| 2013 | 2014 | ||||||
| Price: | 19.38 | EPS | $0.82 | $2.00 | |||
| Shares Out. (in M): | 332 | P/E | 23.6x | 9.7x | |||
| Market Cap (in $M): | 6,430 | P/FCF | NA | 8.0x | |||
| Net Debt (in $M): | 273 | EBIT | 565 | 1,075 | |||
| TEV (in $M): | 7,071 | TEV/EBIT | 12.5x | 6.6x | |||
Sign up for free guest access to view investment idea with a 45 days delay.
Investment Thesis
Subsea 7 SA is the largest pure-play oil and gas offshore construction company in Europe, offering seabed-to-surface engineering, construction and services. The company's primary listing is on the Norwegian stock exchange (SUBC NO).
This is a fairly straightforward situation. The market is overreacting to cost overruns on the Guara Lula contract in Brazil that are project-specific and unrelated to the remaining 95% of its "record" backlog. As a result of losses from this project, 2013 consensus numbers are not reflective of the true earnings power of the business.
The elimination of these losses plus with new contracts starting up and new vessels coming online should result in substantial earnings improvement in 2014. Based on my 2014 estimates, Subsea 7 trades at 6.6x EBIT and 9.7x EPS, or even cheaper on a cash flow basis as maintenance capital expenditures are lower than depreciation.
I believe that as Subsea 7 progresses through the Guara Lula project, the stock will re-rate to its historical multiple on a higher base which will benefit from strong subsea spending growth (20%+ from 2013E-2016E).
As mentioned above, Subsea 7 is an offshore construction company for the oil and gas industry. Simplistically, the company is a deepwater plumber - installing subsea equipment and laying offshore pipelines. Contracts are lump-sum (~70%) or day-rate (~30%). Percentage-of-completion accounting is used for lump-sum contracts.
The business is split into several segments. By far the largest segment is SURF (67% of revenue and 75% of backlog) which consists of pipe-laying, infield construction and heavy-lift vessels. These vessels facilitate engineering, procurement, installation and commissioning of subsea umbilicals, risers, flowlines and structures (i.e. SURF*). A typical SURF contract revenue split is engineering (20%), procurement (40%) and installation and commissioning (40%).
The conventional/hook-up (17% of revenue and 17% of backlog) segment comprises the shallow water conventional unit which provides support in the fabrication and installation of fixed platforms and associated pipelines whereas “hook-up” includes installation of modules on new platforms and the refurbishment of topsides on existing fixed and floating platforms.
Life-of-field (12% of revenue and 14% of backlog) includes the management of installed subsea infrastructures, such as inspection, maintenance and repair (i.e. IMR) over the production phase. The remaining is i-Tech (3% of revenue and 5% of backlog) which provides remotely operated vehicles (ROVs) or high-tech tool boxes for IMR work.
The company’s historical strength is in the North Sea (45% of revenues) and West Africa (30% of revenues).
Competitors include Technip, Saipem, Heerema, Oceaneering, DOF, Cal Dive, Bibby, Fugro, Bisso Marine, among others. The best comparables are Technip and Saipem.
Subsea 7, Technip and Saipem are the industry leaders. These players have a competitive advantage due to technological superiority, scale, skilled labor and market credibility.
*Definitions provided for each of these items in a brief appendix.
Drivers
-Oil and gas prices and deepwater exploration spending
-West Africa and North Sea project awards
-Completion of Guara Lula project
Guara Lula Project - Brazil
After three warnings, the market is discounting additional Guara Lula losses. The project was awarded at a very competitive rate in 2010 (Technip and Saipem both bid) with challenging specifications. I believe this contract is one-off as management bid too aggressively to secure one of the first pre-salt packages in Brazil. Note this project was tendered before the Subsea 7 - Acergy transaction.
The contract is now 56% complete with losses expected to hit 40% of the original contract value. Recently, Subsea 7 reported a $300 MM increase in project-related costs. The reasons cited for the increase include weather-related downtime and subsequent equipment damage, supplier delays, additional duties, custom clearance issues, logistics costs and productivity problems. Previous completion earmarked for 1Q 2014 is now 3Q-4Q 2014. The key event will be the completion of the buoys which should be installed in the latter half of this year.
As a result of this contract, Subsea 7 will no longer seek new lump-sum EPIC contracts with Petrobras in Brazil. The focus will be more on day-rate business.
I add $300 MM to enterprise value (as debt) for this project and assume no recovery of cost overruns from Petrobras, although this is a possibility.
| Revolver ($600 MM) | $0 |
| 2.25% Converts ($20.99) | $500 |
| 3.5% Converts ($15.84) | $275 |
| 1% Converts ($20.84) | $700 |
| Total Debt | $1,475 |
| Project Cost Overruns | $300 |
| Cash | $1,203 |
| Net Debt | $579 |
| Equity Market Capitalization* | $6,430 |
| Enterprise Value | $7,009 |
| Adj. Enterprise Value** |
$7,071 |
Notes:
*Bloomberg share number is incorrect as it captures treasury shares.
**Assumes conversion of 3.5% converts.
***Excludes any value attributed to NOLs of $388 MM or vessels under completion (estimated embedded capex of $300 MM).
| Financials | 2010 | 2011 | 2012 | 2013E | 2014E |
| Revenue | $4,392 | $5,477 | $6,297 | $6,650 | $7,300 |
| EBITDA | $989 | $1,003 | $1,139 | $940 | $1,475 |
| EBIT | $729 | $666 | $806 | $565 | $1,075 |
| EPS | $2.00 | ||||
| FCF* | $2.41 |
EBIT Bridge
Starting with the $940 MM of 2013E EBIT, I add the following items:
-Removal of $300 MM of losses related to Guara Lula project.
-Re-pricing of contracts for flexible pipelay support vessels in Brazil should add $90+ MM in operating profits.
-New build deliveries (Seven Wave) add $25 MM with additional vessels coming online in 2015-2016.
-Previously announced contract wins starting up in 2014 plus underlying growth accounts for the remaining.
In the outer years, I expect increasing margins as low-margin contracts signed during less favorable times are phased out and replaced with more profitable contracts signed since 2011. Per management commentary, through the cycle margins (EBITDA) range from 15%-25% compared to 2012 of 18%.
In addition to the increase in 2014 from company-specific items, earnings should see a further tailwind from subsea spending growth of an expected 24%* annually from 2013 to 2016.
*Pareto
Valuation
In general, the space trades at 6x forward EBITDA. The two best comparables are Technip and Saipem which trade in the range of 6.5x-7.0x 2014 EBITDA. This is inside of historical trading levels for the offshore E&C space of 7.5x forward EBITDA. Subsea 7 is more capital intensive than the comparables so a multiple discount is appropriate, but two turns seems overly punitive.
The merger of equals between Acergy and Subsea 7 which valued Subsea 7 at ~6x consensus 2010E EBITDA.
At 6x EBITDA, the shares are worth mid-20s. If we revert to the historical mean of 7x, the shares are worth in the high 20s. On an EPS basis, at 13-14x EPS compared to a historical average of 16x, the stock is worth in the high 20s. I believe both of these are very reasonable scenarios as I expect valuation to revert to the mean once the Guara Lula project issues are resolved. Even if losses are an additional $300 MM, the per share impact is less than a dollar.
Appendix
EPIC - engineering, procurement, installation and commissioning.
SURF – subsea umbilicals (hydraulics and electrical controls), risers (transport of oil and gas to surface) and flowlines (underwater pipelines).
Umbilical – assembly of hydraulic hoses, which can include electrical cables to control subsea platforms.
Risers – pipe through which liquid travels upward from the seabed to the surface production facility.
Flowlines – pipelines carrying oil, gas or water that connects the subsea wellhead to a manifold or surface production facility.
Dive support vessel – offshore construction vessel that has dedicated diving chambers and dive bells for diving support which help maintain drilling sites and fix damaged equipment.
Flexible pipelay support vessels are construction vessels used in subsea construction and leased on a day-rate basis. These vessels lay pipe(lines) on the ocean floor to transport oil & gas to land.
Enabling vessel is a pipelay and/or construction vessel that has scale, versatility and flexibility to support technically challenging seabed to surface activities.
-Progression of Guara Lula project
-Contract wins
-Guidance from management regarding 2014 (expected 3Q call)
| show sort by |
Are you sure you want to close this position SUBSEA 7 SA?
By closing position, I’m notifying VIC Members that at today’s market price, I no longer am recommending this position.
Are you sure you want to Flag this idea SUBSEA 7 SA for removal?
Flagging an idea indicates that the idea does not meet the standards of the club and you believe it should be removed from the site. Once a threshold has been reached the idea will be removed.
You currently do not have message posting privilages, there are 1 way you can get the privilage.
Apply for or reactivate your full membership
You can apply for full membership by submitting an investment idea of your own. Or if you are in reactivation status, you need to reactivate your full membership.
What is wrong with message, "".