This is the first of a daily business column that will feature a rotating cast of some of the best stock pickers in the industry. They will offer their opinions and insight, and explain how they chose what to buy.

DON HODGES
CO-MANAGER
HODGES CAPITAL MANAGEMENT INC.

COMPANY: Transocean Inc.
SYMBOL: RIG (NYSE)
PRICE: $76.03 (as of Friday)
52-WK RANGE: $42.19 -$77.80
MARKET CAPITALIZATION: $25.1 billion

Don Hodges is co-manager of Hodges Capital Management, Inc., the investment adviser of the Hodges Fund (HDPMX), which has assets under management of $180 million. The fund has enjoyed an annualized return over the last three years of 35.85%. Transocean is an offshore contract drilling services company that rents deep sea rigs to big oil-exploration companies. Mr. Hodges believes it’s a winner. David Dalley of The New York Sun asked him why.

Why Transocean?

RIG owns over 90 drilling rigs (primarily deep sea oil and gas rigs) all around the world. Supply in rigs is necessarily limited. It takes a long time and costs a lot of money to build a new unit. Demand, on the other hand, is strong, and will remain strong as long as oil stays above $40 a barrel.

What’s the connection with the oil price?

Transocean’s customers – the people who actually hire out these rigs – are the big oil companies like Exxon-Mobil. They use them to dig for oil as part of the exploration process, and they pay RIG a rental rate by the day. So the demand for rigs is directly related to the profitability of oil exploration. If the price of oil is high, oil companies will have an incentive to locate additional sources, and so the demand for rigs will be strong. At above $40, it’s very profitable for oil companies to dig for new oil.

Why now?

Those day rates paid by the oil companies to use the rigs – they’re accelerating rapidly. It’s both a function of limited supply and increased demand.

There are about 1,450 rigs of all types operating globally, but the most secure (and the most sought after) are the deep water rigs. That’s where they’re finding the larger oil deposits. RIG specializes in deep sea drilling equipment. With the current price of oil, demand for these units should remain very strong indeed.

What are the risks?

The biggest risk comes from volatility in the oil market. If the price of oil went down, say, to $15 or $20, then I’d be worried. Even at $25 a barrel, it wouldn’t be as profitable for the big exploration companies to dig for new oil, and so demand for RIG’s equipment and services would decline markedly. That said, I don’t see the price of oil going anywhere near those levels. It’s a personal call – I happen to be quite confident in the strength of the oil price.

Another risk is terrorism – if someone decides to blow up one of these rigs – or natural disasters of the type we saw recently with the hurricanes. Storms like those, which damage the world stock of equipment, tighten supply even further. Katrina and Rita definitely aggravated an already tight supply-side situation.

The stock has increased significantly over the last year. Is it still a good buy?

It has gone up a lot, but I think it still has the potential to go up a lot more. And given the current demand/supply situation, earnings are set to increase significantly. For example, the company just announced price increases for a couple rigs stationed off Africa. In one instance, the rate increased from about $85,000 per day to $300,000 per day on a one-year contract. In another case, the rate increased from $90,000 per day to $200,000 per day.

I feel that next year’s earnings will rise significantly as these new price structures take effect. I think the same will occur for the following year. That’s what I believe makes the price of a stock go up. If every year a company reports higher earnings and profits, that forces investors to take notice. RIG has some very strong fundamentals. Its business model is very solid, and I’m excited about its prospects.