OII - Oceaneering International: Buy On A Pullback With Business In Early Stages Of Multiyear Upcycle

2023-10-02 12:42:53 ET

Summary

• Oceaneering stock has risen by 51% since late March 2023, outperforming the S&P 500 index.
• The company's operational metrics indicate a steady improvement, while its financials have shown positive signs, including increasing revenues and operating margin, along with decreasing debt.
• Long-term investors may want to consider buying the stock on a pullback due to the expected cyclical swing.

Since my last article on Oceaneering International ( OII ) in late March 2023, the stock of the leading provider of remotely-operated vehicles (ROVs) to the offshore oil and gas industry has risen by approximately 51% as illustrated in Figure 1, compared to the 7.8% gain achieved by the S&P 500 index. Thanks to this impressive appreciation, Oceaneering now trades about 7.2% higher than the median 12-month price target of $24.00 estimated by seven Wall Street analysts.

On the other hand, Oceaneering has released two quarterly earnings reports since the publication of the aforementioned article and is scheduled to report its third-quarter 2023 results on October 25, 2023 , after the close of trading on the New York Stock Exchange.

At this juncture, the critical question for investors is whether to take profits after the 51% run or to stay put for potential further gains in the foreseeable future. Below, let's attempt to answer this question by analyzing Oceaneering's operations and updating the investment thesis.

Business Operations

Oceaneering's ROV fleet has remained stable at approximately 22,750 available days for 14 consecutive quarters since early 2020. However, during the same period, ROV utilization appears to be gradually recovering despite seasonal variations, with the first quarter often experiencing relative weakness. ROV utilization reached 70.5% by the 2Q2023, as shown in Figure 2.

As a result of improving ROV utilization in conjunction with a stable ROV fleet, there has been an increase in ROV days utilized when seasonal variations are excluded. Simultaneously, the implied day rate, or revenue per day on hire, has also continued to rise, as shown in Figure 3.

Financials

Since both ROV days utilized and the implied day rate have been rising, Subsea Robotics' revenue has reached the highest level since 1Q2016. Revenues from the other business segments have also shown improvement, resulting in a total revenue of $597.9 million, the highest level since 2Q2016, as illustrated in Figure 4. Although the top line was still approximately 40% below the maximum quarterly revenue ($973.1 million) reached during the last oil peak in 3Q2014, the business is clearly in the early stages of steady improvement.

The operating margin has been on an uptrend, reaching 8.2% in 2Q2023, near the highest level since 4Q2015. This uptick is driven by the strong recovery of the Subsea Robotics division, as seen in Figure 5. Similar trends of margin improvement have also been observed in the EBITDA margin (Figure 6) and net margin (Figure 7). Although the margins reached in 2Q2023 are still significantly below those achieved during the last oil peak in 2014, they are clearly in the early stages of a comeback.

Thanks to its improving profitability, Oceaneering has been paying down its debt since 1Q2020, as shown in Figure 8. As a result, the company's balance sheet is now in a relatively healthy shape.

Outlook

The backlog of manufactured products declined slightly in the past two quarters when oil prices had pulled back. However, prior to that, it had recovered to around half the levels reached during the previous peak in late 2013 and early 2014, as shown in Figure 9. This indicates that the offshore E&P industry is slowly recovering, implying stronger financial performance going forward.

Oceaneering guided toward $75-85 million in adjusted EBITDA for the 3Q2023, which is slightly higher than the figure reached in the 2Q2023 ($74.8 million). For the year 2023, the company estimates that it may generate a total of $275-310 million in adjusted EBITDA, marking a 26% increase from 2022, and $90-130 million in free cash flow, reflecting a 176% rise from the previous year, as shown in Table 1. At this rate, Oceaneering could potentially retire all of its debt by the end of the next year using its free cash flow.

Valuation and Risks

Oceaneering is currently valued at 9.5 times its 2023 adjusted EBITDA or at a P/2023 FCF multiple of 23.6X. These multiples might suggest that Oceaneering is expensive. However, as I discussed in another recent article , traditional valuation multiples for a cyclical business can significantly mislead an investor, as taught by Peter Lynch:

" Conversely, a high p/e ratio, which with most stocks is regarded as a bad thing, may be good news for a cyclical. Often, it means that a company is passing through the worst of the doldrums, and soon its business will improve, the earnings will exceed the analysts' expectations, and fund managers will start buying the stock in earnest. Thus, the stock price will go up. "

As discussed earlier, Oceaneering is still in the early stages of a multiyear up-cycle. The company is expected to achieve a 26% growth in adjusted EBITDA and a 176% increase in FCF in 2023 alone. Therefore, from a long-term perspective, Oceaneering may not be as expensive as the multiples suggest.

The primary risk continues to be the reluctance of E&P companies to ramp up their capital expenditures. Rising operating costs in the current inflationary environment are another risk that could threaten margin expansion.

Investor Takeaways

An analysis of Oceaneering's operations and financial performance suggests that the business is in the early stages of a multiyear upcycle, as illustrated in Figure 10. From a long-term perspective, seemingly high valuation multiples may be misleading, considering Oceaneering operates in a hyper-cyclical industry. I maintain the opinion that long-term investors should consider buying the stock on a pullback.

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