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Author: deadcat2 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1153  
Subject: Re: Is there a reason? Date: 10/16/2008 6:56 PM
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Is there a meaningful reason this stock as dropped as low as it has? [...] I increased my position around 140. Seeing this below 70 is preplexing.


As others have mentioned, take a look at the price of oil and you'll see that the price of RIG has mirrored that price very closely. Price of oil from a high of over $145... price of RIG reached it's high a couple months earlier at around $163. Price of oil now dropping to about half - or around $70... price of RIG also dropping more than half to its low, set today, of around $62. RIG also tends to be forward looking regarding the sentiment for oil price movement. When the outlook is positive that future oil prices are going higher, the price of RIG can move dramtically upwards and of course, vice versa (looks like beta is clearly greater than 1 ;-). What we're seeing now is very negative sentiment about the future price of oil and the possibility of sharply lowered demand due to a recession. Check out this chart: http://tinyurl.com/4ekq8d [Probably because I don't have a Stockcharts account, I couldn't lead you to the chart I created, but you can create your own. To see how the price of RIG tracks with the price of oil, select the first "Indicator" underneath the chart at the bottom and in the pulldown menu, select "Price." In the box that follows, type RIG. In the second "Indicator, select "None", or perhaps other drillers of interest like DO and NE. Then select "Update" and you'll see the price of RIG overlaid with the price of oil.]

So like it or not, the price of the drillers tends to move in tandem with the price of oil, even though we know that companies like RIG already have future revenue locked in with multi-year contracts at some still very high day rates. From my perspective, that gives investors a very good entry point at these prices (not that it couldn't continue to drop). Lets look at the possible drivers of the price of oil and consequently, the price of drillers.

1) OPEC has suggested they'd like to hold prices at about the $80 mark. Whether they'll be able to is questionable. As we continue to see financial troubles and recession aound the world, demand is likely to continue to slide. Oil producing countries, especially in an economic downturn, will continue to have their own cash flow requirements which would suggest they'll need to price oil to sell. Set too high a price (and the market is certainly telling us that $80 is too high today) and demand, followed by price, will decline further. Where the price will eventually stabilize, I don't know.

2) As the value of the dollar was dropping, the price of oil as a function of the dollar was going up. Now that the economies of other countries are beginning to experience their own pullbacks, the value of the dollar has been going up, part of the reason the price of oil has been going down. Which makes me think of another issue - I haven't looked up what Transocean's currency exposure might be.

3) If the price of oil continues to decline, the demand for alternative energy sources is likely to drop. When the price of oil was high, so too was the focus on alternative energy development. As the price of oil declines, the research into and the development of alternative energy sources is also liable to slow. Depending on who is elected in November, we might see a gigantic push toward this development but as long as the consumer is pinched, very few will be willing to pay their local utilities extra for wind or solar power. It will take some time before alternative energy sources, without substantial subsidies or incentives, represent an economically viable choice for most.

4) Both political candidates are talking about off shore drilling. Perhaps the greatest potential driver, a change in policy would bode well for the drillers. The increased demand for additional offshore rigs would make these shares very appealing, and increased production (which threatens price) would be years away.

So, what's your outlook? FWIW, I tend to believe that the price of oil is likely to find a bottom soon, and so should the drillers. The replacement of oil by alternative energies - especially in transportation - will be a very slow process over the long haul. When the economy finds its legs again, expect to see the price of oil stabilize or climb. In such an environment, if RIG can stay on track to earn what has been forecast, the stock price should escalate. If they're not forced to change contract terms and can continue to generate eps of around $15/share, expect the p/e contraction to reverse as investors are drawn to the obvious bargain. After all, how many companies priced at $70 can boast forward earnings in the double digits and with a yoy increase? Because of the complexities of price and various supply/demand scenarios, it's difficult to call the future - everything is so interrelated - but it seems reasonable to assume that we'll have an oil-based economy for many more decades and that means that drillers should continue to do well over the long term.

Just my 2¢,
Derek
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