Description

TGS GEOPHYSICAL

Caveat: 

This is not going to be a write-up making a bull case for the oil price. It can, as we have seen in recent years, literally go anywhere. This will affect TGS' share price, and dramatically so in the short term. This idea is only potentially interesting if you think that oil prices will stay at levels conducive to increased E&P spending going forward. If you do,then read on. I like to have a little exposure to increasing oil prices, and TGS is my preferred vehicle. 

Company history

TGS is the result of a combination of TGS, which was founded in Houston, and NOPEC, which was founded in Oslo, Norway (both in 1981).TGS initially built a large 2D multi-client library in the Gulf of Mexico and went on to expand in North-America and West-Africa. Over time, they upgraded their library to include a large library of 3D-seismic in the GoM. NOPEC built a leading position in multi-client 2D seismic in the North Sea, as well as data libraries for the Far East and Australia. After a brief stand-alone stint as a listed company, Nopec was merged with TGS in 1998 to form TGS-Nopec Geophysical Company. TGS has been the leading multi-client seismic company in the world since then and employs over 1000 people worldwide. Its main offices are in Houston, Norway, the UK, Brazil and Australia.

Business model

TGS provides energy data, cloud based data managament applications and analytics to companies and investors in energy markets. Its vast collection of data includes seismic data for both on and offshore oil and gas companies, magnetic and gravity data, multi-beam and coring, digital well-log and production data and various types of renewables data. Last year, TGS acquired Magseis Fairfield and in doing so became the leading provider of Ocean Bottom Node (OBM) services. TGS also acquired 4C and Prediktor in 2022, which operate in the offshore and wind data and analytics space. The company did this in an effort to diversify its operations over time and position itself for the massive renewable investment push that needs to be made globally if the world wants to reduce its dependence on fossil energy sources. Longer term, TGS wants to be an integrated provider of all kinds of energy data, and build a complete digital platform for energy investment and production.

Source: company

TGS has a strong financial track record 

I like the capital light nature of TGS' business (it leases vessels as needed instead of owning seismic equipped ships) and its strategy of always maintaining a solid balance sheet, enabling countercyclical investment and capital returns. Unlike competitors like PGS which seems to be in perpetual restructuring, TGS has been a strong performer historically, especially compared with other companies in the oil service space.

I will not try to supress the fact that this is a cyclical business though (that's partly the point here, too), but considering the line of business TGS is in, I think it's done pretty well (figures in USD). We can clearly see that the last 7-8 years have been weak overall compared to the historical average, albeit with an uptick and partial recovery in 2021-2022. I think this recovery has further to go.

Why now?

During the recent prolonged downturn in oil service spending, TGS has exploited a strong financial position and capital light profile to make larger organic investments in multi-client seismic data than its main competitors (a combined 594m USD in 2022 and 2023 vs 405m for CGG and 172m for PGS). It has made higher MC investments than comps every year since than 2015 in fact, and also acquired both Spectrum and ION since 2019, adding data to its library. The multi-client space now counts only four players, down from 11 in 2012, boding well for pricing dicipline and margins. TGS has about 35% market share in MC and 25% overall.

At its Capital Markets Day in March, the company indicated it sees E&P spending increasing by double digits (12-23%)in 2023. There's little doubt that investments in E&P have been lower than usual in the last seven or eight years, the question is whether it will pick up going forward or if this is a new normal. I'm in the camp that thinks it will pick up, for two main (and related) reasons:

1. Russia's invasion of Ukraine has shown the West that energy security is important enough to allow for continued (higher) oil exploration activity, even if it means coming at the expense of environmental concerns (to a degree). Politicians that can't provide affordable fuel and electricity to their constituents will not be reelected and they know it.

2. With integrated oil major's combined free cash flow now at 250 Bn USD at the end of 2022 versus zero in 2016 and 100 Bn in 2018 (Carnegie estimates), I think there's a plausible case to be made for sharply increasing E&P spending going forward. Dividends and buybacks will continue, sure, but a larger portion will be allocated toward exploration efforts than in recent years.

If we are in the early innings of an upcycle in oil service spending, multi-client seismic will do well, and TGS, having invested countercyclically, will do particularly well and reward shareholders handsomely. The company shared an interesting slide at the CMD presentation. While we should probably take that with a grain of salt, it does point out the potential impact a mid-to-upcycle could have on company financials. Free cash flow could double from ~180m USD in '22 (PF). Comparing that 360 figure with FCF in previous upcycles, it's actually not that much of a stretch.

Timing: The company reported a much weaker than expected revenue update in mid-April, which showed a 25% decline in late sales vs last year.  TGS mostly blamed this on a rapid decline in the oil price in march and heightened macro uncertainty. POC* revenues showed healthy growth yoy though, up 30%. The same pattern was seen in PGS late sales, which came in 50% below consensus. PGS however, also reported strong growth in contract seismic (+ 50% yoy) and reiterated its view that seismic markets were strengthening. The weak revenue updates shifted the market sentiment on a dime and led to a share price decline for TGS of almost 20% at the time of writing. Consensus EBIT estimates came down -8.5% for 2023 and -4% for 2024 after the revenue update.

I think this is a good buying opportunity, as I expect late sales to pick up materially later this year and beyond.

* TGS: "For the purpose of POC revenues, multiclient revenues committed prior to completion of projects are recognized on a percentage of completion (“POC”) basis. This differs from IFRS reporting where revenues committed prior to completion are recognized when the customers receive access to the finished data."

Valuation

I don't have any special insight in seismic economics that would make detailed estimates any use here. I'll rely on historical figures to estimate a fair value. I'll then compare that to consensus estimates to see how my numbers compare to current consensus expectations. Underlying this is of course my hypothesis that we are in fact in the beginning of a seismic upcycle and that TGS' business is as competitive as it was in the last E&P spending upcycle. Considering the more consolidated MC market, the investments that have been made by TGS and its increased market share, I think TGS is even better positioned for an E&P spending recovery this time around.

Bull case assumptions

Upcycle EBIT for TGS ranged from 217m in 2006 to 395m in 2011 before falling again. The mid point is 306m USD/yr. Historically, the typical EV/T12m EBIT multiple (YE) for TGS has been 8.9 (20 year median). If we assume TGS can reach the midpoint of its upcycle EBIT from previous cycles this time, the company is currently trading at just over 6x midpoint/upcycle EBIT, which compares favorably to the historical median of 8.9 times. That means an upside of about 45% from here. Assuming we reach this point in two years time, and that we can expect annual dividend payments of about 4-5% in the interim, the implied total return is around 24-25% per year. 

Market cap: 1.94 Bn

Cash: 0.19 Bn

Minority int: 0.04 Bn

Total debt: 0.11 Bn

Enterprise value = 1.87 Bn USD

Current EV/midpoint of upcycle EBIT = 1.87 Bn / 306m = 6.1x

Current consensus

Compared to current consensus estimates (n=9), my assumptions for 2025 EBIT are not particularly aggressive. Broker recommendations are positive overall, with 6 buys, 2 holds and 1 sell. Clearly, my bullishness on TGS is not a "variant perception" as they say (but that doesn't mean I'm wrong), and given the more positive consensus view we see in the table above, there is the risk that the stock price could fall further should late sales not pick up from Q2 onward, obviously.

Bear case assumptions

In a more bearish scenario where my thesis proves too optimistic and EBIT does not grow at all over the next 2 years (stays at around 130m USD) and the multiple contracts from 14.4 currently to the long term median 8.9x, there's -38% downside here. Assuming lower dividends of 3% per year in the interim, the downside is a slightly smaller -32%.

I assign a 70% p(bullish scenario) and 30% p(bearish scenario) to arrive at an expected total return of 13% per year until 2025, including dividends.

Risks

Fast tightening of charter market for vessels, cecreasing margins and hampering new sales efforts

Weaker E&P spending for longer than expected

Falling oil prices due to broad economic weakness or removal of sanctions on Iran or Russia (the latter seems unlikely right now)

Catalyst

Stable or higher oil prices

Increasing E&P spending