BRISTOW GROUP INC BRS
January 26, 2016 - 5:03am EST by
skierholic
2016 2017
Price: 20.40 EPS 0 0
Shares Out. (in M): 34 P/E 0 0
Market Cap (in $M): 712 P/FCF 0 0
Net Debt (in $M): 1,567 EBIT 0 0
TEV ($): 2,390 TEV/EBIT 0 0

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  • Small Cap
  • Transportation
  • Levered
 

Description

Bristow Inc. (NYSE: BRS)

Summary

Amid indiscriminate sell-off of any vaguely oil & gas related companies, we believe selective opportunities exist to own fundamentally sound companies at a very attractive valuation level. Bristow, a helicopter operator headquartered in Houston, represents exactly such an opportunity. To paraphrase Howard Marks, a value investor should learn to catch “falling knife as skilfully as possible”.

·      Find the survivor!: Given the astonishingly low valuation, we believe this is an “avoid the loser” kind of situation and the upside will easily take care of itself (closing cap to intrinsic value + growth of intrinsic value on the sector upturn). In an oil price “lower for longer” scenario, it is almost certain that the offshore oil and gas (O&G) aviation sector as a whole will continue to deteriorate. The key investment thesis, we believe, is to find the company that is best equipped to weather the downturn on an absolute basis (avoid bankruptcy) and more importantly outperform peers on the upturn (capture market share). We strongly believe that as the undisputed industry leader, Bristow is uniquely positioned to survive the O&G downturn and thrive in the eventual upturn as an endgame winner.

·      Why market is selling Bristow: Ironically market is punishing Bristow for being less resilient to the downturn than advertised by the management. A series of earnings misses and profit warnings have diminished investors’ confidence in the company. A fatal accident earlier this year also did not help with the negative sentiment. Investor sentiment has swing from euphoria to manic-depression. At the current price level, we believe market is overly punitive on Bristow.

·      Cheap valuation: EV/LTM EBITDAR (Earnings before interest tax, D&A and operational lease payments) of 5.2x (historically 7.4x) and a reported P/B of 0.45. The all-in debt ratio is c.60%. A very conservatively estimated liquidation value is c.USD13 per share which means Bristow’s revenue generating capability (LTM EBITDAR of USD 448m) is only worth c.USD350m (For details see Asset Valuation Section)

 

·      Business overview: Bristow operates three types of businesses:

1.   Personnel transportation for offshore O&G through helicopter sector; strong impact from oil price (c.75% of operating revenue)

2.   Fixed wing aircrafts airlines through Eastern Airways in the UK and Airnorth in Australia; medium impact from oil price (c.10% of operating revenue)

3.   Search and rescue operation (SAR) in public sector; little or no impact from oil price (c.15% of operating revenue)

·      Competent and shareholder-oriented management: Based on the evidence we observe now, we feel that management seems to display the right qualities. 1) They have been decisive in introducing defensive measures ahead of the downturn namely – cost-savings of USD 150m, deferral of capex (USD 100m in FY2016 and incremental capex deferrals in 2017 and 2018) and introducing a USD 200m term loan to improve liquidity ahead of the downturn. 2) They have articulated clear capital allocation principles where they target a prudent capital structure and measure new capex investment on a return on capital basis (after tax cash flow discounted at cost of capital c.11%). 3) They have a good track record of returning cash to shareholder`rs via dividends and stock buybacks.

·      Favourable competitive environment: Bristow is one of the two global helicopter operators and commands a significant market share (c. 31%). It is efficiently and prudently operated by a shareholder-oriented management (at least their historical actions seems to indicate so). There are also significantly large moat such as the high capital investment, operational expertise required to navigate the complex offshore projects and O&G producers’ preference for companies with a safety track record (in some regions this is a legal requirement). Interestingly, this downturn has reinforced the barriers to entry and likely to widen the competitive gap amongst the top and mid-tier players

·      Strong downside protection: (See details under “Bristow’s downside protection”)

a)     Two-tiered contract structure with a large portion of revenue derived from fixed charge

b)     Biggest exposure relate to O&G production activities where production activity is sticky downwards with oil price

c)     New revenue stream from the 10-year UK SAR contract (generating USD250m in annual revenue) which is unaffected by the cyclicality of the O&G sector

d)    High residual value of the helicopter fleet even under O&G market turmoil

e)     Ability to meet all contractual cash payments in next 3 years even in a scenario where the core O&G revenue declined by 30% - 35% from 2015 levels without needing any rights issue or new bond offerings

f)     Given Bristow’s favourable competitive position from the strength of its balance sheet and relatively small percent of leased aircrafts, it is reasonable to expect sub-scale competitors to exit before Bristow in the event of a prolong downturn. In fact we believe Bristow should actively pre-empt pricing pressure from oil producers by offering lower price for larger volume to accelerate the exit of sub-scale competitors

g)    Pricing power – We believe Bristow can retain a significant influence over pricing even in most dire situation due to following reasons:

1.   Providing a MISSION-CRITICAL service to the offshore oil producers with a lack of alternative to the helicopter service

2.   Offshore workers perceive helicopter service as core to their basic working conditions. While union have given in to salary cuts and shift extensions, they will fight tooth and nail to preserve the helicopter service

3.   Helicopter transportation costs are a relatively small (c.1%) of the overall cost base

4.   Given the emphasis on safety, oil producers would be reluctant to put too much pressure on the helicopter operators as to compromise safety standard

·      Interesting upside potentials:

o    Bristow is the industry leader and best positioned to gain in market share on the upturn either organically or inorganically (M&A options of buying smaller operators) and this potential upside is enhanced if the downturn is sharper and dragged on longer than expected (more peers announce bankruptcy)

o    Potential new public SAR opportunity globally – UK SAR gives Bristow a strong credential

o    Long term secular trend of increasing offshore O&G growth is still strong

·      Base case scenario: where we assume oil price bottoming out by mid-2017 and core O&G operational performance bottoming out by end of 2017 and resume modest growth in 2018, we arrived at a private market value of c. USD 39 (discounted at c.10%). Note none of the upside is priced into the valuation except for LT secular trend!

 

Bristow’s business model and risks

Given that Bristow’s three business lines – 1) Offshore oil & gas helicopter transportation, 2) Fixed wing aircrafts operations and 3) SAR in public sector – are driven by relatively distinct business factors. We will provide an overview of the fundamentals of each business lines separately and then discuss the current operating environment jointly.

1) Offshore oil & gas helicopter transportation

Overview

Bristow would provide service to both independent and integrated oil & gas companies by transporting offshore workers to and from the offshore platforms. Personal transportation is typically related two types of activities: exploration and production. Bristow would typically sign 3-5 year contracts with customers to deliver helicopter services. These contracts would have three key elements to them:

1.     Fixed charge – Clients would pay a monthly standing charge (which constitutes roughly 70% of the total O&G revenue) to reserve the capacity of a certain number of helicopters. This portion of the revenue provides a very fat margin

2.     Variable fee - Depending on flight hours (utilisation of the helicopter). This portion of the revenue has a low margin

3.     Cost reimbursement – variable costs such as fuel; this varies with every contract

 

Helicopter contracts are cancellable by the client with 30-180 days of notice period (sometimes up to a year) for typically less than 12 month contracts especially in North America. Outside of America, contracts typically run from 2-5 years which typically include rate escalation provisions.

 

 

The table above provides a good summary of how demand for helicopter transport changes over the lifecycle of an offshore O&G project from exploration to production. Key points to note here include the following: 1) Production period covers the longest time in the offshore O&G project lifecycle and provide most stable demand 2) While exploration activity requires more crew intensity, it is more of a function of the prevailing oil price and hence less stable in an oil price downturn

 

Key characteristics: Transport of personnel on and offshore is a MISSION-CRITICAL service and has no other reliable transport means. Safety is a key concern! Hence there are sometime very strict regulatory rules for O&G producers to contract companies with strong track record only!

 

Historical context: In the last upturn (2009 – 2014), offshore drilling industry experienced rapid growth on the heel of triple digit oil price. Offshore projects become increasingly complex and moved further into deep water. On the back of this secular trend, a niche industry thrived – high-spec petroleum aviation. Historically, demand has always outstripped supply in the sector and this is reflected in the helicopter rates. Bristow’s LACE rate (a very good proxy for helicopter rates) has consistently outpaced the offshore rig day rates (See chart below). This is also partly a result of the delayed response on the supply side to meet shifting demand for new-technology, heavy and longer-ranged helicopters. Bristow has been an industry leader because it has the global scale and resources to meet these growing demands. Another very important and relevant point to draw from the chart below is that helicopter costs accounts for a very small portion of the total offshore drilling cost (only c.6% of the oil rig day rate).

 

Long-term operating environment and competitive moat

 

Despite current rout in oil price, offshore oil & gas production has been an increasingly important source of fossil fuel (accounting for 30% of the world’s total production o/w offshore deep water is 9%) with almost all incremental production capabilities coming from offshore oil and gas since the 1990s. As near shore resources quickly depletes, the trend is for oil & gas producer to go further offshore to find oil fields (See charts below).

 

 

The long term sector trend is pretty clear: production growth will primarily come from new offshore oil & gas projects. Within offshore oil & gas production, deep water oil & gas production will grow faster than shallow water oil & gas production. See chart below where 68% of the new oil discoveries have come from offshore and 63% comes from deep water in 2010s. This has come a long way where 50% of new discoveries are from onshore. This is a very favourable sector trend for Bristow as 1) increase in offshore oil & gas activities will mean stronger demand for helicopter services and 2) as oil & gas platforms move further offshore, demand for larger and longer range helicopter will increase.

 

 

Long-term sector risks include:

 

  • Rapid rise of helicopter leasing companies: With the rise of leasing companies, the new entrants can choose to lease a significant portion of its helicopter hence lowering barriers to entry. More importantly as leasing companies become more sophiscated; they might choose to enter the operating sector themselves. This can lead to a material increase in competitive intensity as these leasing companies will have the advantage of lower cost of capital. However the most likely entry strategy is through acquisition of a current operator. Deem this as a high probability and medium impact event

  • Renewable energy: unless there is a completely game-changing technology that suddenly removes the worlds addiction to petroleum, the change in energy mix is likely to be a slow process. Deem this as a low probability event

  • Automation of offshore oil & gas production process: there are talks about oil & gas producers developing more automated production process such that man hours required on offshore platforms can be reduced. However this is likely to involve significant R&D leading to limited cost savings. Given the tight budget of oil producers now, this is probably not going to be a material risk within the next 5 years

  • Maturation of North Sea and Gulf of Mexico: Additional oil fields that are economical to drill might be very difficult to find leading to reduced activities over time. This is mitigated by three factors: 1) Technological advancement might help to bring exploration cost down to offset declining demands 2) Any new oil field are likely to be further offshore which increases demand for helicopter services 3) Reduction in level of activities are likely to taper off over a long period of time and has clear visibility giving Bristow opportunity to find new areas for growth. Interestingly a new 1bn barrel offshore oil field was just recently discovered in North Sea

 

Competitive landscape: There are two layers of competition to offshore oil & gas helicopter services. The first one comes from the alternative transportation methods - namely boat, and the second one comes from competition with other helicopter operators. While helicopter has been displacing the use of boat as for offshore personnel transportation, boat remains an important in many part of the world where the weather conditions are calm (for example in Gulf of Mexico). However the advantage of helicopter over boat will continue to solidify as offshore platforms move further ashore. Offshore workers typically work 1-2 weeks offshore and have 1-2 weeks of holidays. They have a very strong desire (from our conversation with people who have worked offshore – this can be a very strong sentiment) to get back home as quickly as possible. Boats typically take 5 times longer for a similar trip using helicopter. And this has translated into increasing prominent use of helicopters even in shallow water areas. More importantly saved time can also translate into cost-saving in the form of lower salaries paid.

 

The second layer of competition relates to both new entrants and incumbent operators. New helicopter operators have significant barriers to entry due to the initial capital outlay, regulatory barriers, lack of operational track record and lack of operational expertise. In our view, lack of operational record and regulatory barriers seem to be the most potent barriers of entry. Many oil producers simply refuse to work with operators without a long safety track record. The set-up of an aviation company is faced with many complex licensing problems and often requires local partners.

 

Incumbent operators compete on the following factors:

 

  1. Price

  2. Professional reputation in terms of operational excellence and safety

  3. Type of helicopter in fleet

  4. Client relationships

  5. Flexibility in cost structure

Currently there are only two global helicopter operators – CHC Group & Bristow. The top 5 operators own more 50% of the total helicopters in the offshore oil & gas industry. There are smaller operators in each region. It is worth mentioning that CHC, on the verge of bankruptcy, has received an equity injection that almost completely wiped out existing shareholders. It was a classic example of entering a downturn with too much leverage on the balance sheet (not surprising given their private equity owners).

 

Bristow enjoys one of the best reputations in the industry in terms of safety track record and operational excellence. Bristow has demonstrated the operational capability to partner with local operators and overcome regulatory hurdles. This is an important competitive advantage as Bristow can participate in new offshore growth areas as and when new oil fields are being discovered. Bristow’s specific competitive advantages will be explained in more detail in the next section.

 

 

 

 

2) Fixed wing aircrafts operations

 

Overview

 

Fixed wing aircraft operations consist of Eastern Airways in the UK and Airnorth in Australia. They are small regional airlines which provide point-to-point transportation with strong exposure to O&G related clients. For example Eastern Airways fly offshore O&G workers from Aberdeen to other parts of UK and Western Europe. Airnorth provides similar service in Australia. Bristow bought them with the view of providing bundled transportation package to its O&G clients by offering both the helicopter service and chartered fixed wing aircraft services together. There are potentially strong revenue synergies here. However we are currently not including these revenue synergies in the valuation and simply consider it as a free option on the upside.

 

Fixed wing aircrafts operations offer some diversification from O&G sector downturn as a significant portion of the revenues are generated by normal business and leisure travels that are not related to the O&G sectors.

 

Risks: The fixed wing operations are exposed to risks any airline would face and that’s mainly related to economics cycles and pricing risks.

 

3) SAR in the public sector

 

Overview

 

SAR operations in the public space typically involve 24-hour search and rescue services to the coast line where helicopter is especially useful. Public SAR contracts are awarded on an ad-hoc basis. Bristow was recently awarded a 10-year USD 2.6bn UK SAR contract with a two-year extension option. This means run-rate revenue of USD 250m and EBITDAR of USD 110m. 85% of the SAR operations are not related to utilisation and thus management is expecting an EBITDAR margin of mid 40% range. At the end of September 2015, most of the capex related to UK SAR contract has largely completed and expects to become fully operational by mid-2016. We are expecting a decent return on capital over the lifetime of this contract.

 

The timing of UK SAR contract simply cannot be better for Bristow as it provides an alternative revenue stream as core O&G revenue declines. There is no material risks associated with U.K. SAR other than early termination of the contract due to operational incompetence. This is extremely unlikely given Bristow’s track record and management focus on this contract.  

 

 

Current operating environment and why is Bristow likely to emerge as a winner?

 

Current operating environment

 

 

 

 

We are currently witnessing one of the largest supply-driven oil price declines since 2008 and the magnitude of which is comparable to those in 2008, 1999 and 1980. As result of the decline in the oil price, oil producers have responded by reducing capex and operational cost. Since Bristow’s revenue is derived from oil producer’s cost base, Bristow is going to be affected as oil producers rebalance in the downturn. Capex reduction will mostly impact exploration activity levels and operational cost reductions will impact production activities.

 

 

 

Oil producers cut back operational cost: Large amount of operational cuts have already been implemented by the oil producers and we expect incremental cuts in operational costs in a lower-for-longer scenario. For example oil producers are sharing helicopters to optimise the passenger capacity on each trip. O&G producers have optimised crew change dates (from 2-week-on-3-week-off to 3-week-on-3-week-off), streamlined offshore personal by cutting the number of people necessary to maintain offshore production installations. Johnathan Baliff, CEO of Bristow, commented on 2Q call that he expects a lot of the cost-savings related to the offshore O&G helicopter sector to have being largely completed. This is corroborated by our conversations with research analyst and people working in the sector. As a result, we have seen both flight hours and numbers of helicopters under contract to decrease.

 

 

 

On the capex side, exploration and new oil field development has been either cancelled or delayed. Major EMEA O&G producer (collectively responsible for c. 15% of world supply) have announced 25% capex reduction from 2014 levels o/w 15% happened in 2015, 8% expected to happen in 2016 and the rest in 2017. Incrementally more capex reduction might come depending on expectation of the length of the downturn. Globally oil producers are significantly scaling back capital expenditure in anticipation of a lower-and-longer oil price decline.

 

 

 

Oil production level is sticky downwards with oil price: Oil production volume is relatively well insulated to oil price decline for two reasons. 1) Oil producers are very inclined to keep the oil taps on to pay fixed cost and fulfil contractual payments. 2) Growth barrels from new projects coming online will only add onto the production volume. Production will lag behind oil drilling activity. However the reduction in production will eventually kick in in a prolonged O&G downturn.

 

 

 

How will reduction in O&G activity levels hit Bristow’s revenue?: Based on our understanding so far, events are unfolding in the following stages:

 

  • Stage 1: New contracts tenders drop materially. Exploration-related activities dropped significantly while production-related activities held up pretty well
  • Stage 2: Low-hanging cost cutting initiatives started to kick in (streamlining crew change date and reduce number of offshore personnel). Exploration activities level continue to drop and production activities level start to drop modestly too. As contracts comes up for renegotiation, O&G producers are bargaining for better terms and buying less helicopter capacity
  • Stage 3: Most of low-hanging cost cutting initiatives are largely done by this stage and decline in exploration activities begin to stabilise. O&G producers will renew less contracts and might start pushing on helicopter pricing in order to achieve incremental cost-cuttings
  • Based on all the information we have, our best guess is that we are late in stage 2 and moving towards into stage 3. The key for ALL helicopter operators at this stage is to protect the two-tiered contract structure and resist any demands by producers to increase the variable component of the contracts! We believe it is possible given 1) O&G producers’ poor track record in managing contractors 2) Helicopter transport cost only account for a small fraction of the total cost base
  • As clients contract fewer helicopters and maximise utilisation of contracted helicopters, we expect margin compression

 

 

Bristow’ downside protection

 

 

 

 

 

1) Biggest O&G exposure relates to oil production level: 60% of Bristow’s O&G revenue is related to production activities and oil production activities are sticky downwards with the oil price. Hence we believe a large portion of the O&G revenue is relatively well insulated as compared to the revenues relating to exploration activities.

 

2) Two-tiered contract structure: Given 70% of revenue is related to fixed charges, reduction in utilisation of helicopter will have less proportional effect on the overall revenue. This downside protection is only valid to the extent that Bristow face little helicopter cancellation, protected pricing structure and limited reduction of contracted helicopters. Many companies have publicly stated that they see little contract cancellation and held up well on pricing power. However going forward, while we believe Bristow can protect its margins better than its peers, Bristow will still face some margin erosion.

 

3) Relationship with O&G producers leads to limited pricing erosion: O&G producers are heavily dependent on companies like Bristow to provide a mission-critical service to ensure uninterrupted oil production. Operators’ ability to deliver safely is of upmost importance. More importantly there is lack of alternative transport mechanism has given helicopter operators some bargaining power upon contract renewals. Historically O&G producers have not been most efficient in passing cost pressure down to contractors. The relatively low proportion of transport cost as part of the overall cost base, we believe that Bristow can limit the pricing erosion even in protracted downturn scenario.

 

However we are aware that some smaller players are compromising on safety standards to deliver lower price level which would mean that they can probably survive the downturn longer. This confirms that the helicopter operators are stretched to the limits. However we believe maintaining a high safety standard is the right strategy as long term reputation is of upmost importance. All it takes is one accident for everyone to revert to the best operators in the industry.

 

4) High residual value of helicopters: Given helicopter’s inherent flexibility to change roles, helicopters have seen incredible value retention. This is especially true for smaller helicopters that have very varied applications such as emergency medical services, executive transport and law enforcement. The global civilian fleet is about c. 34,000 o/w 2000 helicopter are in the O&G sector. This means that even in an O&G downturn, the price of helicopters should be able to hold up well. The high residual value also gave the company a high liquidation value (Assuming a conservative 70% value retention). However one point to note is that as the larger helicopters have lower value retention as they are less adaptable to other roles as compared to smaller helicopters which have more flexibility to take on new roles. Currently the civilian market consists of roughly 24% large helicopters, 34% medium helicopters and 43% small helicopters. We accounted for this by giving a lower than average value retention for larger helicopters in Bristow’s fleet. We compared our valuation of USD 1.9bn (including small helicopters) against sell-side research valuation of USD 1.7bn (not including small helicopters).

 

 

5) UK SAR contract: As UK SAR revenue continues to ramp up, it can offset some of the decrease in O&G revenue. Based on FY15 core O&G revenue of USD 1.5bn, the ramp up to USD 260m of SAR revenue can offset an 18.2% decrease in core O&G revenue and still keep the total operating revenue flat. Given UK SAR’s independence of O&G cyclical trends, the visibility of this revenue stream provides strong downside protection against revenue deterioration. We view the probability of winning new public SAR projects to be a free option on the upside.

 

6) No liquidity issue even in dire scenario: We want to see how much the operating revenue can decline and still meet all its contractual obligations (capex, interest payment, lease payment, principal repayment and pension obligations) without the need tap new financing be it equity or debt. Assuming very conservative EBITDAR margin, Bristow can sustain a 30-35% decline in core O&G revenue. This really gives us confidence in Bristow’s ability to survive the down even in dire situation. Note that we did not assume any sales proceeds from helicopter which historically have been very high around USD 100 – 400m

 

7) Capex deferrals and cost reductions: Capex deferrals and cost reductions (20% of the announced USD 150m are delivered; majority of the cost savings are expected to come in 1H 2016) are going to be very helpful for the free cash flow generation. Capex deferrals are USD 100m in FY2016, c.USD 50-80m between FY 17 and 18. We see these deferrals as very likely to happen as civilian helicopters represent a small portion of OEMs’ revenue and OEM make more from aircraft servicing rather than sales. Hence OEMs are not likely to force delivery of aircrafts with Bristow. Also helicopter operators have very close relationship with helicopter OEMs. On the cost-cutting side, we like the progress so far and all evidence are pointing to realisation of 100% cost-saving target (though we only assumed 80% completion).

 

8) Reduction in number of helicopter models: Bristow has promised to reduce the number of helicopter models in the aircraft fleet. Maintenance cost of helicopters is very high (10-20% of the revenue) as different helicopter models share no common parts. By reducing the number of models that exist in the fleet, one can cut cost by 1) reducing the need to stock different helicopter parts 2) less time/money spent on training mechanics to serve different helicopter models. Bristow aimed to have 8 models in the fleet by 2020; it has exited 5 models in 2014 and 4 more in 2015. There are currently 14 helicopter models in the fleet.

 

9) Shareholder-oriented management: Based on the evidence we observe now, we feel that management seems to display the right qualities. 1) They have been decisive in introducing defensive measures ahead of the downturn namely – cost-savings of USD 150m, deferral of capex (USD 100m in FY2016 and incremental capex deferrals in 2017 and 2018) and introducing a USD 200m term loan to improve liquidity ahead of the downturn. 2) They have clearly articulated clear capital allocation principles where they target a prudent capital structure and measure new capex investment on a return on capital basis (after tax cash flow discounted at cost of capital c.11%).3) They have a good track record of returning cash to shareholders via dividends and stock buybacks.

 

Why Bristow is going to emerge as an endgame winner?

 

We believe there are favourable competitive dynamics going into the downturn and also help Bristow emerge as an endgame winner on the upturn. These dynamics are upside to the current investment thesis. It is again important to note that none of these upsides are included in the current valuation. The favourable competitive dynamics will stem from the following areas:

 

  1. Balance sheet strength: Bristow has one of the most conservative capital structure (including helicopter leases). This is in our view a key competitive advantage – staying power! As the sector contracts, weaker players will have fold in face of excess supply and pricing pressure and remaining players will increase market share within a shrinking market

  2. Global footprint: Bristow’s global footprint allows Bristow to take full advantage of the geographical diversification. Different oil producing region is facing slightly nuanced difference in oil production profile. This allows Bristow to capture pockets of new contracts that come up even in the downturn

  3. Optimal fleet strategy: In deriving an optimal fleet strategy, one has to think the choice between owning versus leasing aircrafts. The advantage with leasing is lower upfront capital outlay, higher flexibility in terms of increasing aircraft capacity on a short notice and not taking the risk of unexpected erosion of residual value. The disadvantage of leasing is that the lease usually lasts for more than 10 years and is only cancellable upon heavy termination fees. The advantage of owning is no lease payment and flexibility to sell anytime which is extremely important in a downturn.

    On one end of the spectrum, CHC lease about 71% of its fleet which incurred a large fix payment and is not likely to be reduced dramatically in the short term. On the other end of the spectrum, ERA group owns 97% of its fleet. In fact ERA generates c.15% of its revenue from dry-leasing its helicopters globally. Bristow is somewhere in the middle with 31% of its fleet being leased. We believe this is optimal strategy because it allows Bristow to lower capital investment and juice up return on the upturn. At the same time, it also gives Bristow the flexibility to sell aircrafts to reduce excess capacity in the downturn. In comparison, ERA is only a regional player in America and CHC is the true global competitor to Bristow

  4. Capacity to expand: Compared to its peers, Bristow has the largest order book on new aircrafts outstanding. If we exclude UK SAR related aircrafts, we are still looking at 31 firm orders and 21 optional orders in total (though they are due for delivery between FY16-FY18). As the helicopter industry cuts on supply in the current downturn, there is huge value in maintaining the optionality of expanding when the eventual upturn arrives. Bristow would be extremely well positioned to compete for the larger scale projects when the demand for helicopter comes back.

  5. Ability to compete on lower price and gain market share: In a prolonged downturn where oil producers will be desperate to reduce cost, Bristow will have the resources and ability to increase market share by offering lower price on contract renewals. This will result in lower price but larger volume. The net effect is likely to result in flat revenue but increasing market share. Many of Bristow’s debt-laden competitors will be unable to compete on lower price and hence exit the sector. This strategy will allow Bristow not only to have larger market share but also stronger bargaining power with oil producers. This will improve both Bristow’s ability survive the downturn and also pricing power on the upturn. This is a very aggressive strategy and definitely needed to be pursued with caution. However we believe there is no reason why Bristow would not succeed if they choose to pursue this strategy.

 

Below you will find a table on market share analysis to provide further evidence on Bristow’s favourable competitive positioning. Currently Bristow and CHC, the two global operators, have the highest percentage of large helicopters. And these large helicopters are essential as the offshore O&G sector requires larger helicopter to transport more people and over a longer distance. The bias towards larger model have a disproportionate effect on revenue as CHC & Bristow only have 36% of the total fleet but commands 64% of the total market share. This larger-model dominated revenue model has placed Bristow very well for the long term secular trend.

 

 

 

 

 

 

 

 

 

 

 

 

 

By putting the favourable competitive dynamics together with the downside protection, we are looking at a company that can weather the downturn and thrive on the upturn. We try to illustrate this by analysing what will happen in bear, base and bull cases. From a valuation perspective, we try to use mid-cycle revenue as the steady state. In this case, we find it fair to use 2015 level to adjust for the favourable long term secular trend. We included 80% of the cost-savings promised by the management and we spread it over a 3 year period as compared to management’s expectation of 2 year period. For lease payment, interest expense and capex, we took the contractual payments laid out in the annual report for the future.

 

Base case:

 

We believed on, a very conservative level, a terminal unlevered free cash flow of USD250m yields an equity value of c. USD 1bn (discounted at 10%). This implies a share price of roughly USD30 and an EV/EBITDAR of c.6x (a modest multiple expansion from the current level of 5.2x).

 

 

Assumptions:

 

  • Oil price maintains current level until mid-2017 and recovery begins in 2H 2017

  • Global production level will drop marginally and bottom by end of 2016; exploration activities resume only after 2017

  • Pricing pressure is mild however the number of contracted helicopters will drop even further from 2015 levels

 

Asset valuation

 

In this section we tried to look at the balance sheet and establish an understanding of the value floor in terms of liquidation value and reproduction value (how much capital would a competitor need to enter the business). Generally we try to be quite conservative in estimations.

 

We would highlight that a high goodwill assumption (300%) for reproduction cost because we believe the safety track record and client relationships are substantial barriers to entry. Even at USD 157m, we believe the goodwill is extremely conservative. Given the abundance of supply from helicopter leasing companies, new entrants have the option of leasing rather than purchasing new helicopters hence the net PP&E assumption is only set at 50%

 

We believe the outcome of these analyses continues to give us confidence in Bristow’s value.

 

Historical data

 

Bristow enjoy accelerating revenue growth as the offshore O&G sector boomed from 2009 - 1H2015. The low free cash flow is largely due to capex spending related to purchasing aircrafts as the the demand for helicopter service has outstripped supply until the recent downturn. Net capex is the sum of capex spends + sales proceed from asset disposition. The capex spend in 2014 is very much related to the purchase of aircraft for UK SAR contract. The unlevered ROIC is calculated by dividing the sum of working capital + Gross PP&E by adjusted EBITDAR.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

  • Stabilization of operational performance amid a falling oil price environment

  • Better than expected oil price

  • Management engaging in stock buybacks rather than paying dividends given the current low valuation (I find this to be almost risk-free way to increase return for shareholders given the low share price and tax free nature of buybacks)

  • Faster than expected exit of competitors resulting in larger market share for Bristow (especially CHC)

  • Buying up of smaller regional players

  • New public SAR contracts
  • Fixed wing operations benefitting from low oil price

 

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    Description

    Bristow Inc. (NYSE: BRS)

    Summary

    Amid indiscriminate sell-off of any vaguely oil & gas related companies, we believe selective opportunities exist to own fundamentally sound companies at a very attractive valuation level. Bristow, a helicopter operator headquartered in Houston, represents exactly such an opportunity. To paraphrase Howard Marks, a value investor should learn to catch “falling knife as skilfully as possible”.

    ·      Find the survivor!: Given the astonishingly low valuation, we believe this is an “avoid the loser” kind of situation and the upside will easily take care of itself (closing cap to intrinsic value + growth of intrinsic value on the sector upturn). In an oil price “lower for longer” scenario, it is almost certain that the offshore oil and gas (O&G) aviation sector as a whole will continue to deteriorate. The key investment thesis, we believe, is to find the company that is best equipped to weather the downturn on an absolute basis (avoid bankruptcy) and more importantly outperform peers on the upturn (capture market share). We strongly believe that as the undisputed industry leader, Bristow is uniquely positioned to survive the O&G downturn and thrive in the eventual upturn as an endgame winner.

    ·      Why market is selling Bristow: Ironically market is punishing Bristow for being less resilient to the downturn than advertised by the management. A series of earnings misses and profit warnings have diminished investors’ confidence in the company. A fatal accident earlier this year also did not help with the negative sentiment. Investor sentiment has swing from euphoria to manic-depression. At the current price level, we believe market is overly punitive on Bristow.

    ·      Cheap valuation: EV/LTM EBITDAR (Earnings before interest tax, D&A and operational lease payments) of 5.2x (historically 7.4x) and a reported P/B of 0.45. The all-in debt ratio is c.60%. A very conservatively estimated liquidation value is c.USD13 per share which means Bristow’s revenue generating capability (LTM EBITDAR of USD 448m) is only worth c.USD350m (For details see Asset Valuation Section)

     

    ·      Business overview: Bristow operates three types of businesses:

    1.   Personnel transportation for offshore O&G through helicopter sector; strong impact from oil price (c.75% of operating revenue)

    2.   Fixed wing aircrafts airlines through Eastern Airways in the UK and Airnorth in Australia; medium impact from oil price (c.10% of operating revenue)

    3.   Search and rescue operation (SAR) in public sector; little or no impact from oil price (c.15% of operating revenue)

    ·      Competent and shareholder-oriented management: Based on the evidence we observe now, we feel that management seems to display the right qualities. 1) They have been decisive in introducing defensive measures ahead of the downturn namely – cost-savings of USD 150m, deferral of capex (USD 100m in FY2016 and incremental capex deferrals in 2017 and 2018) and introducing a USD 200m term loan to improve liquidity ahead of the downturn. 2) They have articulated clear capital allocation principles where they target a prudent capital structure and measure new capex investment on a return on capital basis (after tax cash flow discounted at cost of capital c.11%). 3) They have a good track record of returning cash to shareholder`rs via dividends and stock buybacks.

    ·      Favourable competitive environment: Bristow is one of the two global helicopter operators and commands a significant market share (c. 31%). It is efficiently and prudently operated by a shareholder-oriented management (at least their historical actions seems to indicate so). There are also significantly large moat such as the high capital investment, operational expertise required to navigate the complex offshore projects and O&G producers’ preference for companies with a safety track record (in some regions this is a legal requirement). Interestingly, this downturn has reinforced the barriers to entry and likely to widen the competitive gap amongst the top and mid-tier players

    ·      Strong downside protection: (See details under “Bristow’s downside protection”)

    a)     Two-tiered contract structure with a large portion of revenue derived from fixed charge

    b)     Biggest exposure relate to O&G production activities where production activity is sticky downwards with oil price

    c)     New revenue stream from the 10-year UK SAR contract (generating USD250m in annual revenue) which is unaffected by the cyclicality of the O&G sector

    d)    High residual value of the helicopter fleet even under O&G market turmoil

    e)     Ability to meet all contractual cash payments in next 3 years even in a scenario where the core O&G revenue declined by 30% - 35% from 2015 levels without needing any rights issue or new bond offerings

    f)     Given Bristow’s favourable competitive position from the strength of its balance sheet and relatively small percent of leased aircrafts, it is reasonable to expect sub-scale competitors to exit before Bristow in the event of a prolong downturn. In fact we believe Bristow should actively pre-empt pricing pressure from oil producers by offering lower price for larger volume to accelerate the exit of sub-scale competitors

    g)    Pricing power – We believe Bristow can retain a significant influence over pricing even in most dire situation due to following reasons:

    1.   Providing a MISSION-CRITICAL service to the offshore oil producers with a lack of alternative to the helicopter service

    2.   Offshore workers perceive helicopter service as core to their basic working conditions. While union have given in to salary cuts and shift extensions, they will fight tooth and nail to preserve the helicopter service

    3.   Helicopter transportation costs are a relatively small (c.1%) of the overall cost base

    4.   Given the emphasis on safety, oil producers would be reluctant to put too much pressure on the helicopter operators as to compromise safety standard

    ·      Interesting upside potentials:

    o    Bristow is the industry leader and best positioned to gain in market share on the upturn either organically or inorganically (M&A options of buying smaller operators) and this potential upside is enhanced if the downturn is sharper and dragged on longer than expected (more peers announce bankruptcy)

    o    Potential new public SAR opportunity globally – UK SAR gives Bristow a strong credential

    o    Long term secular trend of increasing offshore O&G growth is still strong

    ·      Base case scenario: where we assume oil price bottoming out by mid-2017 and core O&G operational performance bottoming out by end of 2017 and resume modest growth in 2018, we arrived at a private market value of c. USD 39 (discounted at c.10%). Note none of the upside is priced into the valuation except for LT secular trend!

     

    Bristow’s business model and risks

    Given that Bristow’s three business lines – 1) Offshore oil & gas helicopter transportation, 2) Fixed wing aircrafts operations and 3) SAR in public sector – are driven by relatively distinct business factors. We will provide an overview of the fundamentals of each business lines separately and then discuss the current operating environment jointly.

    1) Offshore oil & gas helicopter transportation

    Overview

    Bristow would provide service to both independent and integrated oil & gas companies by transporting offshore workers to and from the offshore platforms. Personal transportation is typically related two types of activities: exploration and production. Bristow would typically sign 3-5 year contracts with customers to deliver helicopter services. These contracts would have three key elements to them:

    1.     Fixed charge – Clients would pay a monthly standing charge (which constitutes roughly 70% of the total O&G revenue) to reserve the capacity of a certain number of helicopters. This portion of the revenue provides a very fat margin

    2.     Variable fee - Depending on flight hours (utilisation of the helicopter). This portion of the revenue has a low margin

    3.     Cost reimbursement – variable costs such as fuel; this varies with every contract

     

    Helicopter contracts are cancellable by the client with 30-180 days of notice period (sometimes up to a year) for typically less than 12 month contracts especially in North America. Outside of America, contracts typically run from 2-5 years which typically include rate escalation provisions.

     

     

    The table above provides a good summary of how demand for helicopter transport changes over the lifecycle of an offshore O&G project from exploration to production. Key points to note here include the following: 1) Production period covers the longest time in the offshore O&G project lifecycle and provide most stable demand 2) While exploration activity requires more crew intensity, it is more of a function of the prevailing oil price and hence less stable in an oil price downturn

     

    Key characteristics: Transport of personnel on and offshore is a MISSION-CRITICAL service and has no other reliable transport means. Safety is a key concern! Hence there are sometime very strict regulatory rules for O&G producers to contract companies with strong track record only!

     

    Historical context: In the last upturn (2009 – 2014), offshore drilling industry experienced rapid growth on the heel of triple digit oil price. Offshore projects become increasingly complex and moved further into deep water. On the back of this secular trend, a niche industry thrived – high-spec petroleum aviation. Historically, demand has always outstripped supply in the sector and this is reflected in the helicopter rates. Bristow’s LACE rate (a very good proxy for helicopter rates) has consistently outpaced the offshore rig day rates (See chart below). This is also partly a result of the delayed response on the supply side to meet shifting demand for new-technology, heavy and longer-ranged helicopters. Bristow has been an industry leader because it has the global scale and resources to meet these growing demands. Another very important and relevant point to draw from the chart below is that helicopter costs accounts for a very small portion of the total offshore drilling cost (only c.6% of the oil rig day rate).