There has been a lot of talk of the opportunity in the energy sector as a result in the sell off of the Gulf of Mexico (GOM) producers, drillers, platform operators...etc. Most of these names have been halved in price; BP is offering 10% dividend yield, which is an amazing return by itself.
The question presenting itself, is the disaster an opportunity for stock pickers? Some think it is.
The disaster is a game changer. No one can argue that in a couple of years, and into the distant future, GOM operators will operate in the same manner as they did few years back. I do not think so. Costs are going to go up materially.
Insurance, security bonds, royalties, clean up funds, taxes...etc will be on the rise as a result of this disaster. Some suggest that platform operators like SeaHawk (HAWK), which I reviewed their spin-off and did not like, is a good value proposition as it is selling below liquidating value. However it was selling below liquidation value a year ago as well.
I think the smaller the player the more disadvantaged operationally and financially in the new and expected environment. Weak balance sheets will find it harder probably to comply with bond and clean up funds requirements and will be forced out by the bigger players, who ironically caused the disaster in the first place.
If I wanted to buy, I like McDermott International (MDR), which will spin off it is off-shore construction and management business. The company operates three businesses:
MDR will operate the off shore construction business and the spin-off will own the other two.
My idea is to buy on the spin off date MDR as it will be more than likely added to the several energy sector ETF and mutual funds. Those funds did not own it due to the complexities of the other two units and was not pure play energy equity.
To capitalize on the energy sell off, I will require more odds in my favour and I think MDR might do it.
The question presenting itself, is the disaster an opportunity for stock pickers? Some think it is.
The disaster is a game changer. No one can argue that in a couple of years, and into the distant future, GOM operators will operate in the same manner as they did few years back. I do not think so. Costs are going to go up materially.
Insurance, security bonds, royalties, clean up funds, taxes...etc will be on the rise as a result of this disaster. Some suggest that platform operators like SeaHawk (HAWK), which I reviewed their spin-off and did not like, is a good value proposition as it is selling below liquidating value. However it was selling below liquidation value a year ago as well.
I think the smaller the player the more disadvantaged operationally and financially in the new and expected environment. Weak balance sheets will find it harder probably to comply with bond and clean up funds requirements and will be forced out by the bigger players, who ironically caused the disaster in the first place.
If I wanted to buy, I like McDermott International (MDR), which will spin off it is off-shore construction and management business. The company operates three businesses:
- off shore drilling project management,
- government operation: nuclear submarine building, and
- fossil fuel power construction
MDR will operate the off shore construction business and the spin-off will own the other two.
My idea is to buy on the spin off date MDR as it will be more than likely added to the several energy sector ETF and mutual funds. Those funds did not own it due to the complexities of the other two units and was not pure play energy equity.
- MDR will be less complicated than the other unit from accounting, regulation and business is easier to understand,
- growth potential in offshore drilling around the world; its Arabian Gulf operations is growing at a fast clip and will offset any weakness from GOM operations,
- demand from energy index and sector ETFs as the company will become pure play energy service company. MDR is held in mid cap portfolios but not in sector specific ETF like energy funds; ishares Energy Service, Holders (OIH)...etc. Will the spinoff induce sector specific funds to buy the oil and gas segment to be part of energy ETF/ funds? A very high possibility.
- The backlog of the company alone should provide good support for earnings growth.
To capitalize on the energy sell off, I will require more odds in my favour and I think MDR might do it.
15 comments:
I enjoy your blog, thanks for all of your efforts. Does this mean you will be buying MDR pre or post spinoff? In an unrelated note Did you end up doing any follow up on CCE? FWIW CCE was presented at a Grant's conference and discussed in the 4/2 Grant's newsletter.
thanks Ben for the kind words. I do not post frequently but I post when there is a good idea worth discussing.
I will buy MDR on the day of the spin off. I do not want to own the other business as I am still trying to understand a lot of its issues.
The spin off is a classic case. it occurs not because MDR wants to get rid of under-performing business, but because new government regulations will shut out MDR from bidding in its current structure so they will be split off from that business to allow it to bid and gain access to government contracts. No economic reason just legal structure.
As for CCE the big risk is currency translation as it reports in US but sells in Euro and GBP but the company hedged a bit by issuing debt in those currencies. I am waiting to buy it under the 25 level.
What was Grant's verdict on CCE? bullish or bearish. I do not want to go against him :)
The CCE presentation at Grant's conference was bullish. It was presented by Adam Weiss of Scout Capital and he placed fair value of CCE at "$32-$34" minimum.
Regarding the currency risk have you considered taking a short Euro position as a way to hedge the currency exposure or is that too clever by half.
Also please keep posting your thoughts on MDR.
Cheers,
Ben
Huge fan of your blog, I really enjoy your comments. I have been looking at MDR spinoff for a couple months now.
Confused by the arabian gulf growth comment in your MDR post? From most recent MDR 10-Q "Revenues decreased 27%, or $189.0 million, to $519.5 million in the three months ended March 31, 2010 compared to $708.5 million in the corresponding period of 2009, primarily attributable to decreases in our Middle East ($207.2 million) and Atlantic (which encompasses principally our Americas and Gulf of Mexico operations) ($19.3 million) regions, partially offset by increases in our Asia Pacific ($32.2 million) region." It goes on to say "The decreases in revenues from our Middle East region was attributable primarily to two projects, one for decks and pipelines and one for the fabrication and installation of jackets, decks and pipelines, which were substantially complete in the three months ended March 31, 2010 compared to being highly active in the corresponding period in 2009."
It seems as if Middle East operations were a cause of decrease in revenue these last 3 months.
I agree with your backlog comment, according to the filing MDR has $4.2 B in backlogs for 2010, which should keep them busy. Not sure if I am reading too much into the gulf comment from the 10-q, it could just mean that they finished a project earlier than expected and havent started on any backlogged orders in the region yet?
Also, any thoughts on the B&W equity spinoff, I feel like it has potential for a huge selloff and might create an opportunity.
Rich,
thanks.
I will have to go back to my notes. When I was researching it I was working of their latest annual report which showed revenue gains from middle east/ asia.
I was reviewing fund ownership of MDR. none of the 10 largest energy mutual funds own MDR. none of the ETFs focusing on oil service sector own any of MDR.
May be the spin off will create some demand for the stock post spin off.
The government operation unit may sell off a lot if it does I will buy that also.
I think there is an opportunity in building and servicing power utilities. as utility companies have been cutting capex for few years now, because of potential government regulation and the economic slow down, the natural growth in electricity demand due to population growth and usage may not be able to be met. so there will at one point demand for B&W services. Another area for them is the revival of the nuclear power generation in the US. either way I do not think that B&W will have shortage of work due to alternative energy.
sami
Long time, no blog. Did you buy into the MDR spinoff? Any additional thoughts?
Hi rich,
vacation time and busy catching up on a lot of things. Also I have not found worthy ideas or good valuation to write about.
yes I bought into MDR on the day of the spin off. I still think it will see technical buying from several funds. Also I think its valuation is attractive as it was sold off in light of the GOM spill.
Sami, curious on your thoughts on HAWK given where it is now trading. GoM is still tough, but with ~$3.50 of net cash, 6 rigs working as of today with 2 more coming on later this year and the market valuing each rig at less than scrap (~$2.2MM/rig) if you remove cash from share price, I'm interested at these levels. It may take a while to get a lot of value here, but I feel like it has to be worth more than it is currently trading for even without the contracts it has. Let me know if you have thoughts.
Nathan,
at some price any asset will look attractive. I agree with that notion.
there is a secular issue in GOM and that is wells are going deeper and deeper, which prices out HAWK. it may take awhile but it will eventually get there. Also Pemex is moving deeper and deeper with their new contracts.
GOM gas is further to markets than a lot of the shale gas that will come to market and is flooding the market right now.
so there is a lot that I see that makes me think it is not a business I want to be an owner of.
but is it trading below it is rigs worth ? sure but if the company shows any indication of liquidating, then that is a great price for it.
good HAWK arguments.....
is the index argument strong enough to invest in MDR?
what about NE?
have you looked at SD, selling at 50% discount to Fairfax's purchase price...
regards
i have read some startegy and presentation documents from E&P companies operating in the GOM and their strategies are similar and boil down to:
1. operate shallow rigs for cash flow, milk them with no capex investment
2. invest in deeper rigs
and the recent rig blowout is evidence of it as i think this is the lack of any maint. capital poured into these shallow rigs.
MDR: i initiated a small position in the spinoff. I am willing to sell it in favour of a better proposition.
SD: have not looked at it
NE: market cap excludes it from my universe, unless it is a special situation.
why would one exclude potential opportunities from one's universe, it's hard enough to find value, why apply restrictions, seth klarman said in a recent interview: I will be buying what other people are selling, what is out of favor, what is loathed and despised, where there is financial dis- tress, litigation-basically, where there is trouble. That is how we direct our search. We don’t have a crystal ball, and so we don’t know what those asset classes will be
regards
well I am not Seth in skill or intellect. there are opportunities that i do not have the ability to analyze better and take part in. so I pick the spots that suit me better, like smaller caps or situation like spin offs or corp reorganization. yes I like to buy things that are in distress but I can find them all day long in the smaller cap arena where I do not have much competition from larger players.
that is just my approach. I am not saying it is right or wrong just what I am comfortable with and being comfortable in a style will eliminate or minimize a lot of emotional mistakes.
looking where the competition is low/absent seems like a good approach to me, how/where do you tend to find most of your opportunities? stock screeners, newspapers, internet sites, blogs etc?
regards
several sources:
1. news and articles
2. press releases re mergers, restructuring, management changes, etc I get feed with press releases and filter for industries that I want to focus on
3. SEC forms 12B
4. some bloggers who come up with good ideas. but you have to vet them so you are comfortable with the proposition
these are my main search techniques
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