As I've made my way through the energy services sector recently, I've noted a pretty fair number of stocks that look undervalued on the basis of improving offshore activity and expectations for a better 2014 in North America. Helix Energy Solutions (NYSE:HLX) is an interesting case, though, as although the shares don't appear to be remarkably cheap today, the company's strong utilization and contract positions, coupled with the economics of the services it provides, may make this a pretty good balance of reward relative to risk.
Offshore Interventions On The Way Up
Due to the heavy exploration activity in areas like the Gulf of Mexico and North Sea over the past 10 to 15 years, the number of wells in service for more than five years has more than quadrupled. With age comes a need for intervention - whether to repair tubing, remove scale, repair/replace valves, clean out the wellbore, or perform other necessary tasks to maintain or enhance production and get the most out of the expensive investments made in a subsea well.
This is where Helix comes in with its fleet of well intervention vessels and remotely operated vehicles (ROVs). Helix operates four dedicated intervention vessels, as well as riser systems and subsea intervention lubricators, 50 ROVs, and over 10 additional support and functional vessels.
Subsea well intervention is often performed with mobile offshore drilling rigs called floaters, but Helix's vessels can take on about a third of the work often done by these rigs and they can mobilize faster. Because these vessels are cheaper to build than drilling rigs, Helix can charge/accept a lower day rate - sometimes 20% or more below the rate a drilling company like Transocean (NYSE:RIG) or SeaDrill (NYSE:SDRL) would charge. There are few direct competitors in this space (Island Offshore is the biggest), but there is some risk that drillers will redeploy older/lower-end rigs into the intervention market.
While Helix's vessels are typically restricted to "light" intervention work, those tasks can still improve total well recovery by 10% and Helix already has a solid book of business out to 2017. Helix has three additional vessels on order, with the first scheduled to go into service before year-end. Given that it takes some time to build these vessels (apparently about two to four years on average), I wouldn't be surprised if Helix commits more capital to newbuilds to leverage the expected increase in offshore activity in the coming years.
Offshore Support A Worthwhile Market As Well
Relative to Oceaneering International (NYSE:OII), Helix is a smaller player in the ROV space, as Helix operates about one-sixth the number of ROVs that Oceaneering operates. There's more to the comparison than that, though. About three-quarters of Oceaneering's fleet is deployed in drilling support, whereas Helix rarely puts its ROVs to work in that market. Instead, Helix's ROV fleet is focused on vessel support work (construction, pipeline trenching, intervention/maintenance). On a like-for-like basis then, Helix and Oceaneering are closer in terms of scale than made otherwise appear to be the case.
The ROV market has yet to fully recover for Helix, but the general expectation on the Street is for activity to pick significantly in the coming years. Companies like FMC (NYSE:FTI) and Technip have disappointed the Street with their recent earnings reports, but the backlogs for subsea equipment/projects are very large and construction activity should pick up significantly over the next three to five years. Although ROVs are not all that complicated or expensive to build (about $4 million to $6 million per, with a lead time of one year or less), I do believe that companies like Helix and Oceaneering will see a significant improvement in utilization in the coming years as service and E&P companies build offshore production platforms - modern fleets with advanced capabilities and long industry experience should serve both well.
Queuing Up For A Strong Run?
Helix has more than doubled over the last three years, but I believe there could still be more in store. Given the pent-up demand for subsea well servicing/intervention and the likely upswing in subsea construction activity, I believe Helix will be quite busy over the next five years, with improving utilization rates, dayrates, and margins. All told, I believe the company could see EBITDA grow at an annual rate of 15% to 25% over the next five years, albeit likely not on a smooth curve.
With a relatively clean balance sheet, I would not be surprised to see the company commit more resources to vessel acquisition (either newbuilds or acquisitions/conversions) and expand into new offshore markets. I don't believe the company will look to grow at any cost, though, and if the anticipated IRRs for new capital spending aren't good enough, capital could come back to shareholders in the form of buybacks, special dividends, or a regular dividend.
The Bottom Line
A lack of comparables makes it more challenging to determine a fair and reasonable multiple for Helix. The company is often comped against subsea construction firms like Technip, Subsea 7, and Saipem, but I really don't think those are especially similar firms. Likewise, comparing Helix to offshore drillers like Transocean and SeaDrill doesn't make all that much sense to me. Oceaneering is a better comp, particularly as about 40% of Helix's revenue comes from robotics.
Given the typical multiples for Oceaneering, as well as the growth and return outlook for Helix, I am comfortable with an 8x multiple to forward EBITDA. That suggests a fair value of $26, while the current average sell-side target of nearly $30 works out to a multiple closer to 9x. In either case, I believe Helix is worth a look today; even though the lower 8x multiple doesn't suggest enormous undervaluation, I do believe Helix's order/contract book and price/value proposition in well intervention services reduces some of the risk and makes this an attractive risk-reward opportunity today.
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.