By Marc Djandji, CFA
During 2008-09 demand for offshore support vessels (OSV) dropped below 50%. Since 2010 the demand has recovered significantly, with utilization levels now at more than 80%. The global OSV segment is in a mid-cycle and will resume alongside increased rig activity. The time is right to pick up listed small to mid-cap stocks with exposure to the OSV sector before the anticipated recovery.
STX OSV Holdings Limited (OTC:SXDEF), now rebranded as VARD builds offshore support vessels used in the offshore oil and gas exploration and production (E&P) and oil services industries. Its core business is design and construction of customized OSVs, including platform supply vessels (PSV), anchor handling tug supply vessels (AHTS) and offshore subsea construction vessels (OSCV). The Company generates its revenues from vessel construction contracts, trading and other operations. Its other operations consist of providing labor, onshore installation and services-related to piping and electrical systems. The Company has 9 shipbuilding facilities worldwide i.e. five in Norway, two in Romania, one in Brazil and one in Vietnam. Its customers include DOF, Farstad Shipping, AP Moller- Maersk, Island Offshore, Solstad Offshore, K Line Offshore, Petroleum Geo-Services, Aker Oilfield Services and Rem Offshore.
The company is one of the main players in a segment of highly advanced offshore support vessels. In particular, it is one of the world's most important producers of AHTS, PSV and OSCV. It is also one of the top builders of research, coastal patrol, seismic survey and ice-breaking vessels.
Significant synergies with the new parent: VARD is going through a transformational change in 2013 following the purchase of 55.63% ownership by the Italian shipbuilder, Fincantieri. The new parent, is cash rich company with operations dating back 20 years all over Europe. Potential growth from the new synergies from additional capacity and a larger customer base will start coming in FY13 numbers. Asian shipyards compete primarily on cost and will find it difficult to challenge VARD's design and manufacture capabilities. In addition, the group enjoys a natural advantage from its operational headquarters in western Norway, which remains at the forefront of offshore developments for the foreseeable future.
Despite being one of the largest vessel builders in the world in terms of market share (31% of AHTS and 18% of PSV), having a cash rich balance sheet, a 13% free cash flow yield and a 25-30% return on equity the company had struggled to realize growth catalysts. The main reason behind that has been 100% utilization of its yards and an inability to increase capacity as its former Korean parent, STX Offshore & Shipbuilding, had been pulling out all the cash in the form of dividends (reflected in the high 10-12% dividend yield in the past 2 years).
Now, with the change in ownership, VARD can hopefully keep more of the cash it generates annually and invest it in new yard projects. VARD has a further Brazilian yard currently under construction at Promar where production is scheduled to begin this summer. The new yard is due to deliver eight LPG carriers in 2014-16.
New orders lifted unbilled order book to USD3.0bn: Though below estimates, 2012 new order wins of USD1.6bn helped the company end the year with an order book of USD2.6bn. As on 31 Dec. 2012 the company has order for 48 vessels of which 27 are of own design.
Since the beginning of 2013, the group has secured three OSCV contracts worth USD410mn: i) one offshore subsea construction vessel (OSCV) (overall length of 121m and beam of 23m) for Solstad Offshore for NOK600m (USD108m) to be delivered in 2Q2014; ii) one OSCV (overall length of 143m and beam of 25m) for Farstad Shipping for NOK800m (USD144m) to be delivered in 1Q2015; iii) one OSCV (overall length of 161m and beam of 32m) for DOF Subsea to be delivered in 1Q2015. Value of this contract was not disclosed (expected to be USD170mn).
Stock price is due for a positive re-rating as all negatives are priced in: Minority shareholders rejected the lowball SGD1.22 offer from Fincantieri. The Italian shipbuilder's 598,851,000 share purchase on 23 January 2013 represented a 50.75% stake in the company and under Singapore law, Fincantieri was required to make a mandatory general offer for the remaining shares of VARD. Fincantieri's mandatory cash offer failed to attract shareholders, gaining just 4.88% acceptance. The extra 57,620,268 shares from the mandatory offer takes Finantieri's total stake to 55.63%.
With the Fincantieri purchase out of the way, the overhang on the price has been removed and the stock price can close the gap with peer valuation levels. The stock price should run on its strong balance sheet, cash flow generation and upside from new synergies. Still, it is trading at a nearly 40% discount to its Singapore listed peers which are trading at ~13.5x 2013E EPS.
Operating margin (trailing)
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Sources - Bloomberg, Reuters, company website, The edge magazine, Investment blogs