Description

Elevator Pitch

Shawcor provides various products and services to the automotive, industrial, transportation, and energy end markets.   Despite earning the majority of its EBITDA from non-oil & gas sectors, the company is perceived as an energy services provider in ruins, trading at a distressed 4.5x EBITDA multiple off of depressed earnings.  At C$4.82 per share, the market is essentially ascribing zero value to its pipe coating business, which is positioned to benefit from its robust backlog, improving rig count, upward revisions to oil & gas capital spending budgets, and the highest oil prices since 2014.   

Description

Shawcor is a legacy Canadian energy services business providing pipe coating and inspection services to the oil & gas industry.  In recent years, Shawcor has diversified into growing, non-energy related industries such as automotive and industrial, which now account for roughly half the business.  The Company operates three business segments: Composite Systems, Automotive & Industrial, and Pipeline & Pipe Services. The Composite Systems segment manufactures reinforced plastic underground storage tanks used for retail fuel, water, and wastewater as well as spool-able composite pipe systems primarily used for oil & gas gathering. The Automotive & Industrial segment produces heat-shrinkable tubing along with engineered wire and cable for automotive and industrial applications. The Pipeline & Pipe Services segment provides specialized anti-corrosive and flow efficiency coating systems and field joint application services for both onshore and offshore pipelines.

Investment Setup

Shawcor’s share price peaked in 2014 at C$60.00 and has since fallen over 90% to below C$5.00.  Historically, its energy-related businesses consistently generated in excess of C$250m in EBITDA (its peak was ~C$400m in 2013) but it has declined to roughly ~C$60m in today’s depressed energy spending environment and exacerbated by the Covid-19 pandemic. Global exploration and production capital investment fell from $736 billion in 2014 to $322 billion in 2020. Over that same period, Shawcor’s EBITDA declined from C$390 million to C$74 million (all EBITDA figures presented are ex Canadian Emergency Wage Subsidies, CEWS) in 2020 as demand for large pipe-coating projects dried up.

                                                                                      Source: Rystad Energy, Company Data, Morgan Stanley Research estimates

In 2019, Shawcor acquired ZCL Composites, a manufacturer of composite underground tanks, to help diversify Shawcor’s earnings and capture synergies with its composite pipes business. The acquisition was primarily funded with debt and following the demand destruction caused by Covid, left Shawcor’s net debt at 5.6x LTM EBITDA in Q3 of 2020. Additionally, following the acquisition Shawcor remains a misunderstood and orphaned asset.  It is still categorized as an oil & gas services company despite generating the majority of its earnings from non-energy related end-markets (though this may change as energy capex recovers). The stock is covered almost exclusively by Canadian oil & gas analysts, and trades at a distressed 4.5x EBITDA multiple off of depressed earnings.  

What Has Changed?

Shawcor has emerged from Covid a stronger and more diversified business with improved profitability that is less dependent upon global energy capital investment. The ZCL acquisition added a stable business with low to mid-single digit growth and a mid-teens EBITDA margin. Shawcor has also been able to continue to grow its Automotive & Industrial segment despite headwinds from Covid and the global semiconductor shortage, with LTM revenues 22% higher than pre-pandemic levels.  In late 2020, Shawcor was also able to dispose of its Pipeline Products business for a double-digit EBITDA multiple, reducing its exposure to the energy sector and decreasing its leverage from 5.6x LTM EBITDA in Q3 2020 to 1.6x LTM EBITDA in Q3 2021. Finally, Shawcor has also been able to drastically reduce its cost structure, and it has taken out C$100 million from its pre-covid SG&A expense, from an annual C$300 million to C$200 million.

Variant Perception

Despite a drastically improved oil & gas environment, Shawcor’s valuation has remained flat since WTI oil hit $60 per barrel in April. Over that same timeframe, natural gas prices have doubled (more in some geographies). The number of drilled but uncompleted wells (DUCs) in the US is at its lowest level since 2014. Shawcor has not yet benefited from an improving oil environment because oil & gas companies have remained disciplined in their capital spending, but the current run-rate investment level is unsustainable. Global oil consumption has recovered faster than most anticipated, and as long-term oil price forecasts increase so too does the incentive to invest in exploration and production. On November 15, 2021, Shawcor issued a press release detailing a contract award for a C$25 million project in the Gulf of Mexico. This is the first sizeable contract award it has been granted since before Covid and, combined with a robust pipeline of projects, signifies rebounding demand.

Shawcor’s Automotive and Industrial segment will continue to grow as the semiconductor shortage that has been impacting the automotive industry abates. IHS forecasts for light vehicle production to increase 10.6%, from 74.8 million vehicles in 2021 to 82.7 million vehicles in 2022, followed by an 11.2% increase in 2023. The Automotive & Industrial segment was able to achieve both record sales and EBITDA in 2021 despite the semiconductor shortage and industry-wide supply chain constraints, so it should sustain its momentum as supply chain pressures ease. Longer term, this segment will continue to benefit from the electrification of vehicles, driving content per vehicle and sales growth.

The Composite Systems segment has been negatively impacted in 2022 by raw material shortages, namely resins. Suppliers were forced to declare force majeure due to Hurricane Ida, impairing Shawcor’s ability to procure the components necessary to build their composite tanks and pipes for the next two quarters. Management expects these shortages to subside as they move into 2022. Additionally, the segment’s composite pipe business should benefit from an inevitable upturn in oil & gas capital spending.

Valuation

Shawcor is cheap by just about any metric.  At the current valuation, Shawcor receives zero credit for its Pipeline & Pipe Services business, where pent-up earnings power is greatest.  Moreover, Shawcor’s current market capitalization is only slightly higher than the C$300M it paid to acquire ZCL two years ago—a business which comprises a mere ~20% of Shawcor’s total revenues.

Shawcor is currently trading at $4.82 per share at a near all-time low EV/EBITDA multiple of 4.8x forward EBITDA. The only times Shawcor has traded at a lower multiple were during the GFC and in March of 2020 at the height of the Covid selloff. Combined with the fact that the Pipeline & Pipe Services segment is merely achieving breakeven operating profits, there is opportunity for substantial upside. At its historical average multiple of 7.7x EV/EBITDA, which is comparable to that of industrial peers, on weak consensus 2022 EBITDA estimates (which is expected to be below LTM EBITDA on supply chain concerns), Shawcor would be worth $9.70 per share and offer roughly 100% upside.

Shawcor is trading at such a depressed valuation that even if you ascribe zero value to the Pipeline and Pipe Services segment, which has earned C$40 million of LTM EBITDA at the bottom of the cycle, Shawcor is still fairly valued. At this valuation, investors are essentially getting the Pipeline and Pipe Services business for free.

If you ascribe even a meager multiple of 2.0x EV/EBITDA to the Pipeline & Pipe Services segment, there is 36% upside.

Perma-Pipe International Holdings (PPIH) is the closest public comp for the Pipeline & Pipe Services segment, and it currently trades at 0.8x EV/Sales. Shawcor is larger and has historically operated at higher EBITDA margins. If you value the Pipeline & Pipe Services segment at only 0.6x sales, a 25% discount despite superior operating results, there is still over 100% upside.

All of the valuation exercises presented above are based on trailing earnings generated during a depressed oil & gas capex environment.  Shawcor is highly profitable today in what is the worst energy environment in the company’s history. An upside scenario with normalized Pipeline & Pipe Services earnings at a reasonable multiple provides free optionality and presents an upside scenario far in excess of the analysis described above.  High energy prices (WTI is at its highest price since 2014) and years of underinvestment will eventually lead to incremental oil & gas capex.  It is easy to underwrite a scenario where the Pipeline & Pipe Services segment can get back to earning C$100m in EBITDA.

In summation, Shawcor is a misunderstood and deeply undervalued company trading at a trough multiple on trough earnings with a clean balance sheet.  A stable and growing auto and industrial business combined with a gradual rebound in its legacy energy end markets will unlock tremendous pent-up earnings power.  Downside is limited given Shawcor’s basement level valuation, clean balance sheet, and shareholder friendly management. When the world remembers how dependent it is on fossil fuels and how far away the clean energy transition is, Shawcor’s upside is explosive.

Risks

• Oil and gas capex does not recover or takes longer to recover than anticipated
• The semiconductor shortage impacts Shawcor’s automotive customers for longer than anticipated
• Supply chain constraints impact Shawcor’s ability to get raw materials for longer than management anticipates 

Catalyst

• A recovery in oil and gas capex 
• The company reinstates its dividend
• The company monetizes additional assets