Cal Dive Seems To Be Fighting The Tides

| About: Cal Dive (DVR)
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Offshore diving and construction specialist Cal Dive (NYSE:DVR) is an interesting story. The company's low stock price (close to $2 a share) catches an investor's attention, as does the fact that the shares trade below tangible book value and that there is a sizable short interest in the shares. If Cal Dive can drive better vessel utilization and reap the margin improvements that should come with it, Cal Dive is the sort of story that could spike fairly quickly.

The problem is that I'm not sure how likely that is. Recent awards have swollen the backlog to levels not seen in years, but it remains to be seen just how much they will improve utilization and margins - with weak pricing in the market, did Cal Dive have to surrender margins to secure revenue and cash flow? I'm also concerned that the company is fighting a losing battle with technology as remotely operated vehicles (ROVs) owned by Oceaneering (NYSE:OII), Helix (NYSE:HLX), and Saipem (OTCPK:SAPMY) take share away from diving, while energy companies move exploration and production activity from the shallow waters and into the deep.

A Market Leader, But The Market Is Changing

Cal Dive has long been a provider of manned diving and construction/installation services in the shallow waters of the Gulf of Mexico, as well as select international shallow-water markets. With a fleet of over 20 vessels, Cal Dive serves companies like Chevron (NYSE:CVX), Apache (NYSE:APA), and Pemex, providing services like pipeline installation and pipelay, platform installation, inspection /repair /maintenance, and decommissioning.

It's also worth noting that Cal Dive has long been among the leaders in the Gulf of Mexico. Companies like Subsea 7 (OTCPK:SUBCY), Technip (TKPPY.PK) are more formidable in other regions, but Oceaneering and Tetra Technologies (NYSE:TTI) are among the few rivals with scale to challenge Cal Dive in the Gulf region. To that end, Cal Dive looks to compete on the breadth of services it can offer, as well as the quality/reliability of those services - something that smaller rivals can struggle to match.

The problem for Cal Dive, though, is that the market has changed quite a bit in recent years. More activity is moving away from the shallow waters where Cal Dive operates and into the deepwater areas where others like Oceaneering, Technip, and Saipem are better-equipped to compete. At the same time, investors have soured on E&P companies committing significant resources to shallow water activities in the Gulf and regulators have made life more challenging for those who still wish to operate there by making the permitting process more costly and time-consuming.

That would be bad enough, but there's more. Cal Dive is, in my opinion, on the wrong side of technology for the long-term trends in the market. The ROVs operated by Oceaneering, Helix, and Saipem don't need breaks, don't need the same level of support, don't complain, and can be more consistent in their performance. There are still tasks that these robots cannot handle, or handle as well as divers, but that list is shrinking as the technology improves.

International Is An Opportunity, But With Its Own Set Of Challenges

While Cal Dive has historically generated a large portion of its revenue from the Gulf of Mexico, the company has been broadening its horizons and doing more work outside of North America. Australia has already developed into a solid opportunity for Cal Dive, and the company has recently started building its presence in West Africa. Larger and more diversified service providers like Technip and Subsea-7 have longstanding operating relationships in many of these regions, but it is also true that the shallow waters of many international markets haven't been exploited to the same extent as the Gulf of Mexico.

Still, I would be careful about counting on international markets to make everything better. The company's foray into Southeast Asia hasn't really gone so well so far, and I do wonder about the risk of competition from local providers. Likewise, some of the same pressures (including the share/usage growth of ROVs) will be every bit as relevant.

Utilization Seems To Be The Key Now

I don't believe management is blind to these challenges, and the company is still in the midst of a restructuring (or "rebalancing") process that has seen the sale of low-return assets and a greater emphasis on operations/operating areas with higher return potential.

Unfortunately, capacity utilization is still problematic - overall effective utilization was at 43% in the second quarter, down from 48% in the year-ago period, and pricing has been soft due to overcapacity in the Gulf. Although saturation diving capacity utilization is decent (65%), the delays and weak interest in building new platforms and decommissioning old ones has kept the construction barges idle (capacity utilization of less than 20% versus 39%). What makes those numbers more sobering is that 2012 was a miserable year for the Gulf of Mexico construction market.

I would expect these numbers to improve in the second half of 2013. Cal Dive's backlog roughly doubled from the first quarter to the second (ending at about $400 million), with much of that scheduled for the second half of the year. Assuming that the company didn't underprice the work, that should produce much-needed cash flow that the company can use to further clean up its balance sheet and build up its ex-North America operations.

Still, I don't have a lot of confidence in the long-term outlook. Even the more optimistic operators in the Gulf are calling for conditions to "improve", but nobody seems to be expecting a return to the pre-2010 days - when Cal Dive's EBITDA margins were in the 20%'s. That said, I do think there's a respectable chance that the company can deliver double-digit EBITDA margins again in 2014 on a pickup in Gulf activity, and that would support a fair value in the $2.50 to $3 range.

The Bottom Line

Maybe business will pick back up for Cal Dive - there is certainly worthwhile potential in multiple international shallow water markets, not to mention quite a lot of decommissioning work that needs to be done in the Gulf over the next decade. Moreover, while the robots operated by Oceaneering and Helix can do a lot, they can't do everything a diver can do, so there are still situations where Cal Dive has a value proposition to offer.

This, then, is a high-risk/high-reward proposition. If Cal Dive reports good margins from the business it booked in the first half of 2013, and continues to book more for 2014, improving utilization should lift margins and that may well prompt a short squeeze. That's a lot of "if", "should", and "may", though, so even though Cal Dive looks cheap today, investors should not lull themselves into forgetting or overlooking that it may be cheap for a reason.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.