Description

Technip Energies is a 2.1b EUR market cap company with a net cash position of 2.5b EUR. They are guiding for 262m EUR in Net Profit this year, implying an 8x earnings multiple. Their 17.8b EUR backlog (with more new projects in the pipeline) roughly covers 3 years of revenue.

The caveat is that there is a 3.3b EUR negative working capital position. TE’s customer pays whenever TE reaches certain milestones, but this is heavily front loaded over the life of a typical project. As a consequence, there is a large inflow of cash in the early years of a project, followed by a cash outflow towards the later years. Given the cyclical nature of the business, most of the net cash should be kept in reserve in case the company can’t sign new projects in a downturn. Sell side reports are focused on how much of the negative working capital should be added to the EV (the 2.6b EUR net contract liability, or the ~2b EUR contract liability using pre-IFRS 15 accounting rules). This misses the point: which is that TE has an extremely attractive cost of capital and a clean balance sheet. As long as the company is a going concern, it should be valued at an earnings multiple, in which case I find the current 12% earnings yield quite attractive given the clean balance sheet.

Furthermore, while working capital movement will be very volatile, TE recently signed a 6.5b EUR project with Qatar LNG which will bring cash in, while their other large project Yamal LNG is nearing the end of its negative cash flow impact. In other words, I think the working capital level should be somewhat stable going forward.

What creates the opportunity?

The opportunity probably exists because TE FP is a new security, spun off from FTI this February. Q1 was the first Q reported as a stand-alone company, but those financials have not yet found their way into Bloomberg, making it hard for the quants and lazy institutional investors to do their work.

As a short history, the French Technip combined with the American FMC technologies in early 2017 after having partnered on subsea for 2 years. FTI was both listed on the NYSE and on Euronext Paris. In 2020 it was decided to split the business in Upstream (TechnipFMC, FTI) and Midstream / Downstream (Technip Energies, TE). After a small delay due to Covid, the spin off was effectuated on February 16^th 2021. FTI shareholders received ~14 USD worth of TE for every 40 USD worth of FTI. However, the TE ADR (THNPY US) was listed OTC, making it harder to hold for the non-European investors. To top it off, on February 12^th, FTI US was also booted from the S&P500. This by itself must have caused quite a bit of forced selling.

At the time of the spin, FTI retained 50% of TE. After having sold some shares to TE’s 2^nd largest shareholder Bpifrance, and selling 14% of TE on April 25^th, they still own close to 33% on which they have a lockup until June 24^th. They communicated their intention to sell out of their entire stake in 12-18 months after the spinoff. So there is still a slight overhang, further explaining the depressed share price.

Business

Just a few words on the business. TE is effectively an EPC (Engineering, Procurement, Construction) contractor in the energy industry. In a typical project, a group of 1000 disgruntled engineers perform mundane tasks which results in the creation of thousands of technical drawings and spreadsheets, which are subsequently sent to 10.000 even more disgruntled construction workers whose only real interest is in booking overtime but who occasionally weld some steel together according to said drawings. In the defense of those construction workers, projects are often in remote locations and performing physical labor in Siberia on projects such as Yamal LNG or Artic LNG 2 is effectively the Russian equivalent of the death penalty, presented to the employees as a career opportunity.

EPC contractors either take on a project on a cost-plus basis (the client bears the risk of cost overruns and the EPC contractor just earns a margin) or lump-sum (the EPC contractor carries most of the risk, although they try to blame cost overruns on the client and try to reclaim the money through contracts known as "Change Orders"). It has always been a competitive market, and the last 10 years have become more competitive, especially in the Middle East where Korean companies have underpriced the market. Not surprisingly, every downturn 1 or 2 EPC contractors go belly up (CBI / MCDIF) because of cost overruns or 1 or 2 lump-sum projects. Senior executives at Petrofac who pleaded guilty to bribery and corruption charges related to project awards in the UAE are also telling for what it takes to be awarded a contract these days.

At the same time, being able to deliver an LNG terminal on time is worth a lot to a client. I believe Technip has by far been the most successful company in the LNG space in the last decades, having built >20% of existing capacity. The last train of Yamal LNG was delivered a year ahead of schedule (the project was taken over from CB&I after they fumbled the FEED contract in 2012). Arctic LNG 2 (next door to Yamal, also owned by Novatek) was awarded to TE based on their past performance, not because TE undercut its competitors on price. The 13b USD Qatar LNG (4 LNG trains, split 50/50 with Chiyoda) was awarded to Technip because they built the existing 6 LNG trains at the facility. Qatar will award another contract for 2 more trains in the next few years, which will be Technip’s to lose.

To my knowledge, Technip does not work on any large lump-sum projects in the US (unionized labor), which is really what caused the bankruptcy of CB&I. For larger contracts, risk is often split through a JV with construction partners Chiyoda or Saipem. And most importantly, there are currently no large projects at risk of falling behind schedule. In the last 10 years, EBIT margins for TE have fluctuated between 2.8% and 7.1%, but have never been negative and they averaged 5.4% (current guidance is 5.5%-6.0%). In other words, Technip is one of the best operators in what is generally a lousy industry and I’m comfortable with the operational risk.

Finally, Technip Energies is marketing itself as an energy transition play. 70% of their projects is related to CO2 reduction (low carbon LNG, etc), carbon capture and storage, biofuel, hydrogen, etc. Many of those projects are currently in a FEED (front-end engineering and design) phase, meaning a portion of them will actually end up being built which results in a lot more work for TE. I’ll leave it to the ESG funds to figure out whether natural gas is essential for an energy transition. All I care about is that TE seems a lot less untouchable for ESG funds than FTI, at a time where ESG funds might suddenly find them at risk of underperformance if they don’t own any energy or materials companies.

I expect TE to rerate as they continue to show steady quarters and the market figures out that 8x P/E for a capital light, net cash company seems pretty cheap in these markets. I think everyone who looks at the financials will come to the same conclusion, most people just haven't looked yet. They should start paying out 30% of profits (4% dividend yield) in 2022. Note that the mid-term guidance is for further margin expansion of 100bps which would lower the multiple to 6.5 – 7.0x.

Catalyst

Forced selling / FTI overhang to disappear

Increased awareness as Bloomberg updates latest financials

Announcement of dividend (30% payout, ~4% yield) in 2022

Continued in-line performance

Easier to understand financials as a stand-alone company. TE will also show proportionate consolidation of their JVs which will help readability.