near term, watch the $120 level as the technicals have really dictated this volatile and whacky market as of late. As long as you've got a stop just below $120, call it good. Or, you can take the Buffett-buy-and-hold approach with this name, as they stand to benefit over the long haul.

Source: StreetInsider

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