January 19, 2011 | In: Energy

Is RIG Overvalued?

RIG, as I’ve stated before, is one of my favorite stocks. A month ago, I argued that it was undervalued, along with other offshore drilling stocks, but is it still undervalued? Is it not, at the current price of over $80, a bit overvalued?

Let’s examine the company, the industry, and the connection between the price of oil and the stock (RIG).

Transocean is a very solid company, it went through last year’s storm with some bruises, but with an intact reputation. Although it was the one who built the oil rig, it managed to throw nearly a 100% of the responsibility on BP (see the blame game), and it managed to convince the public opinion, and the investors, that it really wasn’t Transocean’s fault that that rig exploded. Now, just for contemplation sake, if Toyota built a car, and that car, heaven forbids, exploded purely because of a mechanical problem while the person was driving it, do you blame the person, or the car manufacturer? Transocean managed to blame the person, claiming that it built the car to that person’s specifications. Whatever… Anyway, what we need to know from this paragraph is that Transocean is one strong company that can stand up for itself, and it’s here to stay.

Transocean’s industry, as you may all know, is offshore drilling. Offshore drilling is a controversial industry for a long time now, and it became more controversial, and was banned for several months (or is it several years), following the Deepwater Horizon explosion. However, there seems to be consensus among high level politicians that, “offshore drilling, if done right, has acceptable risks“. Now I don’t want to go into conspiracy theories behind this change of heart, but this is oil, and it’s probably the most important commodity on this planet, at least from our perspective, so there must be a lot of lobbying going on (by the way, lobbying is legal in the United States, there’s even a lobbying act). The heart of what I’m saying here is that offshore drilling will never go away (at least for the foreseeable future), and they ban it in one area, then others will allow it in several areas. So, no worries here either.

Now let’s examine the connection between RIG and the price of oil. Take a look at the below chart, comparing RIG with HOU (which has x2 the NYMEX performance):


Now I agree that the above is not a very accurate representation of the movement of RIG with respect to oil (HOU is, again x2 NYMEX and it’s priced in CDN), but it gives us an idea. First we know that RIG (surprisingly), as of the end of 2009, moves proportionally with the oil. Diverging for a few months, and then converging (take a look at May, September, and November of 2010). Now if you look at this month’s movement, you will see there’s a huge divergence between the two, RIG has moved 18% higher than HOD, which means that there’s a huge possibility for RIG to move down, to meet HOD, halfway down the road. So what should really be the price of RIG? I think it should be around the $70 – $75 level, and not more, even when the oil is at $100.

I think there is too much excitement over RIG at the moment (it was undervalued at one point), and I think the stock will experience some negative correction in the course of the next few weeks. It is already down over 2.5% today, currently trading at $80.81.

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