Plunging The Depths Of Cal Dive's Earnings

Mar.26.14 | About: Cal Dive (DVR)

Summary

Cal Dive has deferred collections from Q4, and rocketing backlog and prospects, that should become clear in Q1 earnings and return its valuation to historic norms.

Continued recovery in the Gulf following the 2010 Macondo disaster.

Selected as “preferred contractor” for the huge Cape Wind wind farm project in Nantucket.

Cal Dive (NYSE:DVR) is a marine contractor providing manned diving and underwater construction services, primarily for the offshore oil and gas business. The stock now trades at around 10% of its heyday in 2007 -- and at roughly ⅔ of book value -- despite being essentially break-even, with fast rising backlog, and having good near-term prospects for profitability.

As I'll discuss in a bit, their Q4 break-even (disregarding a small impairment charge) was misleading, because Cal Dive has very substantial deferred collections for service delivered in Q4. The reality is much more positive than the Q4 numbers suggest; and that should become apparent in the Q1 and Q2 earnings.

Cal Dive has been kicked down and walked on by the triple whammy of: (1) the recession; (2) the 2010 Macondo oil spill (which froze offshore rig permitting in the Gulf of Mexico); and (3) the onshore shale oil boom (which suppressed oil prices and discouraged investment in offshore exploration).

Cal Dive services construction and pipe laying down to 1000 feet -- deeper wells are generally constructed and serviced robotically. So Cal Dive can participate in much of the market, but not in the move to very deep water. Traditionally its area of activity has centered on the Gulf of Mexico; but the Macondo event forced Cal Dive to expand overseas, which will benefit them going forward.

I'm not trained or brave enough to dive into 1000 feet of murky Gulf water. But I did plunge the depths of Cal Dive's Q4 earnings call -- and what I found there is, as they say in the oil biz, a "prospect."

I'll summarize all my points here, in case you don't feel like reading on down to a bunch of detail:

  • large deferred collections from Pemex for already-completed work in Q4

  • confirmed completion of other Pemex work in January, also ripe for Q1 collection

  • relaxation of rig permitting in the Gulf (recovery following the 2010 Macondo disaster)

  • selection as "preferred contractor" for the Cape Wind wind farm in Nantucket

  • other diversification, both geographic and by industry

  • asset sales and cost reduction

  • ship leases

  • non-linear dynamics of return to profitability

Much of the clarity into the upcoming Q1 earnings comes from the timing of the Q4 earnings call. That call took place just recently on March 5; and they dropped clues regarding Q1, which by then was mostly over.

Backlog at the end of 2013 was $249M -- up 45% YoY -- much of it uncompleted work relating to their $290M Pemex contract. Towards the end of the Q4 earnings call, the CFO indicated that although 60% of the Pemex work had been completed as of Q4, only 30% had been collected on. So in Q4, Cal Dive essentially broke even, despite not collecting on an enormous chunk of revenue due to it. Collections on the Pemex contract are milestone-based, and there's not much visibility into precisely what those milestones are. So it's not absolutely certain that the other 30% was collected on in Q1 -- but it's highly likely.

Furthermore, they indicated that the pipe lay portion of the work was completed in January. So Cal Dive is very likely to have collected on the other 30% of completed Q4 work AND a substantial amount of (confirmed) Q1 work -- all in Q1. That amounts to possibly 40%-50% of the $290M figure -- or roughly $120M to $150M in revenue -- just from Pemex!

So Q1 2014 revenues could easily double the $81M figure from Q1 2013, when Cal Dive reported an $18M loss. The last couple of years have been very hard on them, which makes their presumed return to profitability this year all the more dramatic.

I emphasize that this presumed Q1 revenue is not extrapolated from backlog -- this is for confirmed, completed work, where all they need to do is swim back to the surface and get paid (modulo any milestone-driven collection stipulations). Depending on accounting, the uncollected Q4 work alone may be almost $100M that goes straight to Q1 EBITDA.

Brent Smith, the CFO, spoke openly in the Q4 call of being "very confident" of "significant improvement," as well as outrightly referring to "the improvement we are going to have" in the first half of 2014. I think he could be absolutely confident, because when he said that we were already into March -- those major collections had likely already taken place! I really like the CFO, because every time he removes his snorkel to speak, he says something intelligible, quantified, and actionable.

And even on the off chance that I'm wrong about those collections in Q1, it just means an even sharper revenue spike in Q2.

Looking a bit further, some portions of the large Pemex contract are pushed well beyond Q1, with $40M of the work explicitly being deferred to summer. The CFO spoke explicitly about "large collections" from Pemex in late spring and early summer (so Q2 and Q3). These are traditionally the best quarters for Cal Dive, due to weather in the Gulf.

Macro Picture (Oil Services)

Drill permitting in the Gulf continued to recover in 2013, albeit modestly. The benefit to Cal Dive's bottom line has yet to be seen, as Cal Dive's profits historically lag drilling activity by 9-18 months. And of course vessel utilization is better in the summer and early fall, due to weather. This is all well understood by analysts, and suggests a summertime collections boon for Cal Dive.

Another macro issue is of course the price of oil, which is loosely coupled with investment in exploration. Oil is actually expected to drop slightly in the coming years -- just by a couple percentage points -- partly due to the onshore shale oil boom. No major drop is forecast. And of course the long-term trend is up.

The overseas picture is much better. By one account, subsea construction related to LNG infrastructure off the shores of Australia -- where Cal Dive is increasingly active -- is expected to quadruple in 2014.

Cape Wind

Cape Wind is a huge, $2.6B wind farm project off the coast of Nantucket. It will consist of 130 enormous wind turbines in the shallow water of Nantucket sound. Each turbine will be installed on an underwater monopole foundation, and wired with underwater cabling -- requiring manned diving in the construction process.

Through a joint venture, Cal Dive was named as the "preferred contractor" for Cape Wind.

Cape Wind is a huge positive for both Cal Dive and the region -- and not just for obscuring the ocean views of wealthy New England political dynasties. It will deliver 420 megawatts of clean energy to the area, or ¾ of the Cape's needs.

Cape Wind is a private venture, but has backing from the state and federal governments as a clean energy initiative. State and federal approvals for Cape Wind were obtained in 2009 and 2010, respectively. There was a recent spate of legal victories against opponents of the project, clearing the way for further financing and construction.

Some limited construction already began in 2013 (apparently to qualify the project for an expiring tax credit). Major construction on the turbine foundations is not expected until 2015.

There is not much visibility into Cal Dive's projected revenue or collection timetable for the Cape Wind project. I would only venture that the underwater platform construction would presumably be early in the project (2015); and that the revenue will be substantial. It also establishes Cal Dive as a go-to-contractor for other wind farm projects around the world.

Management

Although the Gulf market is recovering, Cal Dive's management is taking action to reduce their dependence on the health of that market. Cal Dive's revenue increasingly comes from overseas -- the North Sea, Asia, and Australia.

So Cal Dive is diversifying geographically as well as across industries. International work now accounts for 70% of revenues (though note that Pemex is Mexican, so Gulf work on their behalf is counted in the int'l figure).

As further efforts to return to profitability, management is selling assets: they have already sold at least $7M of "non-core assets" in Q1. And they are reducing dependence on leased ships, in favor of their own. They also now lease their own ships to other players, as another revenue source. All these factors should result in greater utilization of their own remaining assets.

To further reduce dependence on the tepid market recovery in the Gulf, they are closing an operations base and reducing headcount in the region.

Due Diligence

As part of his investor pitch for Cal Dive, Eric Almeraz of Apis Capital publicly confirmed the appraised value of Cal Dive's ships, and their insurance coverage. He states that Cal Dive has 28 ships -- all insured -- appraised at $600-$700M.

Those are the major components supporting Cal Dive's book value of around $2.50/share. Mr. Almeraz's price target for DVR is $3.50, double its current trading price. And that was stated in November, before the completion of the recent Pemex work, before the favorable indications from the Q4 call, and before the recent favorable news on Cape Wind.

Mr. Almeraz also cites Cal Dive's good safety record, which he describes as a barrier to entry in their market.

Financials

For some reason, the stock has not responded to Cal Dive's favorable prospects and rising backlog. There has been an inordinate amount of short selling on this tiny stock.

There is an issue regarding a portion of its debt in the form of convertible notes, with the option for the debt to convert to stock at $2.24 per share. This may trigger dilution and result in a temporary ceiling at around $2.24.

Non-Linear Dynamics

I'll touch briefly on what I see as a couple of non-linear dynamics specific to Cal Dive's situation.

The first is that of an indebted company coming back into profitability. Newfound profits allow a company to refinance debt on more favorable terms, thus lowering interest payments and accelerating profitability.

The second dynamic is that of a low-priced stock breaking into a price range that allows for margin trading. DVR's book value is around $2.50 per share; and if there's any sanity in this world then showing profits gets it there and higher. Recall that the price target given in the aforementioned investor pitch is $3.50. If and when DVR crosses $3, where it deserves to be, this allows it to be bought on margin at brokers like Schwab. Crossing the $3 barrier is often an accelerator for a rising stock, due to the margin funds that suddenly come into play on the demand side.

In Summary

Cyclical and weather trends portend a rise for DVR in the Q2/Q3 timeframe -- that's well understood and anticipated by the analysts. My point is that the jump is expected for Q2/Q3; but I'm expecting a sharper initial spike around the time of the Q1 earnings call. Don't wait for the analyst upgrades following the Q1 call.

Unlike the subject of my previous articles -- and despite what I said about Cal Dive being 90% off its peak -- I don't think DVR is a near-term 10-bag. The tepid recovery in the Gulf and other market factors work against it.

To reiterate, though, Cal Dive trades at ⅔ of book value. To put a fine point on that, they could call it quits, strip off the wet suits, sell the ships, pay off debt, and be worth 1.5 times what they're trading at (whatever "worth" means in this market). A return to book value is a 50% gain.

Though its official book value is about $2.50, I think a fairer book value (simply assets minus debt) is around $4/share. If you value the company as, say, book value plus 1 year of [projected] yearly revenue, I come up with something around $10/share. That's a 5-bag plus from today's trading level. This rationale also makes Cal Dive a ripe candidate for buyout.

In one month, Cal Dive executives will come up for air and deliver their Q1 earnings report. Just as divers can't stay submerged indefinitely, so DVR cannot stay below its book value forever. Rising revenue is the swelling air that will bring it to the surface.

My suggestion: Go long DVR ahead of Q1 earnings; but prepare to hold for 1-2 quarters.

Disclosure: I am long DVR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.