Dolphin Group DOLP W
July 16, 2013 - 10:20am EST by
2013 2014
Price: 5.70 EPS $0.00 $0.00
Shares Out. (in M): 357 P/E 0.0x 0.0x
Market Cap (in $M): 346 P/FCF 0.0x 0.0x
Net Debt (in $M): 44 EBIT 109 205
TEV ($): 390 TEV/EBIT 3.6x 1.5x

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  • Out-of-Favor
  • Offshore Oil and Gas
  • Oil Services
  • Highly Cash Generative
  • Cyclical
  • Low multiple


Long Dolphin Geophysical
Long Offshore Oil Services 
Thesis: Dolphin is positioned well in a tightening market for a very hated sub-sub-sector (offshore seismic vessels) in a hated sub-sector (oil services) in a hated sector (energy) and is valued very cheap.
Offshore Seismic:
There have been a number of trades written up about the offshore seismic space and I feel Dolphin Group is the best positioned name to play in the space on either an absolute or relative basis. To understand why Dolphin is cheap you have to look at the offshore seismic space. To understand why all the offshore seismic vessel owners (PGS, Dolphin, Polarcus) are cheap you have to look at the offshore oil services. To understand why most offshore oil serives are cheap (offshore drilling, seismic, supply vessels, equipment providers, subsea installers, integrated services providers) you have to look at all oil services spending in general. And that links to the E&P Capex budgets of the majors. And that links to their FCFs and that links to ultimately the oil price, more specifically Brent.
So this thesis is going to be top down driven from very high level and ultimately leads to a number of trade ideas and one recommendation is Dolphin.
Oil Price, Forward Curve, Supply and Demand.

Energy is a hated sector right now. The amount of portfolios allocated to energy are at their lowest in a while. The oil services names have been a graveyard for investors and all of it links to the Brent price. Looking at the last 52 week Brent average, it has traded down from a high of 114.04 on 3/30/12 to 109.54 now. Moreso than the average, the spot itself plays a major role on the equities and spot has traded in the low 100s recently. What's worse is that the forward curve is in backwardation and the long-term oil price dropped another $5 recently from $90 to $85. The forward curve is in steep backwardation because there is a fear of continuing drop in US oil demand due to natural gas substitution in trucks, fewer vehicle miles travelled, along with a glut of shale oil coming on the supply. This forward curve scares investors since they see that the oil majors are already FCF negative after dividends so there is an expectation that future capex budgets will get squeezed and hence the oil services industry will suffer. And within oil services the developments projects will proceed but the exploration stuff will get curbed and hence offshore seismic spending will get squeezed. 
Now that I have laid out the bear thesis, I'll proceed to destroy it.
US oil demand: US oil demand has fallen recently because of 3 major factors, motor gasoline usage (mostly due to a fall in vehicle miles travelled), distillate fuel oil and residual fuel oil. The residual fuel oil usage is structural and will never come back as homes will not use oil for heating in future. But it has already fallen to be an insignificant amount so not much further decline to go. Vehicle miles travelled have stabilized and most research on their decline has focused on the one-time gain from the US car fleet gaining GPS tech which allowed more efficient car travel, again a one-time gain. Distillate fuel oil (diesel) has dropped not due to any switch to natural gas but the switch of intermodal containers from trucks to trains. That effect still has some ways to go but the major substitution is done as trains can reach much fewer nodes and still require trucks to reach the whole network. I forecast US demand to stop dropping and while it won't recover, it should stabilize at 18.5ish mbpd. The threat from natural gas switching on trucks is a very very slow process. Most truckers want 2 year payback on investment as opposed to the current 4 year payback. And the lack of the infrastructure build-out remains a major hurdle. There are VIC notes on Westport and Clean Energy which shed a lot more light on why this threat is a non-starter. 
China oil demand: China's SUV mania is about to kick its oil demand into high gear. The Chinese have gone nuts for SUVs and minivans which are taking a bigger proportion of the automotive sales each year. And overall car sales are already running at 10-15% per year. The market is underestimating the demand kick that will result as Chinese automotive demand keeps kicking on.
US Shale oil: US shale oil production growth peaked in March 2013 and has started declining. Last year US increased production by 800kbpd and I expect the increase this year to be 600kbpd and the growth to keep falling. So far production growth has surprised on the upside on each of the last 4 years and investors are now scared at how high the production can go. I feel investors are projection that the production from the wells on the periphery of these basins will match those that were drilled initially on the sweet spots and they will be disappointed.
Legacy production: Legacy oil production continues to fall at an alarming rate. Statoil in particular has been trying to dampen the declines with infill drilling and the costs of doing so is exploding. The reason majors are focusing on keeping these old dying fields alive is that they get valued on replacing their barrels and all new barrels are to be found offshore in deep complex finds. The cheap onshore barrels are effectively a political backroom dealing game with availability in Iraq or Kurdistan or Russia overshadowed by the politics. Unless you expect a political solution in Venzuela shortly, the only place to get new barrels (outside of US onshore shales, which I explained are limited), is offshore. The majors have consistently disappointed in their forecast productions for the last decade and I expect them to continue to do so.
Oil Price: I believe Supply will be tighter than people are expected and demand more robust. I think oil price holds up above the $100 mark for the next several years and then starts ticking up as opposed to falling to $85 that the curve suggests.
Given my thesis on oil prices, and where the barrels are to be found, I believe offshore capex budgets will keep rising. The capex will shift from onshore to offshore, and more capex is funded either by debt or a cut in dividends or a forced rise in oil price due to a tight market. The world needs more barrels, the new barrels are found offshore, and the oil majors will have to pay up for it. The drillers, subsea installation and equipment, and integrated and other offshore players are all set to benefit from this trend.
Since most new finds and hence new barrels are offshore, the majors are spending ever more dollars chasing them. The new finds in Angola prompted a gush of seismic activity in the area. East Africa is now seeing some vast surverys being done on the back of recent finds. Uruguay is doing some large surveys on its adjoining basins to the established Brazilian ones. The Barrents Sea in the north is seeing major activity after the Kruugard discovery. Each discovery begets a lot more exploration. There are still a lot more areas that are lined up to see more activity including deeper Gulf of Mexico, Western Australia, India, North-eastern Brazil, Eastern Spain and other offshore areas. In addition new seismic technology keeps prompting a survey of already surveyed areas with new equipment. There are parts of Gulf of Mexico that have been surveyed 3 times now, once in the 90s, once about 7-8 years ago and once more again recently. Since the Norwegian govt reimburses almost 90% of the cost of exploration, the norwegian offshore seismic market is very important. In addition since that market is only open in the Jun-Aug summer months, it causes a further crunch and rates generally peak in the summer. Other markets are nearer the equator and ships can go there all year round. Demand should continue to increase at a steady pace going forward.
On the supply side we know the exact number of new vessels coming to the market over the next 3 years. PGS has 2 vessels that arrive in 2013 and 2 in 2015. Western Geco has 2 vessels that arrive in 2014. And Dolphin has 1 vessel that arrives in 2013 and one in 2015. Polarcus has no more vessels to come and CGG recently purchased all of Fugro's vessels and is busy absorbing them. This should create a tight market going forward. Infact rates have already risen from closer to $200-220k per day to $300-$320k per day recently. But as my analysis will show, Dolphin doesn't need rates to rise, it's cheap even if they stay steady.
Dolphin Geophysical was founded by Atle Jacobson and the old Wavefield team. Wavefield was acquired by CGG Veritas and they founded Dolphin after acquiring some seismic boats on leases through bankruptcy. Dolphin has continued on a leasing model which is unlike what other vessel operators follow who largely own their boats including PGS, CGG Veritas, WesternGeco (Schlumberger) and Polarcus. Dolphin's leasing model provides superb asymmetric risk reward. As the boats get older, they are able to release the boats from their leases and do deals to lease newer boats. They have structured the leases so that they have the option to extend the leases if they want and can release them if they choose to do so. In addition the leases' expiry is staggered so they can manage the number of boats they operate and can react if they market takes a downturn. Also they don't take any capex or yard delay risk as that's transferred to the boat owners. 
Dolphin still owns all the seismic equipment on the boats and it has financed this with 50% debt secured on the equipment and 50% equity. In effect Dolphin has extreme operational leverage since a new seismic boat, which may cost $140m for boat plus $60m in equipment, can be purchased with only $30m in equity and very good financing terms for both the secured debt on equipment and the lease rates. Since doing these leases, the breakeven dayrates for Dolphin were coming to about $180-200k. But the tight market has increased dayrates over the last year to $320k. Dolphin is also benefitting that its boats are of better quality than Polarcus (although not as good as PGS's) even though they are effectively costing Dolphin less (Polarcus' debt has been expensive). They are also getting a premium to Polarcus' rates and are on par with PGS.
Dolphin also picked up another vessel from the fallout of CGG Veritas's acquisition of Fugro's vessels. CGG decided that it had too many vessels to absorb and returned one of the leased vessels to its owner, which Dolphin has duly snapped up at a great rate subject to the owner doing some upgrades to it. This vessels will be available from Jan 2014 as well. So even without factoring in any dayrate increses and standard utilization assumptions (there is steaming time between projects plus yard stays) as below
SEGMENTS USDm   2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E
Dayrates USD           1.10 1.33 1.00 1.00 1.00
Polar Duke "         210,000 250,000 312,550 312,550 312,550 312,550
Polar Duchess (533) "         210,000 235,000 312,550 312,550 312,550 312,550
Polar Explorer "         60,000 65,000 86,450 86,450 86,450 86,450
Artemis Artic "         160,000 185,000 246,050 246,050 246,050 246,050
Artemis Atlantic "         60,000 82,000 86,450 86,450 86,450 86,450
Sanco Swift "             312,550 312,550 312,550 312,550
Sanco Sword "               312,550 312,550 312,550
Geo Atlantic               296,923 296,923 296,923 296,923
Super Duke                   343,805 343,805
Contract Utilization* %                    
Polar Duke "         51% 43% 83% 83% 83% 83%
Polar Duchess (533) "           64% 71% 68% 65% 62%
Polar Explorer "         50% 6% 0% 0% 0% 0%
Artemis Artic "         46% 57% 53% 50% 47% 44%
Artemis Atlantic "         0% 57% 39% 39% 39% 39%
Sanco Swift "           0% 17% 83% 83% 83%
Sanco Sword "               75% 83% 83%
Geo Atlantic                 83% 83% 83%
Super Duke                   60% 83%
  USDm   2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E
EBITDA             84 156 280 299 310
Capex             (121) (190) (130) (84) (57)
Interest             (5) (11) (15) (16) (12)
Tax             (10) (26) (47) (52) (55)
Levered FCF             (51) (70) 88 148 186
Levered FCF Yield               -20% 25% 43% 54%
M Cap (current)               346 346 346 346
Net Debt (yead end)               44 (30) (171) (354)
EV               390 315 175 (9)
Note the $57m capex in 2016 should be the run-rate capex with MC investments and maintenance capex.
Doing a DCF with a 12% discount rate and a 8 year further duration after 2016 of the levered FCFs gives me a target price of 15.2 NOK.
Using a EV/EBITDA of 4.0x on 2014 EBITDA gives me 19.4 NOK.
What management told me is that instead of a secured debt funding for the streamer packages for the Sanco Sword, Geo Atlantic and Super Duke, they could use more cash to fund it. 
This firm is going to be spitting out tons of cash. It should atleast double if not more and that's without dayrates moving up, which I think they will. 

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


Sentiment shift on oil services / seismic
FCF generation
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