This week, Durig Capital reviews a provider of marine transportation services to the oil and gas, construction and military industries primarily in the Gulf of Mexico. Hornbeck Offshore Services has been building momentum over the past few quarters, posting consecutive, quarter-over-quarter increases in revenues. Its latest quarterly results (Q4 2017) continues to build on this momentum.
- Revenues increased 34.1% year-over-year.
- Q4 EBITDA totaled $13.9 million, a massive increase over Q4 2016 EBITDA of $1.1 million.
- Operational cash flow in Q4 added nearly $8 million to Hornbeck’s balance sheet.
Hornbeck was able to secure a new credit facility in June 2017 and subsequently repurchased at a discount and retired $200 million of its outstanding bonds. The company has come through what appears to be the worst of the oil recession of the past few years and is ready to move forward. Hornbeck’s 2020 bonds, couponed at 5.875%, are currently selling at a significant discount, giving these a yield-to-maturity of about 25%. The discounted price and corresponding outstanding yield make these bonds an ideal candidate for addition to Durig Capital’s Fixed Income 2 (FX2) managed income portfolio, the most recent aggregated performance of which is shown below.
Q4 2017 Results
Hornbeck’s most recent quarterly results show some improvements for the offshore oil services firm.
- For Q4, revenues were $56.2 million, an increase of $14.3 million or 34.1% over Q4 2016.
- Q4 revenues also increased sequentially over Q3 2017, coming in $2.5 million or 4.7% higher. This sequential increase was due to higher effective dayrates of the company’s MPSV fleet (multi-purpose support vessels).
- Q4 EBITDA was $13.9 million, an impressive increase from $1.1 million in Q4 2016, as well as a sequential improvement over Q3 2017 which registered EBITDA of $10.6 million.
- Net cash provided by operating activities for Q4 2017 totaled $14.5 million as compared to a negative $5.1 million in the prior year period.
- Operations added nearly $8 million to the company’s balance sheet for the quarter.
Also, in Q2 2017, Hornbeck completed a bond repurchase, retiring $200 million of its outstanding bonds. Another issuer who has been successful in reducing their debt is Men’s Wearhouse in our last review, “Collect 8.1% YTM with Men’s Wearhouse..”. Hornbeck management believes that 2017 marked the beginning of the end of the oil downturn in the offshore drilling market. With the recent large discovery of oil at Ballymore in the eastern part of the Gulf of Mexico, as well as ExxonMobil’s recent announcement that it plans to invest more than $50 billion over the next five years in its U.S. operations, Hornbeck management could be right on the money.
About the Issuer
Co-founded by Todd Hornbeck in 1997, Hoss Offshore is a leading provider of marine transportation services to exploration and production, oilfield service, offshore construction and military customers. Since the company’s establishment, it has primarily focused on providing innovative, technologically advanced marine solutions to meet the evolving needs of the deepwater and ultra-deepwater energy industry in domestic and, more recently, foreign locations. Throughout its history, Hornbeck has expanded its fleet of vessels primarily through a series of new vessel construction programs, as well as through acquisitions of existing vessels. The company is based in Covington, Louisiana and its customer list contains many well-known names in the oil, construction and military industries – Chevron, ExxonMobil, Shell Oil, BP, McDermott International and the U.S. Navy’s Military Sealift Command.
Offshore Declining Production
Most of Hornbeck’s operations are in the Gulf of Mexico. W&T Offshore is another oil & gas producer operating in the Gulf of Mexico, and had a similar yield-to-maturity of 25% in our last review of the issuer, “Drill into 25%+ YTM with W&T Offshore..”. Hornbeck provide services primarily to oil exploration and production companies operating offshore as well as deepwater drilling wells for oil and gas. With the extremely low oil prices of the past few years, many of the large, multinational companies that can afford to drill in offshore / deepwater locations, have drastically reduced capital expenditures (CAPEX) for new exploration and development. This low capex environment has persisted over the past few years. Since then, existing offshore and deepwater wells have continued to decline in their production (which can be as much as 10% per year). Although decay rates on offshore / deepwater wells is significantly less than with onshore and shale oil wells, with little to no new exploration or production coming online, production in the Gulf can’t help but decline.
Todd Hornbeck, President and CEO addressed this point on the company’s last earnings call saying, “Current healthy production from the Gulf of Mexico is unsustainable absent new investment by our customers. Depletion is real. Consider in 2014, there were 114 floaters under contract across our three focus areas of operation, plus 45 jack-ups in Mexico. Today, there are 57 floaters and 20 Mexican jack-ups under contract in our core markets. So the contracted rig counts have been cut in half”. Without new investment, oil production / supply will naturally decline, while demand continues to increase. The U.S. Energy Information Administration (EIA) has forecasted global oil consumption growth of 1.7 million bpd this year and a bit less in 2019.
There are a few other developments that investors should be aware of in regards to Hornbeck Offshore. First, offshore operations are seasonal. Hence, the company fully expects that Q1 2018 will show decreased revenue and EBITDA levels, due to the slowdown in activity in the winter months. Second, in its latest earnings release, management stated that even with current decreased operating levels, cash from operations as well as cash on hand and credit facility availability would be sufficient to fund operations at least through December 31, 2019.
Management also “remains fully cognizant of the challenges currently facing the offshore oil and gas industry and continues to review its capital structure and assess its strategic options”. These strategic options could involve a third-party transaction or a bond extension. Hornbeck has the lion’s share of its bonds coming due in 2020 and 2021. It is not unusual for companies who need to maintain operational liquidity to offer to extend bond maturities for bondholders. This may be an option for Hornbeck as 2020 approaches.
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it is an indication of a company’s ability to service its existing debt levels. For its latest quarterly results (three months ended December 31, 2017), the company shows an operating loss of $14.3 million. However, when removing the non-cash depreciation and amortization charge of $28.4 million, operating income comes in at $14.1 million. With a Q4 interest expense of $12.2 million, interest coverage calculates to just above 1x – 1.15x to be exact. While this interest coverage is lower than some of the other issuer’s reviewed by Durig Capital, Hornbeck does appear to be on the upswing in activity and revenues.
As of December 31, 2017, Hornbeck’s total liquidity (cash and credit availability) was $323.5 million. This figure includes $186.8 million cash as well as $136.7 million available under the company’s first-lien credit facility. This liquidity level represents an increase of 2%, or $7 million from the end of the third quarter.
The risk for bondholders is whether Hornbeck can continue to build momentum even as offshore oil and gas services look to be picking up momentum. The company has registered healthy year-over-year increases in revenues and EBITDA in its most recent quarter. Also, the company has already withstood the worst of the oil downturn, while some of its closest competitors have struggled, even going through bankruptcy proceedings within the last twelve months. Activity in the Gulf of Mexico does appear to be picking up with new oil discoveries as well as large multi-national oil companies increasing capital spending. In light of these considerations, the 25% yield-to-maturity currently indicated with Hornbeck Offshore’s 2020 bonds appears to outweigh the risks identified.
One of the challenges Hornbeck identified in its last earnings call was being able to attract qualified personnel as activity begins to pick up again. Many individuals with the skill sets necessary to offshore services providers have moved to other industries as the oil downturn has continued far longer than anticipated. In order to lure back these workers when needed, providers will need to be prepared to pay a premium to secure the necessary workforce to increase activity.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Hornbeck Offshore Services has survived what has been an unprecedented long-term depression of oil prices. The company has recently strung together consecutive quarters of revenue increases and also managed to increase its cash balance from its operations in Q4. Another issuer who seen several consecutive quarters of revenue growth was 99 Cent Only Stores, in our review “99 Cent Only Stores, 12.79% Yield-to-Maturity...” Hornbeck is covering its interest and has excellent liquidity levels. There are signs that activity is increasing in the Gulf of Mexico and when oil finds an equilibrium level, this could provide the incentive for oil exploration and production companies to finally increase capital spending. Hornbeck’s 2020 bonds are selling at a significant discount, resulting in an outstanding yield-to-maturity of 25%. With this outstanding yield, this bond is an ideal candidate for addition to Durig Capital’s FX2 managed income portfolio, the recent benchmarked and aggregated performance of which is displayed above.
Issuer: Hornbeck Offshore Services Inc.
Ratings: Caa3 / CCC
Yield to Maturity: ~25.13%
About Durig Capital
Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
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Disclosure: Durig Capital and certain clients may hold positions in Hornbeck Offshore’s 2020 bonds.
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