Description

FMC Technologies, Inc. (ticker FTI) was spun out of FMC Corporation in June 2001, and fully distributed by the end of that year. The company’s core and fastest-growing business, Energy Production Systems, is by far the market leader in the production of subsea systems, a market that displays very attractive secular growth. FTI has two competitors in this space – soon to become one, when Cooper Cameron completes its anticipated purchase of ABB’s Vetco unit. This should lead to more rational industry pricing and will be a net positive for FTI. In addition, its Airport Systems division will continue to generate cash with further military orders, and its primary customer base is more likely to get better than significantly worse from this low level. Finally, FTI – while not your classic value investment at 19x 2003 EPS – trades at a significant discount to its main comparables, Cooper Cameron (CAM) at almost 28x and Dril-Quip at 30x. Beyond growth in earnings, multiple expansion is a strong possibility.

Company Description

FTI is organized along three separate business lines: Energy Systems (divided between Production and Processing), FoodTech, and Airport Systems. Energy Systems, at 64% of 2002 revenues (45% in Energy Production and 19% in Energy Processing) and 57% of operating income (37%, 20% respectively), is the engine for FTI. Energy Production is involved in the subsea equipment, surface equipment, and offshore construction businesses, though the manufacture of subsea wellheads and systems makes up the bulk of this segment. Energy Processing designs and manufactures fluid control systems (valves and fittings) for oil service companies, loading systems (including to the potentially high-growth LNG industry), and measurement solutions.

FoodTech (24% of revenues, 32% of operating income) provides food-processing equipment and systems to large food suppliers, processors, and other institutions. In terms of market position, the company’s equipment processes 75% of the citrus produced globally, and freezes approximately half the world’s commercially frozen food.

Airport Systems builds cargo loaders, deicers, passenger boarding bridges, and other equipment and services to airports, airlines, airfreight companies, and the US Air Force. While the weakness associated with commercial airlines has had an impact on this segment’s results, it has been partially offset by US military orders for Halvorsen loaders.

Valuation

FTI trades at:
19.5x 2003 EPS 15.6x 2004 EPS (comps at 29.6x 2003 and 20.6x 2004)

9.6x 2003 EV/EBITDA 8.4x 2004 EV/EBITDA (comps at approx 14x ’03 and 11x ‘04)

10.7x 2003 P/CF 9.4x 2004 P/CF (comps at 14x ’03 and 11x ’04)

Reasons to Buy FTI

Market leader in growing industry
FTI has an estimated 40% share is subsea equipment (specifically trees, the most important part of the market), followed by CAM at 25% and ABB Vetco at 20% (with Dril-Quip and Kvaerner making up the rest). This market has witnessed a 42% CAGR between 2000 and 2002, and the growth this year is expected to be 45%. Going forward, it is not unreasonable to model 10-20% revenue growth in this market (management expects 15%) as deepwater projects in the North Sea, Gulf of Mexico, Brazil, West Africa, Australia and elsewhere come online. Compared to other segments of oil services, deepwater projects are not overly influenced by commodity prices – these are long-lived projects, the majority of them owned by the major oil companies (Shell, BP, etc) and state oil companies, as well as certain strong independents. FTI has alliances with Shell, BP, Statoil, Woodside, Norsk Hydro, Petrobras, Kerr-McGee, and others while its competitors have few, if any such arrangements. This represents a significant barrier to entry.

Competitive landscape rationalizing, leading to better pricing
ABB is close to determining the successful bidder for its Vetco unit. According to industry sources and as quoted in the NYT on May 13: “The Cooper Cameron Corporation, a United States maker of oil equipment, is the lead bidder for the most lucrative part of the division, people close to the company said…. Though small, Cooper Cameron, based in Houston, is believed to be the preferred bidder because it is rich in cash. Cooper Cameron is said to be interested in ABB's Vetco Gray oil field wellhead valves business and its subsea oil business.” This announcement will be a nice catalyst for FTI as CAM will likely be more rational in its pricing when it only faces one other competitor.

Upside to estimates as rig count ahead of company’s projection
Part of FTI’s business, specifically its surface production equipment, is levered to the rig count. FTI incorporated an increase in the rig count of 6%-8% in 2003 over 2002, but YTD, the count is over 25% higher than the year before. As we really saw an acceleration through the last part of Q1 and into Q2, and taking into account the lag time before orders, we should see the impact with this quarter’s earnings. The Street is expecting $1.10 for 2003, at the high end of management’s $1.05-1.10 guidance.

“Non-core” businesses cash flow positive, and in the case of Airport Systems, more likely to go up than down
FoodTech and Airport Systems both require minimal capex, and according to management, they generated approximately $40-50mm and $9mm in free cash flow, respectively, in 2002. As discussed above, the Airport Systems segment has suffered given the issues in the airline industry, but has been able to replace some its lost revenues with business from the military. FTI delivered 133 loaders to the Air Force in 2002, and it is likely they will be able to get an additional order for another 350 loaders to be delivered through the next 3-4 years.

Solid balance sheet with strong free cash flow and ROIC
The company’s target is $200mm in net debt (was at $214 at the end of Q1, equating to net debt to cap of 39%) and it has been closing in on that with its free cash generation. As it approaches its target, the company will likely uses its free cash for share buybacks and tuck-in acquisitions (<$50mm). Since going public, FTI has achieved 14% ROIC in 2001 and 2002, with the same expected in 2003 (meaningfully above the median for their peer group in oilfield services) – a testament to the company’s focus on this metric in running their business.

Risks

Oil price collapses
Any dislocation that causes oil companies to rethink their deepwater strategy would have an impact on FTI. At oil below $15, there is severe risk to continued revenue growth.

Linkage to OSX
While perhaps not necessarily deserved, FTI has to date traded in a close pattern to the Oil Services Sector Index (though it has fared better than the Index since its IPO). To the extent the OSX gets hit, which would most likely occur if natural gas prices decreased substantially and/or the US rig count dropped, FTI might fall in sympathy.

Catalyst

Contract wins in West Africa deepwater – likely that the company has already won some here and has yet to announce them (two projects are particularly interesting: Rosa-Lorio with 43 trees and Baobob with 11 trees…each tree is ~$6mm in revenues)

Earnings beat as leverage to rig count starts showing this quarter

CAM buys ABB Vetco – will likely be consummated this summer

Further military orders for Halvorsen loaders (increases conviction that this revenue stream can last a few years – 2007?)