The Two Great Survivors In Offshore

Thursday morning saw a tremendous spike in share prices of the two biggest deepwater drilling rig owners, Transocean (RIG) and Seadrill (SDRL). After so many months of bad news and dropping share prices, is it finally time to get back on board to these specialists? Well, let's say it's time to finally put them back on your long-term radar.

Transocean particularly shocked the street on their ability to beat every estimate out there on Thursday, with earnings of $865m, which translated to $0.95 a share, 17 cents above consensus. Seadrill also beat on revenue by a meager $10m, but based on Transocean's good numbers, the two are enjoying a strong bounce in the pre-market. With the spike today, are we ready to latch back on to either of these two?

There's a lot to decipher and digest in these names and a quarterly beat is the least of them. These two are the kings in very specialized ultra-deep water rigs and the trajectory of that sub-sector is what we need to assess before laying our money down. No need to get nervous that a $1.50 pop in RIG has suddenly taken the opportunity away in deepwater - if you are looking at either of these names, you know this is going to have to be a very long game.

So, let's look at the negatives first. With oil below $75, there is little incentive to initiate new and very complex deepwater projects. This is why Transocean avoided guidance for the rest of 2015, it cannot in any way guess at what revenues, beside the already contracted $7b, will emerge. But we can be relatively sure it won't be much. Even if oil were to recover immediately, it would be at least a year before new contracts delivered either RIG or SDRL a decent 90%+ utilization. The nervousness about when the cycle will turn (and whether it will be in time) has led to several downgrades of both the stocks and their debt. Things aren't likely to really get better until mid-2016 at the earliest.

Now, let's look at the positives. Both Transocean and Seadrill have been greatly aware of the dire moment they're in. Both have aggressively scrapped older, more maintenance intensive rigs and continue to lower Capex costs. Both have slashed their dividends, Seadrill completely and RIG by 80%. We're finally done with 'goodwill' write-downs, with RIG taking its last one in this quarter. What is emerging are leaner companies, with more modern, efficient fleets.

We can see the scenario clearly, then - provided these two survive, a strong recovery in oil leads directly to a shortage of deepwater assets and a spiking day-rate on floaters. Their exclusivity and specialization is what matters. In the end, there are only two places a major oil company can go to lease a rig capable of working a 6 year project that produces oil 3-5 miles beneath the sea - these two.

We've watched these two get their share prices pummeled for months and we're not predicting the end is here yet either - but both are at or near enough to single digits and leave little risk now for a long-term investment in either, besides a real bankruptcy risk. Today may not be the day to do it, as the euphoria of a quarterly beat is not something I ever like to trade on. Oil stockpiles will continue to increase throughout the Spring, so despite Brent oil's recent rally on Libyan shutdowns, I don't see oil getting away to the upside so quickly.

But, provided your outlook is ready for a two-year commitment, the value in both of these deepwater specialists is here. Only another two years of sub-$70 oil introduces bankruptcy risk, which I do not believe will happen. I am long Seadrill shares.

Deepwater oil production is a vital piece of the global supply chain. They're going to drill again, you can bet on it. And when they do, only two companies can make that happen. Transocean and Seadrill.