GEOS - Recent Contract Boosts Geospace Technologies But Some Concerns Persist

2023-03-24 12:38:55 ET

Summary

• A recent defense sector deal related to an advanced marine seismic acoustic technology has brightened the company's outlook in 2023.
• It plans to consolidate its OBX rental operations and reduce costs by selling the satellite use facility.
• Free cash flow remained mildly negative in FY2022.
• The primary concerns include slow demand growth in the rental and marine wireless nodal products, and several years of net losses.

GEOS Fights Back On New Contract

Geospace Technologies Corporation (GEOS) turned the tide to its favor earlier this year when it secured a $1.5 million contract with DARPA (Defense Advanced Projects Research Agency). GEOS's stock price, which moved sideways for several months, seems to have kick-started its growth engine following the DARPA deal in late February. Following the acquisition of Quantum in 2018, it has integrated a platform that detects, locates, and tracks items of interest in real-time. The company also aims to diversify away from the typical border security work with Quantum's Analytics Technology applications. As a result of these positive changes, the company's gross and operating margins grew in Q1 2023.

However, investors need to be concerned about the operating risks. GEOS has been making losses for several years now. Although it has a clean balance sheet, net loss on top of negative cash flows can be concerning. Also, its low market capitalization can make it vulnerable to stock price volatility. Given its low current valuation relative to the past average, investors might want to "hold" it for now. GEOS's current EV/EBITDA multiple (14.9x) is lower than its five-year average (22.8x).

Explaining The Growth Drivers

GEOS designs and manufactures seismic instruments and equipment to locate, characterize, and monitor energy reservoirs. It also manufactures for the offshore and defense sectors. The company has devised a system that deploys passive seismic-acoustic phased arrays for various environments. Geospace's experience in high-quality seismic data acquisition through cabled and nodal seismic systems would give it an advantage over its peers.

Especially the company's passive acoustic and seismic technologies are considered superior to overhead surveillance. Such technologies are used for non-line-of-site signals for vibrational sources. Since the announcement of the DARPA contract, the company's share price has rallied by 5.7%. During this period, the VanEck Vectors Oil Services ETF (OIH) lost 11% of its value.

Recently, higher offshore activities have boosted demand for the company's seismic sensors and marine products and have become the company's primary driver. Plus, much of the sensor sales are long-term, which would help its revenue visibility. It also plans to streamline operations and reduce costs by selling the satellite use facility. Following the sale, it will consolidate its OBX rental operations into the central campus location. Among the legacy products in the Adjacent Market segment, GEOS's ruggedized water meter connector cabling, specialty cables, and the Aquana smart valve products may see market share growth.

The Changing Industry Dynamics

Seismic exploration demand dipped during the pandemic as drilling activity was subdued. However, the US drilled and completed wells for the past year increased by 25% each until February 2022. The demand side strengthens, given China's re-opening of the economy and higher demand for oil, gas, and energy, despite the geopolitical uncertainty related to the Ukraine war. Much of the improvement has been offshore. That is why GEOS's OBX (a marine-based wireless seismic data acquisition system), the rental fleet, and ocean bottom nodes drive revenue growth in this environment.

The company's management has high hopes for the Mariner, a shallow water design node. Data from the Mariner and OBX 750 is cross-compatible because both equipments can operate simultaneously, and cross-combination is possible. So, even though both serve different markets, they can be mixed for various usages to decrease operating costs.

Analyzing The Q1 Drivers

From Q1 2022 to Q1 2023, the company's revenue increased by 73%. Revenues from the Oil and Gas Markets segment saw the highest revenue rise (109% up) because higher demand for seismic sensors and marine products increased. More importantly, much of the sensor sales are long-term, which will help improve revenue visibility into the future. Its wireless product revenue saw a similar rise in revenues in the past year due mainly to higher utilization of the OBX rental fleet. Higher sales of OBX ocean bottom nodes contributed to the largest portion of wireless seismic revenue.

Revenues from the Adjacent Markets segment increased by 32% in the past year until Q1 2023. higher demand for cables and smart water meter connectors led to the rise. The revenue traction also led to higher profitability. But lower imaging product revenue during the holiday season partially offset the growth.

A Margin Discussion

Higher sales of marine wireless exploration products, increased demand for water meter cables, and better OBX rental fleet utilization led to a steep margin recovery. From Q4 2022 to Q1 2023, the company's gross margin expanded significantly (by 950 basis points), while the improvement was even better year-over-year. The company's EBITDA also turned positive in Q1 2023 compared to negative EBITDA for several quarters.

Cash Flows And Liquidity

In FY2022, GEOS's cash flow from operations (or CFO) remained lightly negative and nearly unchanged from the previous year. With a low capex, free cash flow remained mildly negative in FY2022. Given the new rental contracts, the company expects to spend ~$6 million in capex on the rental fleet in FY2023. As of December 31, GEOS's debt was nil - a clear advantage over some of its peers (FTI, PFIE, SLB). Its liquidity was $20 million on December 31.

Risk Factors

The oil and gas industry has an inherent lag between the change in oil prices and the resulting change in demand for oilfield services products. Although the offshore market started to grow, crude oil prices falling from the 2022 high can blow its medium-term performance. Since the 2020 downturn, operators are allocating their cash flow towards increasing shareholders' returns through stock buy-backs and dividends. As a result, demand for the company's Oil and Gas Markets products and rental, marine wireless nodal products would stay low in the medium term.

As a result of the above, the company has been incurring net losses for the past several years. As a result, its retained earnings have also been negative, reducing shareholders' equity and increasing the stock's risk profile. For a relatively small market capitalization company like GEOS (~$83 million), a change in its risk profile can impact the share price.

What's The Take On GEOS?

GEOS has turned the table following the DARPA deal in late February. The project relates to advanced marine seismic acoustic technology, where the company has already built expertise over the past few years. I expect the company's OBX and Mariner products are expected to drive growth in offshore and shallow waters. I also expect its market share in the ruggedized water meter connector cabling to grow. So, the stock outperformed VanEck Vectors Oil Services ETF last year.

But the company's financials are still not out of the woods because of the continued net losses over the past several years. Its Oil and Gas Markets products and rental, marine wireless nodal products may stay low in the medium term. Although its cash flows are minimal, a debt-free balance sheet would always catch the attention of investors looking for a safe bet. The stock is apt for a "hold" for now.

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