2023-03-24 05:08:09 ET
Summary
- TechnipFMC has a strong balance sheet, attractive earnings outlook, and potential for valuation re-rating upwards as earnings inflection triggers positive momentum.
- The updated guidance is very impressive and I believe management can achieve it.
- The company's capital allocation is impressive, with significant progress made toward its buyback authorization and dividends.
Investment thesis
I recommend a buy rating for TechnipFMC ( FTI ). There's no denying that the industry has been through a secular deflationary cycle for the better part of a decade, making for a difficult supply chain. But I think FTI has leveraged this time to come out on top as a more formidable company. Growing interest in Subsea 2.0 products gives me hope that the adoption cycle may quicken even in a moderated FID environment, as it reflects a more general cultural shift toward greater vendor-based integration and early engagement. The investment narrative for FTI is pretty simple. FTI has a strong balance sheet (<1x net debt to EBITDA ratio), an attractive earnings outlook (consensus expects $0.98 EPS in FY24 vs $0.04 in FY22), and a high possibility of valuation re-rating upwards as earnings inflection triggers positive momentum.
4Q22 results
The results were $1.70 billion in revenue, $121.1 million in EBITDA, and $503 million in free cash flow. FTI's 4Q22 results were generally strong, and the company's earnings cadence through 2023 was slightly stronger than expected. Certainly, the revised outlook out to 2025 is impressive, and it adds weight to the case that the offshore market will continue to rise steadily over the next several years.
FTI finally released the revised outlook for its long-term subsea guidance (last given since Nov 21 Investor Day ), and it did not disappoint. As market conditions have significantly improved , it is my belief that numerous investors have been anticipating a revision to the 2025 guidance. For context, management guided for $7.0 billion in Subsea revenue, $1.05 billion in EBITDA (a margin of about 15%) back in November 2021. The previous guide was, of course, not without doubts from the investing community. For myself, my main concern was what is the mature margin profile. While management, back then, mentioned that the guided 15% was not the peak, it was hard to underwrite and believe that was the case. However, fast forward today, the revised guidance came out better than the 15% guided previously, and it was a marked improvement. Subsea revenue is now expected to reach $8.0 billion with 18% EBITDA margin, resulting in an EBITDA of $1.4 billion. This was a significant increase from the previous guide, which had been set at $1.2 billion. In addition, management expects total Subsea inbound orders of $25.0 billion by 2025, which is an increase of 23% vs 2022 on an annual basis. Crucially, the FCF conversion rate is now projected to increase from 30% in 2023 to 50% in 2025. Even though investors are typically wary of multi-year forecasts, I am confident in FTI's forecast because the company has a track record of issuing accurate forecasts (I am much more confident today than in 2021). On top of these, management added their own dose of optimism. They pointed out that even if the 18% Subsea margin goal is reached, it shouldn't be seen as a ceiling because 11% of the anticipated Subsea revenue mix in 2025 will still reflect legacy backlog. All in all, I believe the forward looking statements are very positive and the market clearly loves it based on the share price reaction.
Further discussion
During the 2021 FTI Investor Day, the management team presented a set of key drivers that could potentially boost the Subsea margins. These drivers included improving operational efficiency, utilizing plants and vessels to their maximum potential, backlog projects coming online, and the incremental contribution from Subsea Service. These drivers are still relevant today, and the projected increase in Subsea Service revenue attests to their ongoing relevance. FTI also highlighted its unique offerings, such as iEPCI and Subsea 2.0, which are supported by the company's industrialization initiatives. I believe these offerings distinguish FTI from its competitors and contribute to its potential for continued growth and success. Moreover, FTI's focus on energy security enables it to work with the right partner that it can extract maximum synergies from. I expect such focus to be reflected in the alignment of contract terms and contributes to FTI's competitive differentiation in the marketplace.
According to Surface Technologies' management, the company will earn $1.375 billion at 13% margins in 2023, which will lead to 30% y/y EBITDA growth. Specifically, I anticipate that the international sector, particularly Saudi Arabia and the United Arab Emirates, will be the primary driver of growth, with the latter contributing significantly to the former through a boost in international revenue. The elimination of underperforming NAM region stores and product lines will have a negative effect on Surface revenue, but expansion into new international markets will help mitigate this effect. Nonetheless, these changes should have a positive effect on bottom lines generally.
Capital allocation
The management team has made significant progress towards its share buyback program, purchasing around $50 million worth of shares. This purchase signifies that the company has completed 25% of the buyback authorization that was last year. Moreover, the updated guidance suggests that the company's FCF conversion is expected to increase from 30% in 2023 to 50% in 2025. Given this improvement, I continue to anticipate that shareholder returns will remain a priority for the company. In fact, the management team has reiterated its commitment to initiating a quarterly dividend in the second half of 2023.
Valuation
My variant view for FTI is that I expect valuation to re-rate upwards to 7x forward EBITDA from the current normalized multiple 5.3x (using 24mths forward EV/EBITDA multiple), which I don't think it's fair given the strong earnings growth outlook (FTI is expected to increase its EBITDA by nearly 2x from FY22 levels). As to why I put the valuation at 7x is because historically it is where FTI would trade at when earnings outlook was particularly strong. This is the case in FY15, where FTI traded at 7x forward EBITDA when EBITDA, then, grew more than 2x from ~USD950million to ~$2.1 billion.
Risks
The growth of the oil field services industry is directly proportional to the amount of money invested in it by upstream oil and gas companies. And expenditures are proportional to the cash flow from E&P, which is highly sensitive to the price of oil and natural gas. For FTI, a prolonged period of low oil prices could have a negative effect on its backlog and future earnings potential because of the prolonged period of low orders for subsea equipment. In addition, the nature of mega-projects in the deep sea means that orders for subsea trees have historically been lumpy, adding an additional dimension of uncertainty. Risks associated with civil unrest, terrorist attacks, currency fluctuations, and governmental actions are all on the rise in a number of international markets.
Conclusion
FTI is a buy-rated stock with a strong balance sheet, attractive earnings outlook, and potential for valuation re-rating upwards as earnings inflection triggers positive momentum. The 4Q22 results were impressive, and the revised outlook for the long-term subsea guidance exceeded expectations. The company's capital allocation is also impressive, with significant progress made towards its buyback authorization and dividends. Overall, FTI is poised for steady growth over the next several years and is a solid investment option.
For further details see:
TechnipFMC: Things Are Setting Up Well For Strong Years Ahead