SAPMY - Saipem: Huge Backlog Is Precursor To Upcoming Earnings Growth

2023-03-24 17:28:30 ET

Summary

• Saipem SpA has a massive backlog, which is a precursor to upcoming earnings growth, with the consensus estimate placing the company's EBITDA 2.5 times higher than FY22 levels by FY26.
• The sale of the drilling business has strengthened the balance sheet position of Saipem.
• Saipem presents a long-term investment opportunity due to various persistent structural trends in the oilfield services industry.

Overview

Saipem SpA ( SAPMF ) presents a long-term investment opportunity based on various persistent structural trends in the oilfield services industry. These include deepwater exploration, presence in the Middle East, a surplus of offshore drilling resources, and the liquefied natural gas market.

Even though SAPMF is no longer wholly owned by Eni S.p.A. (E), the company still counts it as a major client alongside Aramco. The sale of the drilling business was a smart strategic move that strengthened SAPMF's cash position and made it a low-leverage company, and both are fundamental to improving SPM's valuation and share price. The investment story is straightforward: SAPMF has massive backlogs, which will translate into earnings growth (the consensus estimate places SPAMF's EBITDA 2.5 times higher than in FY22 levels, at around EUR1.2 billion in FY26).

As such, I find Saipem SpA to be a compelling investment due to its solid earnings potential and balance sheet (after refinancing). I believe the market is already slowly catching up on this story as seen from the share price reaction post earnings, where investors are digesting the improved guidance presented. Following the earnings, SAPMF also announced its confirmation of a long-duration contract for the Deep Value Driller , which further improves its backlog and potential earnings growth in the coming years.

Despite the many positives, I believe the revised guidance (upwards) on CAPEX for FY23 seems to be the "negative," which I guess is fine given the tradeoff for capitalizing on growth opportunities. Given the prominence free cash flow ("FCF") deployment was given in the Q4 conference call , I can rest assured that it is a top priority for management.

In my opinion, management should use FCF to strengthen the company's balance sheet and return some of that money to shareholders (e.g., return capital). Elsewhere, the incorporation of four newly leased rig units should have a mildly positive effect on valuation, as they shift the overall margin mix toward drilling. The E&C onshore margin was the only thing that worried me about the Q4 2022 results as a whole, but I don't think that should take away from what was otherwise a very encouraging message about the state of the market and the company's ability to turn a profit.

Q4 2022 results summary

Revenues in 4Q22 increased by 3% quarter-over-quarter to €2.9 billion and by 62% year-over-year. Adjusted EBITDA decreased 18% quarter-over-quarter to €150 million, indicating a margin of 5.1%. The fourth quarter margin for E&C onshore was the biggest letdown, but the outlook for FY23 looks promising (which I take as the E&C onshore margin letdown is not going to happen again). The quarter's order intake of around €6 billion resulted in a book to bill ratio of 2.05x, and the full-year FY22 backlog now stands at $24 billion.

More vessels coming online

Management has noted an uptick in vessel day rates and contract duration, citing discussions of a possible 10-year drilling contract. This seems to be especially true for high-spec vessels, and if SAPMF is successful in matching client contracts with lease agreements, it could add two more deepwater vessels this year. If this were to happen, the company's long-term earnings prospects would improve even further.

Backlog and strategic plan

The conversion of backlog to earnings is the core part of my thesis. Assuming nothing drastically changes in the world, this will happen. After winning the Qatargas contract, SAPMF saw a surge in order volume in 4Q22, increasing their book to bill ratio to 2.05x. In comparison to the previous quarter, 4Q22 saw a 15% increase in SAPMF backlog, reaching €24.0 billion. To put things into perspective, this was the highest quarterly order intake for SAPMF since 2Q14, eight years prior.

Dividends

The possibility of dividend payments being resumed after 2024 could be a boon to the share price. As the balance sheet returns to normalcy, which I expect to happen by FY25, the company's management has mentioned considering reinstituting the dividend at that time at the earliest. By FY25, assuming no debt reduction occurs between now and then, the consensus estimate for EBITDA suggests a net debt to EBITDA of just 2x - which is a fairly strong balance sheet. As for the near term, the allocation of capital to take advantage of the uptick in offshore drilling and the maintenance of sufficient cash on the balance sheet are, in my opinion, far more important to the business and its shareholders than the payment of dividends in the near future.

Risks

There are a few potential pitfalls here. The volatility of oil prices, the rate of significant new E&C awards, and the length of time it takes to retire SAPMF's deepwater offshore rig contracts are all factors that could have a significant impact on the company's earnings. In my opinion, legal risks are also frequently disregarded. SAPMF is currently facing a large number of lawsuits with high face values totaling multiple billions of dollars.

Conclusion

Saipem SpA appears to be a compelling investment opportunity based on its solid earnings potential, strong balance sheet, and positive industry trends. While there are some risks to consider, such as the volatility of oil prices and legal challenges, the company's recent strategic moves and backlog growth are encouraging signs for future earnings growth. Additionally, the possibility of dividend payments resuming after 2024 could be a positive catalyst for the share price. Overall, I believe that Saipem SpA has the potential to generate long-term value for investors.

For further details see: