|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|
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!
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.
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).