It's Not Time To Sell Marine Seismic Service Providers

by: Elliott Gue

Although the industry consensus calls for manageable capacity additions over the next two years and the global fleet includes a number of older vessels that would be candidates for retirement, shares of many marine seismic services have pulled back over the past six months after trading in a tight range.

Source: Bloomberg

This underperformance reflects several recent developments.

Michael Rae, an analyst at Goldman Sachs (NYSE: GS), in mid-January published a research report warning that lower oil prices would sap demand for marine seismic services in 2014, while planned capacity additions would exert further pressure on day-rates in 2015.

Rae's negative outlook for the industry prompted him to cut his rating of Petroleum Geo-Services (OTC: PGSVY.PK), a pure play on marine seismic, to a sell from a buy. The analyst also downgraded shares of Compagnie Generale de Geophysique Veritas (NYSE: CGV), while maintaining his neutral rating on TGS Nopec Geophysical (OTC: TGSNY.PK), a name that stands to benefit from lower day-rates because its asset-light business model involves leasing vessels to build its library of multi-client seismic surveys. Accordingly, shares of TGS Nopec Geophysical, which had lagged the competition prior to 2013, have rallied in recent weeks.

Over the past few years, providers of marine seismic services have enjoyed a significant spike in sales of multi-client surveys in the fourth quarter, as exploration and production companies seek to allocate the remainder of their capital expenditures. However, with the exception of TGS Nopec Geophysical, which grew its late multi-client survey sales by 39 percent from year-ago levels, this revenue bump fell short of expectations in the fourth quarter of 2012.

Petroleum Geo-Services, for example, suffered a disappointing 38.8 percent decline in late sales, while Compagnie Generale de Geophysique Veritas posted a 53 percent drop in fourth-quarter late sales of multi-client surveys. But investors shouldn't read too much into these shortfalls: Fourth-quarter sales activity hinges on the geographic mix of a company's multi-client survey library and its exposure to upcoming licensing rounds. Several management teams in the industry attributed this disappointment to delays in the official announcement of Brazil's highly anticipated licensing rounds for offshore blocks. Although not necessarily a sign of deteriorating fundamentals, these hiccups also spooked investors.

This recent pullback comes on the heels of an impressive performance by shares of marine seismic-service providers in 2012, during which relatively new entrants to the industry, Dolphin Group (Oslo: DOLP, OTC: DOLPF.OB) and Polarcus (OTC: PLRUF.PK), more than doubled in value. Shares of established players such as Compagnie Generale de Geophysique Veritas, Petroleum Geo-Services and TGS Nopec Geophysical also generated total returns that dwarfed the measly 0.6 percent gain posted by the Philadelphia Stock Exchange Oil Services Sector Index in 2012.

Source: Bloomberg

After turning in an impressive performance in 2012, the group was due for a breather. For one, many of these stocks traded in a tight price range heading into year-end, unable to breach their 52-week highs. And with the global fleet of seismic vessels operating at elevated utilization rates, continued pricing improvements and a tight supply-demand balance represent the biggest upside drivers for industry profit margins.

Although we're not surprised that shares of marine seismic-service providers have pulled back in recent trading sessions, we see several reasons to remain bullish on this highly cyclical industry in general.

First, industry surveys suggest that oil and gas companies will increase their capital expenditures on exploration and production by 6 percent to 9 percent in 2013, down from last year's roughly 12 percent uptick in spending but still supportive of demand for marine seismic data.

A number of upcoming offshore licensing rounds will also provide an upside catalyst for providers of marine seismic services. In particular, Brazil's Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (ANP) in late 2012 announced the first auction of deepwater oil and gas concessions in six years.

Slated to take place in May 2013, the 11th bidding round will include blocks in the Brazilian Equatorial Margin, a region that exhibits similar geological characteristics to oil and gas fields recently discovered off the coast of West Africa. Thus far, 36 companies from 15 different nations have registered to participate in the sale.

But anticipation is especially high for Brazil's first bidding round for production-sharing contracts in the ultra-deepwater pre-salt fields, an auction that's tentatively scheduled for November 2013. These offshore blocks would be in the same region as Lula and other mammoth finds offshore Brazil.

Both bidding rounds would drive sales of multi-client seismic data, while subsequent exploratory efforts in these offshore blocks would also call for additional mapping services.

Moreover, management teams appear universally bullish in their 2013 outlook for the seismic-services industry.

  • Compagnie Generale de Geophysique Veritas: During a conference call to discuss 2012 results, CEO Jean-Georges Malcor told analysts, "Overall demand for seismic is expected to remain solid, driven by exploration of new frontiers area such Barents Sea Arctic, Angola, Gulf of Bengal, East Africa and more." Malcor also noted that tendering activity had picked up relative to year-ago levels and that a number of highly anticipated licensing rounds would be a boon to the industry. The France-based operator also reaffirmed its outlook for a 75 percent prefunding rate on multi-client surveys and a 7.5 percent uptick in the company's base day-rate on marine seismic services. Management attributed this inferior growth outlook (relative to its peers) to a higher rate base on its existing contracts.
  • Dolphin Group: Management expects average day-rates on contract work to grow between 10 percent and 20 percent this year.
  • Petroleum Geo-Services: The company enjoyed a 15 percent increase in contracted day-rates and anticipates similar growth in 2013. In a conference call to discuss fourth-quarter results, CEO Jon Erik Reinhardsen discussed his sanguine view for the coming year: "[Our] outlook continues to be solid in terms of market activity. We see oil companies becoming increasingly proactive in securing capacity. We see the North Atlantic summer season being stronger than 2012." Management also noted that the tight supply-demand balance in the latter market has prompted some shut-out customers to inquire about 2014 availability-a bullish indicator for the market. At the same time, activity remains strong offshore Uruguay, East Africa and South Africa. Reinhardsen indicated that pricing in the Asia-Pacific region appeared weaker than in other markets.
  • Polarcus: In a conference call to discuss fourth-quarter and full-year results, the Norway-based provider of marine-seismic services forecasted that demand would grow at an average annual rate of 10 percent between 2013 and 2015, driven by exploration of offshore basins outside the usual hot spots. Management expects day-rates to increase by an average of 15 percent this year.
  • TGS Nopec Geophysical: In a conference call to discuss the company's 2013 guidance, management noted that the firm is paying 10 percent to 15 percent more to hire vessels this year, confirming forecasts from shipowners. That TGS Nopec Geophysical has been able to pass through these cost increases to its customers suggest that the supply-demand balance remains tight in the market for marine seismic services.

But what should we make of concerns that pricing improvements could prompt the marine geophysical companies to overbuild once again?

Industry participants have pointed to the high level of visibility on deliveries of new vessels, which usually take 24 months to 36 months for shipyards to build. Based on the industry's current order book and plans to scrap vessels, overall capacity is expected to increase by 4 percent in 2013, 2 percent in 2014 and 7 percent in 2015.

Barring a retrenchment in oil prices, we expect the market to be able to absorb these new vessels without diminishing prevailing day-rates.

We're also encouraged by the discipline exhibited by industry participants regarding orders of new vessels. Compagnie Generale de Geophysique Veritas in summer 2012 announced an agreement to purchase Fugro's (OTC: FURGF.PK) geosciences division, a deal that will net the acquirer four high-end vessels capable of collecting 3-D seismic information.

In a conference call to discuss the transaction, management noted that the deal has positive implications for both the company and the industry: "This provides us with a sound alternative to the newbuild option that we were contemplating while keeping the industry's capacity constant."

We've covered Petroleum Geo-Services and other marine seismic providers since early 2010 and have long warned that the outlook becomes murky after 2014. Although we'd hesitate from making a firm call on what this highly-cyclical, niche industry's fundamentals will look like in two years, no major warning signals have emerged that warrant selling out of the group. We prefer to concentrate on near-term upside catalysts that could send shares higher in coming months.

Disclosure: I am long OTCPK:PGSVY. 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.

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