Teekay's Confidence And Adjusted ROA Improvements Contradict Bearish Expectations

Summary

• Teekay Offshore Partners LP is expected to see a declining Adjusted ROA (ROA’), but management’s confidence in their better cash profile indicate that this is unwarranted.
• TOO is trading at a 1.2x Adjusted Value to Assets Ratio (V/A’), near historical lows.
• Management’s confidence in their improving liquidity and sustainable cash flows indicate that market expectations appear unwarranted, and that equity upside and multiple expansion may be justified.

Performance and Valuation Prime™ Chart

The PVP chart below reflects the real, economic performance and valuation measures of Teekay Offshore Partners LP (NYSE:TOO) after making many major adjustments to the as-reported financials. This chart, as well as the detail behind the graphics, can be found here.

The four panels explain the company's historical corporate performance and valuation levels plus consensus estimates for forecast years as well as what the market is currently pricing in, in terms of expectations for profitability and growth.

The apostrophe after ROA', Asset', V/A', and V/E' is the symbol for "prime" which means "adjusted." These calculations have been modified with comprehensive adjustments to remove as-reported earnings, asset, liability, and cash flow statement inconsistencies and distortions. To better understand the PVP chart and the following discussion, please refer to our guide here.

The firm has seen historically volatile ROA' performance, collapsing from a peak of 10% in 2005 to a mere 2% in 2006, before modestly recovering to 6% in 2008. ROA' then ranged from 4%-6% levels in 2008-2014, before climbing to 8% in 2015. Meanwhile, Adjusted Asset (Asset') growth has been largely non-existent outside of the firm's 58% and 29% growth in 2006 and 2015, respectively.

Performance Drivers - Sales, Margins, and Turns

It can be helpful to break down ROA' into its DuPont formula parts, Earnings' Margin and Asset' Turns, which are the cleaned up margins and turns metrics used to calculate ROA'. The chart below details both Earnings' Margin and Asset' Turns historically, to help us better understand the drivers of the firm's profitability and performance. The detail behind the chart can be found here.

Trends in the firm's volatile ROA' have been driven by fluctuations in Earnings' Margin. Earnings' Margins collapsed from 31% in 2005 to 9% in 2006, before rebounding to 18% in 2007. Earnings' Margins then remained relatively stable from 2007-2014, ranging from 16%-20%, before jumping to 30% in 2015. On the other hand, Asset' Turns have been consistently stable, ranging from 0.2x-0.3x since 2005.

Embedded Expectations Analysis

As investors, understanding what the market is embedding in the stock price in terms of expectations is paramount to making good decisions. Without understanding what the market is pricing in, it is impossible to claim that the market is wrong. We derive market expectations for the firm from valuations and historical performance trends, to give a clearer picture into what the market is projecting for the firm.

TOO is trading at a 1.2x V/A', which is near historical lows. At these levels, the market is pricing in expectations for a declining ROA', from 8% in 2015 to 3% in 2020, accompanied by 2% Asset' growth.

Analyst and Management Expectations and Alignment

Analysts have bullish expectations relative to the market, expecting ROA' to decline to only 5% in 2016 before recovering to 7% in 2017, accompanied by no further Asset' growth.

Furthermore, Valens' qualitative analysis of the firm's Q1 2016 earnings call highlights that management is confident in the sustainability of cash flows from their on-the-water fleet, as supported by a diverse portfolio of long term, high-quality contracts. They are also confident in their improving liquidity profile resulting from cash conservation and refinancing measures.

Valuation Matrix - ROA' and Asset' Growth as Drivers of Valuation

When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential overvalued or undervalued prices for TOO at various levels of profitability (in terms of ROA') and growth (Asset' growth). Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.

To justify current prices, TOO would only need to maintain ROA' above levels seen in 2014, without growing the business. Considering recent improvements in ROA', as well as management's confidence in their improving liquidity profile and sustainable cash flows, market expectations for a declining ROA' appear unwarranted. Equity upside and multiple expansion for TOO may be justified.

To find out more about Teekay Offshore Partners LP and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with lead analyst, Joana Halcon. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.

Disclosure: I/we 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.