FTI Looks To Overcome The Short-Term Weaknesses
TechnipFMC (FTI) provides products, services, and fully integrated solutions that are used in the energy industries as well as in the consumer and industrial markets. I think a higher margin from the iEPCI contracts in offshore and the rise in LNG projects in the international markets can boost returns from FTI’s stock price over the medium to long run.
The most promising development over the past year has been the company’s considerable improvement in inbound orders and backlog. It has bagged significant projects over the past year that can boost revenue generation in the short to medium term.
On the other hand, longer-than-expected on-going completions activity slowdown and weakness in pressure pumping product sales offset some of the positive factors in 2019. The company’s share repurchases and dividend programs should maintain investors’ confidence. I will start the discussion with the primary drivers for TechnipFMC in recent times.
TechnipFMC’s strategy: Two catalysts
TechnipFMC’s current initiatives are revolving around servicing the downstream activity, creating value through collaboration with Saudi Aramco (ARMCO), iEPCI contracts in subsea, and the LNG opportunities. I will focus on the iEPCI contracts and LNG projects – because these two appear to be the most robust value drivers in the current energy environment. In the Subsea segment, FTI is progressively moving towards integrating with the iEPCI projects. These projects include integrated engineering, procurement, construction, and installation services. Through a single contracting mechanism and a single interface, FTI believes it can achieve durable project economics by engaging in these projects. In this context, investors should note that the company will offer these projects for the first time to BP (NYSE:BP) and Lundin (OTCPK:LNDNF). So far in 2019, it has secured seven new iEPCI projects. Since these projects leverage the company’s human resources, manufacturing operations, and the asset fleet, the company’s fleet utilization is likely to accelerate.
The prominent feature of the subsea iEPCI projects is its integration with FTI’s Subsea 2.0 platform. Approximately 60% of the company’s Subsea FEED studies have included Subsea 2.0 technology since 2018. Now the company is in the process of tendering Subsea 2.0 production systems. During Q1 2019, the majority of the awards the company received included a diversified mix of iEPCI projects as well as subsea services. On top of these projects, the company received equipment and installation contract for Petrobras’ (NYSE:PBR) Mero 1 project in Brazil and Equinor’s Johan Sverdrup project in the North Sea.
This is how the iEPCI projects complement the Subsea 2.0 technology: The 2.0 technology can accelerate the time to drill, which fast-tracks the installation portion of the contract. As a result of this acceleration, asset utilization can increase significantly. So, FTI has been prioritizing the project activities in recent times. The effect of this acceleration has already resulted in the inbound order growth in Q1. The company expects some of the installation activity to commence in 2020 instead of 2021 under a conventional Subsea project.
LNG projects: FTI eyes the robust growth potential in the LNG market in the Asia Pacific region. The management believes in the next one to two years, LNG project capacity can increase considerably, which can add to FTI’s top line in the medium term. The company is currently tracking more than 20 projects in the LNG space globally. However, the company focuses on only five of these projects which are located in five different countries. The company is primarily doing FEED (Front End Engineering Design) studies in these projects but can expand its activities as the projects grow.
According to a McKinsey report, between 2017 and 2022, natural gas demand and supply are expected to grow by 1.6% CAGR. Demand for LNG will primarily arise from China, South Asia, and Europe. The LNG market is also likely to rebalance around 2022.
Subsea Segment: Performance And Outlook
Despite the positive developments mentioned above, FTI’s Subsea segment continued to get adversely affected by competitively priced backlog and lower vessel utilization. As a result, the segment revenue decreased by 4% in Q1 2019 compared to Q4 2018. The segment operating margin, however, turned positive in Q1 compared to an operating loss in the prior quarter, due to lower operating costs. The company kept its 2019 financial guidance for the segment unchanged from the previous guidance due to a healthy backlog, which means the segment revenue would be ~14.7% higher than FY2018 at the guidance midpoint. I will discuss more on the backlog later in this article.
Surface Technologies Segment: Performance And Outlook
FTI’s Surface Technologies segment is adversely affected by North America onshore operations, which has been weaker than earlier expected. Although the West Texas Intermediate (or WTI) crude oil price recovered considerably in Q1 (by 32%) after a sharp decline in Q4 2018 (by 38%), a couple of issues have not gone in upstream companies’ favor. Despite the growth in the DUC wells in the key unconventional Basins, the completions activity has not picked up yet. More concerning, many estimates suggest there will be a considerable decline in the upstream capex budget in 2019 compared to the previous year, which can reduce the top line and the bottom line for the OFS companies like FTI.
The saving grace would be the completions activity growth in the international market, which can offset some of the downward pressure in North America. As a result of higher demand for pressure pumping equipment from outside North America, the segment revenues increased by 24% in Q1 versus the previous quarter, while the segment operating income tuned to positive from an operating loss in Q4.
Adverse developments in the Surface Technologies segment: So, the traits that mark the activities in onshore operations include the continued headwinds in the U.S. completions activities and idling of pressure pumping assets or removing assets from the fleet. Such behavior by the upstream producers can have a long-lasting impact on FTI’s outlook because the company provides high-pressure consumables for the hydraulic fracturing industry. Until recovery occurs in this business, the whole cycle of inspecting, maintaining, repairing, and replacing the fleet is adversely affected. The other issue involves the high cost of introducing new and innovative products. Although advanced products are offered with an expectation of capturing higher market share, the marginal costs can be higher than the legacy products. Given the below-par demand in the market, the new products can reduce the segment operating margin.
Outlook: Given the mid-single-digits fall in revenues in Surface Technologies, FTI’s management believes the completions activity headwind in North America will keep pricing pressured for the most part in 2019. So, the company, in its most recent update, has lowered its guidance for the segment. It now expects revenue to range between $1.6 billion and $1.7 billion and an EBITDA margin of at least 12% in FY2019, which means it has lowered its previous revenue guidance by 5.7% but has kept the EBITDA margin guidance unchanged.
Onshore/Offshore Segment: Performance And Outlook
From Q4 2018 to Q1 2019, the company’s Onshore/Offshore segment revenues decreased by 20%, while the segment operating income margin decreased to 11.6% in Q1 2019 from 12.3% in Q4 2018. As it turns out, the projects awarded in recent quarters are yet to contribute to the top line. So, we can expect more significant contributions from them in the coming quarters. The company’s backlog in this segment has also grown significantly in Q1. Thus, the management has revised up the segment guidance. It now forecasts the revenue guidance to a range of $6 billion to $6.3 billion in 2019, which would be a 5% rise from the previous guidance at the guidance midpoint. The segment EBITDA margin is also raised from 12% to 14%.
In Q1 2019, FTI’s inbound orders increased by 77% compared to a year, which was higher than the inbound order growth from FY2017 to FY2018 (40% up). The Onshore/Offshore segment accounted for 51% of the total orders in Q1. The three key orders in the Onshore/Offshore segment include a reimbursable contract with Exxon Mobil (XOM) for the Beaumont refinery expansion, an offshore natural gas FPSO award for BP’s Greater Tortue project in West Africa, and an EPC contract for MIDOR refinery expansion and modernization in Egypt. The Onshore/Offshore segment inbound orders resulted in a book-to-bill of 2.4. Inbound orders indicate confirmed customer orders.
FY2019 Capex And Cash Flows
FTI expects to increase capex by 5% to ~$350 million in FY2019 compared to FY2018. Its cash flow from operations turned positive in Q1 2019 compared to a negative CFO in Q1 2018 due to improvement in working capital following the receipt of customer prepayments on key project awards. Despite the improvement in cash flow from operations, the company’s free cash flow remained negative due to a steep rise in the capex in Q1 2019. Much of the company’s capex has been going to the Yamal LNG project.
During Q1 2019, FTI reduced net debt by $336 million. FTI’s debt-to-equity ratio (0.38x) is lower than its peers’ average of 0.61x. Halliburton (HAL) has higher leverage (1.18x). Baker Hughes, a GE Company’s (BHGE) and Schlumberger’s (SLB) leverages are lower than the average.
In December 2018, the company disclosed that it would buy an additional $300 million worth of shares. The offer remains valid until January 2022.
The company pays a dividend per share of $0.52 (annualized), which translates into a forward dividend yield of 2.21%. Between dividend and share repurchases, its balance sheet shows strength in providing flexibility for cash distributions.
What Does The Relative Valuation Tell Us?
FTI is currently trading at an EV-to-adjusted EBITDA multiple of 6.6x. Based on sell-side analysts’ EBITDA estimates, its forward EV/EBITDA multiple is lower, which implies higher EBITDA in the next four quarters. The company is currently trading at a premium to its past two-year average of ~6.0x.
The sell-side analysts expect FTI’s EBITDA to increase in line with the peers in the next four quarters, which typically results in a similar EV/EBITDA multiple compared to its peers. However, the company’s EV/EBITDA multiple is lower than its peers’ (SLB, BHGE, and HAL) average of 9.3x. So, the stock can be relatively undervalued at the current level. I have used estimates provided by Thomson Reuters in this analysis.
According to data provided by Seeking Alpha, 27 analysts rated FTI a buy in May (includes strong buys), while three recommended a “hold." One of the sell-side analysts rated it a “sell.” The consensus target price is $30.3, which at the current price yields ~32% returns.
What’s The Take On FTI?
TechnipFMC is focusing on improving its margin through undertaking the fully integrated EPC contracts, particularly in the offshore business. Over the medium to long run, the growth in the LNG market, particularly in the international markets, can boost FTI’s growth. The most promising development over the past year has been the company’s considerable improvement in inbound orders and backlog. It has bagged significant projects over the past year that can boost revenue generation in the short to medium term.
Longer-than-expected completions activity slowdown and weakness in pressure pumping product sales can drag revenue and margin lower in FY2019. FTI has a vast war-chest of cash & equivalents built to last the current weaknesses in the energy market environment. The company’s share repurchases and dividend programs should maintain investors’ confidence. I expect the company’s stock price to produce positive returns in the long run.
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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.