Description
Helix Energy Solutions Group, Inc. is something of an orphan, a fallen angel, and a punt on oil prices. It’s not big enough to attract any real coverage (though UBS and Jeffries cover it), it’s not small enough to move the needle quickly with a large well, and it’s in a highly cyclical business. Consequently, it may appeal to the value investor if the margin of safety is sufficiently large.
It is an aggregation of two complementary businesses: finding/ developing oil and gas (ERP), and contract servicing for oil and gas producers (CS). The contracting business could be bifurcated further into deep water and shallow water services, as they are very different, and require different equipment. In deep water contracting, they have certain proprietary technologies and equipment which has promulgated large and rising margins. In the shallow water of the Gulf of Mexico (GOM), they are the largest competitor. However, shallow water contracting has been deemed non-core, and a shelf IPO has been filed with the intention of ultimately fully divesting it.
The stock is not fairly valued due to its complex business model, its recent acquisition of a diversifying asset and due to its series of one-off charges. In July of 2006, they completed the acquisition of Remington Oil and Gas for $1.4b (a type-C deal). Hurricane Katrina set back their production schedules, but also added substantially to the load of contracting work and to rates. In addition to the 7-06 acquisition, there have been other “one-time” charges in the first six months of 2006, all of which have contributed to the opacity of the name.
While I have no delusions that I can lift the veil from HLX, it may be possible to suggest that an investor can acquire not only an excellent stream of income from contracting services, but also substantial oil and gas properties at a modest price. Strategically, the business model evolving at HLX is very appealing. They now have “all the tools in the toolbox”, some very interesting drilling equipment that is difficult and time consuming to replicate, and a promising group of conservative development properties which can be drilled at their leisure or when contract rates decline.
Even against depressed multiples in the industry, HLX gets little respect, in part because of the complexity of CS and the relative size and diversification achieved with the REM acquisition. The OSX, the oil service index, trades at a 2006 PE of 14.5x; and the XOI trades at an 8.3 forward multiple. HLX trades at a 2005 PE of 10.6x, a 2006 PE of 10.2x, a 2007 PE of 6.9x despite an ROA= 11.1%, ROE= 26.9%, ROI= 17.3%, EV/ EBITDA= 7.8x, IBES estimated l/ t growth= 40%, 5-yr sales growth= 30%, EBIT/ total interest= 23.0x, TD/ EBITDA= 2.6x, gross margin= 37.3%, operating margin= 29.2%, profit margin= 19.5%, --- and these results have been depressed by a series of one-time factors. In the latest quarter alone, EPS were $0.60 f/ d., and one-time events detracted $0.40. A very simple view is that base case valuation is 7.5x times cash flow (about where it trades today), so that any growth in EBITDA would be reflected in a commensurate increase in price – without giving any consideration to the untapped asset base in ERP; that asset base has a discounted NAV a/o 12/31/05 of $1.964b or crudely (excuse the pun) $20 per share ($57.75 oil, $10.08 gas, less production costs, then discounted at 10%). Debt assumed to complete the merger will be reduced with the sale of non-core assets (including the shelf registration for shallow contracting – old Cal Dive), as the company has targeted debt/ capital ratio of 35%, from 48% currently; so the benefits of growth will accrue largely to the equity holders.
Therefore, the central issue for investors is the value of the contract drilling operation. Whatever residual value is ascribed to ERP (use your own discount rate) can be measured against one’s assessment of oil/ gas prices and their volatility. As of October 2, company guidance was for contracting revenues of $930- $970m, with a gross margin of 40%. Applying one-half of SG&A and d+a to CS, using an operating cash flow multiple of 7.5x and net debt $1.204b (i.e., entire company net debt), and with f/ d. shares outstanding of 96.9m, yields approximately $21 per share. Add this $21 for CS, and the $20 for ERP, and one gets $41. This gives no credit to growth (assuming that 7.5x CF is the base case) for a business that has grown revenues 30% cagr in 5-years, and for which “Street” estimates project a 40% growth-in-sales rate, or for two joint ventures which may add $4 to $8 per share (Marco Polo and Independence Hub). All together, HLX should be worth $45 p/s, or about 45% more than the current price.
Continuing on, to count the deck chairs rather than the lifeboats, let’s take a look at some income statement data without the benefit of management, which will adumbrate their projections in Dec 2006.
2007 2006 LTM 2005A
Sales 1.800 1.400 1.235 0.799
CGS 60% 62% 63% 65%
SG&A 8% 8% 8% 8%
EBIT 0.576 0.420 0.360 0.220
Net 0.397 0.291 0.241 0.153
EPS $4.05 $3.01 $2.79 $1.87
PE 7.7 10.3
PS 1.7 2.1
Remember, the latest quarter was decremented by several “one-time” charges (management’s characterization, not mine) which in the aggregate were $0.40. Assuming management is not disingenuous, a run-rate of $1.00 per quarter looks very conservative. In fact there are 11 analysts who opine on HLX. Their mean 2006 estimate is $2.99 (with a range of $3.31- $2.71) and a 2007 mean estimate of $4.45 (and a range of $5.51- $3.03). Remove one outlier and the means increase to $3.02 and $4.60. My take on management: straight shooters, good operators, experienced, and conservative.
On almost any measure, compared to historical ratios, HLX looks very cheap. The last time the PE was lower it was 8.3x in 1999Q1; the last time price to sales was lower it was 1.9x in 2003Q4; the last time p/ cf was lower it was 3.7x in 1998Q4; and EV/ CF was 7.3x in 2004Q4. In short, HLX has never been cheaper than it is today, despite the addition of large reserves, and technologically sophisticated drilling assets, and expansion into the North Sea and Western Australia.
HLX is now, and will be for some time, best described as a punt on oil prices, despite the fact that it’s production aspirations are modest (it drills mostly proven undeveloped reserves), and its income stream from oil services has been steadily growing. Personally, I think we have seen the highs for oil for some time, but the bottom is not going to be below $45. The oil producing nations are controlled by generally repressive regimes dominated by lunatics (and I include Russia). Places where even the giants of the industry can drill are limited by political risk, and technological barriers. More drilling in more dangerous places is inevitable -- our appetite for oil will not seriously diminish (even at $3.00 gas). As a hedge against a 2007 recession, or vastly higher oil prices, HLX might prove an interesting speculation at an attractive price.
Note: HLX has a 30-day volatility of 46, so that some of the ratios may be affected by intra-day price fluctuations.
Catalyst
2006 EPS maeet or beat management estimates
oil prices increase
additional contract wins at 40$ gross margins