- Steady subsea tree awards, contract renewals, and longer contracts will benefit OII's operating margin in the medium term.
- Its backlog went up by the end of Q2, which indicates enhanced revenue visibility in 2H 2021.
- The company will continue to face headwinds in the Manufactured Products segment in 2H 2021.
- Cash flows recovered sharply in 1H 2021; so, with sufficient liquidity, its leveraged balance sheet is manageable.
OII Has Rooms For Margin Growth
In 2H 2021, higher subsea tree awards are likely to result in an elevated demand for ROVs (remotely operated vehicles), which, in turn, will benefit Oceaneering International (NYSE:OII). In 2H 2021, its operating results for most of its segments are likely to improve except for the Manufactured Products segment. Notably, contract renewals and longer contracts will benefit the margin, despite minor changes in market share or the lack of new contracts. The recent growth in backlog will support the relatively bullish outlook.
However, its Manufactured Products segment will remain cramped in the short term due to the weak activity in the Mobility Solutions businesses. Plus, higher infrastructure costs can dampen the operating margin in the Aerospace and Defense Technologies business. Although high leverage indicates financial risks, robust liquidity and cash flow mitigate the balance sheet risks. The growth factors will outweigh the downside, and the stock will produce positive returns in the short term.
The Current Challenges And OII's Response
At the start of 2H 2021, OII's management seems more optimistic about its outlook on the ROV business. In the Subsea Robotics segment, the revenue split between ROV and the combined tooling and survey businesses was 80/20 in Q2 compared to 78/22 in Q1. Also, the company is upgrading its ROV fleet. ROV revenue per day on hire increased by 2% in Q2 versus Q1. By June end, it had ROV contracts on 73 of the 126 floating rigs under contract, which translated into 58% market share, according to the company's estimates. However, the market share remained nearly unchanged compared to a quarter ago.
In the near term, the management does not expect to see any dramatic rise in the number of floating drilling rigs. However, it does see contract renewals and longer contracts. For example, some of the contracts stretch from one year to two years. So, despite the lack of new contracts pulling revenues up, the project ramp-ups will benefit OII's prospect. Read more on the company's business in my previous article here.
In FY2021, the company raised its adjusted EBITDA guidance to $212.5 million (at the guidance mid-point) from the previous guidance of $185 million, which would be ~15% higher than FY2020. It expects annual operating results to remain consistent or improve in the operating segments except for the Manufactured Products segment. The Manufactured Product segment can remain weak due to the long cycle nature of this business and lower capex commitments from its customers.
Steady vessel utilization and active IMR work in the Gulf of Mexico in the OPG (Offshore Projects Group) segments, and incremental multiyear contracts in the Integrity Management & Digital Solutions (or IMDS) segment can benefit the company's topline and operating income in FY2021 due to incremental multiyear agreements, particularly in 2H 2021. Plus, a growing international activity will keep the SSR (Subsea Robotics segment) forecasted adjusted EBITDA margin resilient in the year.
Subsea Robotics Segment: Signs Of Stability
In Q3 2021, a relatively flat activity level can lead to higher adjusted operating profitability in the ROV, survey, and tooling businesses. Also, a similar ROV utilization can result in a consistently adjusted EBITDA margin in Q3 compared to Q2.
The ROV utilization level (62%) and days on hire increased in Q2 2021 compared to Q1. However, the drill support market share decreased (from 60% to 58%) between Q1 and Q2. Going ahead, I think the market share can steady at ~60%.
Manufactured Products Segment: Performance And Outlook
The Manufactured segment recorded the steepest fall in revenues (9% down) in Q2 2021 compared to Q1. Despite that, the backlog on June 30 was $248 million, or an increase of 27% compared to Q1. Also, its book-to-bill ratio has increased to 1.2x, which was significantly higher than a year ago.
I think the uncertainty remains in this business in the short term. While the energy products businesses will remain steady, the company expects to see marginally lower activity in the Mobility Solutions businesses.
Non-Energy Business: Performance And Outlook
In OII's non-energy business, the Integrity Management & Digital Solutions and Aerospace segment had a terrific quarter in Q2 following the start-up of several new multiyear projects. However, the operating income declined marginally in the Aerospace and Defense Technologies segment. The company also expects revenues and operating income to remain weak in Q3 due to higher IT infrastructure costs and incentive-based compensation.
Long-Term Debt And Cash Flow
OII's aggregate debt ($770 million) will be due between 2024 and 2028. Its debt-to-equity (1.37x) is much higher than the peers' (OIS, HLX, FTI) average of 0.63x. The company's liquidity was $956 million (excluding working capital) on June 30, 2021.
The company's cash flow from operations (or CFO) increased by 8.1x in the past year due to favorable timing of vendor payments, higher contract liabilities, and increased accruals of incentive payments. Free cash flow (or FCF), too, received a boost after it turned from a negative to a positive in the past year. So, with sufficient liquidity, the company has room to service its debt, or repay it, if it chooses so.
Linear Regression Based Forecast
I have observed a regression equation based on the historical relationship among the crude oil price, the US offshore rig count, and OII's reported revenues for the past six years. I also observed the previous four-quarter trend. Assuming the long-term factors will be dominant, I expect revenues to remain nearly unchanged in the next couple of years.
Based on the regression model using the average forecast revenues, I expect the company's EBITDA to increase in the next twelve months (or NTM 2022). However, in NTM 2023, the model suggests a decrease in EBITDA.
Relative Valuation And Target Price
I have calculated the EV using OII's forward EV/EBITDA multiple and its past average multiple. Returns potential using the forward multiple (27.8x) is higher (45% upside) than the returns potential using the Wall Street analysts' price forecast. At present, three sell-side analysts are "bullish" on the stock, while six are "neutral', according to Seeking Alpha. None of the analysts is "bearish." The consensus target price is $16.56, which, at the current price, yields 23% returns.
The company's EV/EBITDA multiple (10.0x) is significantly higher than its peers' (OIS, HLX, and FTI) average. On relative valuation based on OII's forward EV-to-EBITDA multiple contraction versus the adjusted trailing 12-month EV/EBITDA compared to peers, I think the stock is still marginally undervalued at the current level.
What's The Take On OII?
In 2H 2021, while the number of floating drilling rigs may not change much for the company, the upward push will come from contract renewals and longer contracts. OII's backlog also went up by the end of Q2, which indicates enhanced revenue visibility. The stock significantly outperformed the VanEck Vectors Oil Services ETF (OIH) in the past year.
However, uncertainty remains in this Manufactured Products segment in the short term. On top of that, the operating margin in the Aerospace and Defense Technologies business can weaken in 2H 2021 due to higher infrastructure costs. The company has robust liquidity and robust cash flows, which, I think, can inflate further as the topline improves. Given its relative valuation multiples, I think the investors may consider buying the stock for a positive return in the short-to-medium term.
This article was written by
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