Helix Energy Is Not Hot
Helix Energy Solutions (HLX) offers well intervention services in the U.S. Gulf of Mexico, Brazil, North Sea, and West Africa offshore. The company also operates remotely operated vehicles (or ROV), trenchers, and ROVDrills for the offshore energy drillers. Over the medium term, the slow translation of tendering activity into actual project commencement in the offshore and subsea segment can prolong the stock's sustained recovery. I do not think investing in the stock would be a prudent decision at this point.
The Droshky asset acquisition, completed early in the year, has been quite successful in improving asset utilization. The recent contract of the Q700 semi-submersible well intervention vessel is also a milestone towards improved utilization. However, higher-than-expected downtime in the Q5000 vessel contract with BP can affect the top-line adversely in the short term. Better utilization and cost rationalization are expected to lead to a higher margin in the short term in the Robotics segment. On a more positive note, the company's debt profile is strong enough to sustain deterioration in the energy environment.
The industry movement exhibits uncertainty
The West Texas Intermediate (or WTI) crude oil price has declined by 21% in the past year, although it remained relatively steady during Q2 2019. The crude oil price volatility reflects, among others, uncertainty about global oil demand growth, geopolitical uncertainty, and robust supply growth in the U.S. which has led to global oil inventories build up so far in 2019. The price volatility discourages capital investment and lessens revenue and margin potential for the oilfield equipment & service (or OFS) providers.
The EIA expects the crude oil price to increase marginally in 2020 compared to the levels experienced so far in 2019. As margin remains tight, the upstream energy producers are now more focused on improving cash flows and returns. While some estimates suggest oil majors will spend $208 billion on offshore drilling and other oilfield services in 2019 and other OFS companies are citing estimates for higher tendering activities, HLX's management is relatively unconvinced about how many of these projects will see the light of the day. It believes that the offshore market will remain challenging and would require a consolidation among the existing players before rates improve.
Analyzing the Well Intervention segment drivers
As noticed in the previous cycles, well intervention and workover were among the first activities to recover after the downturn. In Q2 2019, HLX's revenues from the Well Intervention segment increased by 30% compared to Q1 2019. Operating income in this segment improved by a whopping 177% during the same period. The improvement was due to the seasonal growth in the North Sea. The most significant contributor was the rise in vessel utilization, which increased remarkably to 94% in Q2 from 74% in Q1.
However, some of the vessels performed better than the others. While Q4000 achieved utilization of 93% after commencing work on one well in the Droshky field, the Sea well achieved 97% utilization. Investors may note that HLX acquired subsea assets from Marathon Oil Corporation (MRO) in the Droshky Prospect on Green Canyon in the Gulf of Mexico on January 2019. On the other hand, Q5000, which entirely worked for BP in Q2, saw a much lower utilization (77%) due to a technical failure on the jointly owned Helix OneSubsea 15K IRS system.
Here is what's expected of some of these key vessels shortly: Margins generated from the Q400 vessel in Q2 will be recognized in Q3. Q500 will remain with BP in Q3 while enhancement work continues. The subsea system IRS 6 has been integrated into the vessels. Also, in the North Sea in Europe, the company expects to maintain a high level of activity until Q4. So, we can expect the utilization level to remain steady in Q3 compared to Q2. Also, in May, the company acquired Subsea Technologies Group Limited - a U.K.-based designer and manufacturer of subsea hydraulic and mechanical connectors. The acquisition is expected to enhance subsea product development for new well intervention technologies.
In August, in a major development, the Q700 vehicle was contracted to perform subsea workover and integrated well intervention services in offshore Nigeria. The project is scheduled to begin in January 2020.
Robotics Segment Asset Utilization Improves
HLX's Robotics segment revenues increased by 16% in Q2 compared to a quarter ago. The improvement was led by seasonal growth in trenching rates in the North Sea and long-term chartered vessel utilization rate (92% in Q2 versus 88% in Q1). The segment operating profit also turned positive in Q2 compared to an operating loss in Q1. Most of the company's robotics vessels were contracted to perform trenching and renewables projects in the North Sea. Given the current trend, we can expect to see improved utilization and better performance in Q3.
In Q4, Siem Helix 2 will have its scheduled downtime, while the maintenance work on the Siem Helix 1 has been pushed into 2020. The Siem Helix 1 and 2 are well intervention vessels. Also, in Q2, an operational downtime on the 15K IRS system again caused downtime on the Q5000 BP contract. Helix has modified and redeployed the system. In the short term, the Robotics segment is expected to see lower cost and increased margin.
The company's FY2019 EBITDA is expected to range between $165 million and $190 million, which at the guidance mid-point, represents a 10% increase compared to FY2018. I have already discussed the primary drivers above in the article. In short, the company expects Siem Helix 1 and Siem Helix 2 in Brazil to see consistent activity throughout 2019 and North Sea Well Intervention market to maintain a high-level activity into Q4. However, the typical slowdown in activity in the winter season can affect the top-line adversely. The Robotics segment is expected to see a lower cost structure in 2H 2019, while the net margin in this segment can also benefit from the forward currency hedges.
In this context, I will discuss a bit on the company's plans geographically. Currently, two of the company's interventional assets are based in the North Sea, two in the Gulf of Mexico, and two in Brazil. Up ahead, it plans to diversify into West Africa, Brazil, the North Sea, and Asia-Pacific. As Q700 also joins the fleet and utilization improves, we can expect to see a marginal improvement in rates.
As of June 30, 2019, HLX's backlog was $1.0 billion, which was a 9% decrease compared to December 31, 2018. The two Petrobras (NYSE:PBR) contracts, the BP Q5000 contract and the Helix Producer 1 contract accounted for 86% of the backlog. Lower backlog typically indicates lower visibility into future revenues.
Cash Flows Deteriorated
In 1H 2019, HLX's cash flow from operations (or CFO) decreased by 67% compared to 1H 2018. The cash flows reduction reflects working capital deterioration due to higher regulatory certification costs for the vessels.
Although capex declined in 1H 2019, a steeper decline in CFO resulted in lower free cash flow. The company's management expects capex to remain steady at ~$145 million in FY2019 compared to FY2018. A majority of the FY2019 capex would be spent on completing Q7000.
In the remainder of FY2019, HLX has $23 million of debt repayment obligations. Between 2020 and 2023, it has to repay $403 million of debt. A significant portion of the company's debt has equity conversion features, but the trigger prices are considerably higher than the current share price. Its liquidity (cash plus revolving credit facility) is $436 million. During Q2, it extended its maturity of the credit facility and increased the revolving credit facility. The company faces no repayment risk in the near term. I think it is likely that the free cash flow will remain positive in FY2019 but may not increase significantly from the current level.
HLX's debt-to-equity ratio (0.27x) is significantly lower than its peers' average of 1.3x. McDermott International (MDR) and Oceaneering International (OII) have higher leverage (4.4x and 0.56x, respectively). Dril-Quip, Inc. (DRQ) has not debt.
What Does The Relative Valuation Imply?
Helix Energy is currently trading at an EV/EBITDA multiple of 9.7x. The forward EV/EBITDA multiple is 8.5x. Between FY2013 and FY2018, the company's average EV/EBITDA multiple was 8.6x. So, it is currently trading at a premium to its past eight-year average.
HLX's forward EV-to-EBITDA multiple compression versus its adjusted trailing 12-month EV/EBITDA is lower than the peers' average EV/EBITDA compression, which implies a less steep rise in the EBITDA in the next four quarters compared to peers. This would typically result in a lower current EV/EBITDA multiple compared to the peers. After excluding DRQ, which has an excessively high EV/EBITDA, the peers' average is higher than Helix's EV/EBITDA multiple. I have used estimates provided by Seeking Alpha in this analysis.
According to data provided by Seeking Alpha, six sell-side analysts rated HLX a "buy" in August (includes "outperform"), while none recommended a "hold" or a "sell". The consensus target price is $10.5, which at the current price yields ~42% returns.
According to Seeking Alpha's Quant Rating, the stock receives a "Neutral" rating. Its rating is high-to-moderate on momentum and EPS revisions, while they are poor on value, growth, and profitability. I think Seeking Alpha's assertion of a very low rating on profitability is conservative. Compared to some of its closest peers, the company's profitability measures are on the higher side. I also do not agree with the high rating on EPS revision because its earnings missed analysts' estimates thrice out of the past four quarters. I agree with Seeking Alpha's low rating on growth, though. I think its relative valuation multiples are reasonably placed, as I discussed earlier in the article, and so, the low rating on value is conservative.
What's The Take On HLX?
Much of Helix Energy's growth prospect is tied to the offshore energy activity revival in 2019. A couple of events in the recent past have yielded different results for the company and pulled its performance in opposing directions. While the Droshky asset acquisition, completed early in the year, has been quite successful in improving the asset utilization, higher-than-expected downtime in the Q5000 vessel contract with BP has affected the vessel utilization and topline adversely in 1H 2019. The company's well intervention vessel utilization has improved significantly in Q2, especially after the addition of Q7000 in the well intervention vessel fleet. Also, the cost reduction efforts are expected to lead to a higher margin in the short-term in the Robotics segment.
While the falling cash flow in the first half of the year was a concern, HLX's debt profile can withstand deterioration in the energy environment. However, the slow translation of tendering activity into actual project commencement in the offshore and subsea creates uncertainty over the recovery process in the medium-term. Investors may look to avoid the stock at this point.
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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.