Let me start by saying that I believe in the oil drilling business over the long term. Energy experts have stated that the world’s energy demand will increase fivefold between now and 2050, from 10 Terawatt-hours to 50. While a great deal of demand is likely to be satisfied by cleaner energy sources such as nuclear and solar power, there will still be an enormous demand for fossil fuels as long as supplies exist, which will be further in the future than some will have you believe. However, over the short term, some of the major players in oil drilling are having a shaky year, including Transocean LTD (NYSE:RIG), which happens to be my favorite. Let’s take a look at why I think this one is still a buy, and some others in the space that will also be winners.
Transocean LTD (NYSE:RIG) is one of the largest offshore drilling contractors in the world. The company has a large fleet of rigs including midwater, deepwater, and ultradeepwater units. Transocean LTD (NYSE:RIG) was the owner of the infamous Deepwater Horizon, which exploded while under lease to BP. Ironically, the rig was the subject of some very positive news one year earlier, as the 35,050 ft well established by the rig was the deepest in history and was seen as quite an engineering feat before the disaster.
With much of the legal implications (but not all) from the Deepwater Horizon spill in the rear-view mirror, investors can finally begin to look to the future. As of the company’s last quarterly report, Transocean LTD (NYSE:RIG) had a contract backlog of $28.8 billion, which should keep the company busy for the foreseeable future.
Another good indicator of the company’s bright future is the recent authorization of a $2.24 annual dividend, which at the current share price represents a yield of about 4.77% per year. Even though this is an excellent yield, it represents less than a 50% payout ratio (based on future earnings projections), which should mean that the dividend will be safe for the foreseeable future.
Why it’s a good value
Now, it is certainly true that a good yield doesn’t always mean a good value as an investment. Industry experts project improving demand for Transocean LTD (NYSE:RIG)’s services, which means higher dayrates paid for the use of their rigs, which is expected to produce revenue growth of 17% next year (2014). Combined with higher cost efficiencies in the company’s operations, this should translate into nice earnings growth over the next few years.
In fact, Transocean LTD (NYSE:RIG) is expected to earn $4.32 per share this year, meaning that shares currently trade for 10.9 times 2013’s earnings. The consensus calls for earnings to grow rapidly to $5.83 and $6.35 in 2014 and 2015, respectively. 47% earnings growth over a two year period more than justifies the P/E and also compensates investors very generously for any added risks they take in owning the stock.