SUBCY - Subsea 7: Progressive Rebound For Offshore Project Manager

2023-03-20 04:52:37 ET

Summary

• Subsea 7 is a London-based offshore project manager delivering services to develop complex offshore oil, gas & wind developments.
• The company is strategically branching out to renewables to complement its conventional subsea business line.
• The order book has swollen, but country risk, concentration, and state funding for renewables plays remain possible future challenges.

Company Introduction

Subsea 7 ( OTCPK:SUBCY ) is a world class offshore oil & gas project manager providing subsea field development products and services including project management, engineering, procurement, installation and commissioning (EPCI).

The $3.4B offshore services provider provides offshore pipelay, construction, fabrication and installation of subsea umbilicals, risers, and flowline systems, along with offshore inspection, repair, and maintenance. Additionally, the company operates heavy lift operations and transportation services of jackets, wind turbines and ancillary offshore structures.

Decommissioning of offshore oil platforms is another segment the oil & gas project manager provides. All in, the company delivered FY2022 EBITDA of $449M on sales of $5.135B, trading at almost 32x forward.

Subsea 7 covers a comprehensive range of life of field services.

The past 5 years have been somewhat of a rollercoaster ride for Subsea 7 equity holders. The wholesale paralysis of the global energy industry driven by the SARS-Cov2 pandemic not only saw the London based project manager shed -70% of its value at the time but provided the firm an opportunity for a strategic rebirth with renewed focus on heavy lift and offshore wind.

Over this period, Subsea 7 has seen the departure of veteran CEO , Jean Cahuzac, and the arrival of John Evans in early 2020. Under Evans, that leadership team has been reshuffled with industry veteran Olivier Blaringhem running the conventional cash cow part of the business and Marcelo Xavier, a Brazilian subsea engineer, focusing on strategic development and sustainability. Its telling to have a Brazilian on the leadership team, perhaps for the first time, and highlights the importance of the ultra-deep water subsea market for the offshore energy player.

These organizational changes, coupled with Stuart Fitzgerald’s timed exile to head industry leader Seaway7, provide insights into the direction the firm is likely to take. At ZMK Capital, we believe it is a positive one.

Our outlook for the firm remains positive [Hold] with the caveat that Brazilian political stability and a renewal of energy prices need to be present for any new investment in the firm. The offshore wind business is likely to continue its growth trajectory and offset a potential slowing of investment in ultra-class offshore petroleum developments. Global economic growth is likely to be a factor too with any signs of a year-end recession likely to put pressure on aggregate demand, energy prices, and consequently move energy project timetables to the right. Hold.

Project Overview & Prospects

Solid progress is being made on the Sakarya Field Development with 89% of works complete. The gas field located in the ultra-deep waters of the Black Sea, some 175km off Eregli, Turkey is a project being carried out for state-owned oil & gas company Turkish Petroleum. In the future, the development is expected to provide 30% of domestic natural gas demand with first production in the second half of 2023. Subsea 7 has participated in a consortium with Schlumberger to complete engineering, procurement, construction, and installation which was awarded at the end of 2021.

Scope of works have included installation of subsea production systems, subsea umbilicals, risers and flowlines ((SURF)), ancillary subsea hardware, the laying of a 170km gas export pipeline and development of an onshore production facility. It is worth noting that Saipem ( OTCPK:SAPMF ) (pipelay) and Tenaris ( OTCPK:TNRSF ) (steel pipe supply) actively contributed to this project too.

Senegal’s conventional Sangomar Field Development is 72% complete with Seven Vega and Seven Sisters actively working on the field. Australian nameplate oil gas developer Woodside ( OTC:WOPEF ) is actively managing the field, which was discovered in 2014. Commercial production of oil is penned in for the end of 2023 with all-in development costs expected to be around the $4B mark. 23 wells, a floating production, storage, and offloading facility (managed by MODEC ( OTCPK:MDIKF )), subsea manifolds, trees and related architecture make up the entire project’s scope of work.

Bacalhau is an ultra-deep water oil field development in the Santos basin offshore Brazil. Discovered in 2012, the project is not as advanced with only 55% scope of work complete. Field depth is 2,050m with appraisal wells confirming the presence of light oil with API 31. This is relatively unusual for Brazilian mega fields that tend to have high levels of hydrogen sulfide and carbon dioxide. Life of field is expected to produce between 700M and 1.3B of high-quality sweet crude.

Mero 3 is another Brazilian ultra-deep water play, presently at its early stages with some procurement works completed. The field is situated some 180km offshore Rio de Janeiro in the pre-salt area of the Santos basin. Mero 3 works are an extension of a field having already achieved first oil in early 2022.

The Seagreen Off Shore Windfarm is a North Sea renewables development between TotalEnergies ( TTE ) and SSE Renewables. Project works are almost completed with Subsea 7 having installed 105 jackets and commenced yard demobilization.

The Dogger Bank Wind Farm has progressed with 33% of contracted works complete. This is an extensive North Sea development which will be among the world’s largest once completed.

Subsea 7’s current project portfolio is heavily focused on ultra deep offshore Brazilian plays and UK wind.

The outlook for future work remains heavily focused on lucrative but complex deep water offshore Brazilian pre-salt oil plays. At least 5 projects weighing more than $750M apiece are likely to be tendered over the coming years for Brazilian giant Petrobras ( PBR ) while Guyana and its newly discovered gas fields is likely to continue to attract additional project works.

In Africa, Cameia, a conventional Angolan deep water oil play run by Total E&P Angola ((TTE)) is likely to generate interest. Developments in the prolific Browse gas field will be the main show in town in the Asia Pacific region while some smaller works in Europe and extension works in Turkey are likely to be key targets.

Future subsea projects represent the lion’s share of the project manager’s revenues.

The offshore wind market is heavily focused on North Sea developments with both the United Kingdom and the European Union sharing the main part of future prospects. This is particularly important given the degree of market concentration implying a correlation between the wellbeing of the European/ UK economy’s and future public investment and subsidization of renewable energy.

Offshore wind projects are an important part of Subsea 7’s growth portfolio.

Financial Results

Subsea 7 delivered substantively better financial results driven by renewed interest in oilfield development of the back of a post Covid energy boom. Backlog remains strong with the Subsea & Conventional order book totaling $8.2B and the smaller renewables business representing $0.8B. 2022 saw a mammoth order intake with the company acquiring roughly $7B of new business.

The oil field market is recovering strongly, with highest order intake since 2013. While we are a long way away from the huge numbers posted during this period (FY 2013 EBITDA $815M on sales of $6.2B), solid order intake presages perhaps what lies ahead for the offshore project manager. Backlog has provided good visibility on workload for the firm over the next 3 years.

A massive boom in EBITDA margins occurred when supermajors fast tracked projects only for the second half of the decade to see overcapacity, a lull in prices and the eventual impact of the SARS-Cov2 pandemic.

EBITDA margins have continued to improve despite being a long way away from the big margin boom-time of the middle of the last decade. Margin recovery is slowly coming about auguring well for the future of the company’s workload. Strong improvements in awarded project margins was noted in the second half of 2022 with lower margin jobs likely to be executed during this year. Adjusted EBITDA margins are expected to return to 15%-20% levels previously witnessed but remain dependent on conservative project management and sound project costing.

Subsea and conventional work accelerated during 2022. Backlog increased +37% to $8.1B with award wins in the Gulf of Mexico, offshore Brazil, the North Sea, Guyana and Angola. Revenues increased +6% to $3.9B and EBITDA margins moved to the upside at around 13.6%. Solid progress continues to be made in Subsea 7’s biggest segment but attention needs to be made to the lag factor between energy prices and the sanctioning of new work.

The renewables business saw somewhat of a downturn in 2022. Backlog was down -32% and revenue regressed accordingly as projects such as Seagreen neared completion. Adjusted EBITDA levels came in lower at (0.4% in FY 2022!) but improved during the latter part of the year. While the renewables business is a notable line of growth, it generally relies heavily on State-funded subsidization and the growing importance of sustainability in the energy mix. Skill sets required are often not as specialized as subsea petroleum engineering meaning barriers to entry remain lower.

The company delivered notable improvements in cash flow.

Subsea 7 delivered solid operating cash flow in 2022 with a $27M decrease in working capital positively impacting cash flow from operations. The company continued to deploy capital with $231M in capital expenditure linked to new build vessels and dry docking of older units. Lease payments to fund the company’s extensive fleet totaled $111M with another $78M being paid out as dividends.

Guidance for 2023 remains bullish with the company expecting to better 2022’s results. Revenues are likely to exceed $5.1B allowing for adjusted EBITDA to top $559M delivered in 2022. Net operating income is expected to be in line with 2022’s results (~$150M) and capital expenditure is expected to accelerate (~625M) on the back of targeted investments in Seaway7, the firm’s heavy-lift business offering.

Subsea 7 continues to build its ownership stake in Seaway7 with the company announcing an additional 21% increase in shareholding. The fact that the deal was all shares does indicate perhaps management believes Subsea 7 equity remains on the high side, particularly given the $645M the firm holds in cash & cash equivalents.

Subsea 7 is an extremely asset intensive business with high levels of fixed operating costs & sizable barriers to entry.

Risk

There is sizable risk in holding Subsea 7 equity despite some of the positive economic signals the firm has been telegraphing. The company finances an extensive fleet of pipelay, heavy lift, construction, inspection, maintenance and repair units which inflates fixed operating costs and makes matching supply and demand rather complicated. The subsea project industry has been prone to notable boom and bust cycles (2013-2016) linked to the time to market for newbuild construction vessels.

The lag between new build capacity and work is a complicated one to manage and has resulted in notable bankruptcies, financial strain, and restructurings (Sapura Energy ( OTC:SKPBF ), Mcdermott ( OTC:MCDIF ), Saipem). While Subsea 7 has been conservatively managing debt loads, tighter credit markets are likely to impact costs.

The company’s has wagered heavily on offshore wind which is a market heavily subsidized by sovereign states with meaningful activity in the North Sea. The United Kingdom’s dour financial state post Brexit may impact future project funding while concentration risk (most projects are either UK/ Europe) prevails.

Country risk linked to Brazil is also an important factor to consider. Political volatility in Brazil following the recent election of Lula is likely to put Brazil’s rich pre-salt oil plays into a state of flux as the newly elected government attempts to reverse some of the Bolsonaro policies. While correlation does not equal causation it is important to highlight that the current president was linked to Brazil’s biggest oil corruption scandal – operation car wash.

Key Takeaways

Subsea 7 presents an interesting investment opportunity for long-term exposure to energy. It has a compelling portfolio of projects, improving order book, conservative finances and interesting strategy focused on growing the renewables business.

But this does not detract from risks that exist – a boom-to-bust track record of offshore project managers, concentration in deep water Brazil and the UK/ European renewables markets and pressure on oil prices driven by a decline in the global economy. For those reasons, we will remain on the side-lines.

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