Global exposure is key to our *top pick* designation for TS, but global trade uncertainty remains a key overhang. Earlier this week in a pair of tweets, Trump announced restoration of steel/aluminum tariffs on Argentina, Brazil and France for “massive devaluation” of currency. Given its Arg exposure (annual160kt of tubulars imports), TS traded lower on the news, but lack of price action indicates that the market is discounting follow-through on the latest tweets (a la Turkey on Oct 14th). caught up with the company yday, we see the most likely outcome (if tariffs are enforced) as a <75bps margin impact driven by a manufacturing shift to US/MX/CA and/or rationalization of W-Hemi shipments to the E-Hemi. The higher-level takeaway is that despite our positive view of TS’ FCF potential (HSD % yield) and optimal exposure to the cycle (offshore optionality), we recognize that global trade/steel uncertainty may be untenable to potential (incremental) investors.
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In a pair of tweets on Monday, Trump announced restoration of tariffs on Argentina/Brazil in response to “massive devaluation” of currency (countries previously exempt from the May 2018 steel/aluminum duties of 25%/10%). Despite its exposure to Arg, TS is down just 2.5% this week (vs. OIH -1.5%), perhaps a signal that the market is discounting any follow-through on the tweet (X-NC is down 5% today, conceding gains from yday’s protectionist read). We caught up with IR, and in-step with the muted TS stock reaction believe the tweets to be a wait-and-see catalyst of relatively modest impact.
Within, we delve into three key OFS/NAM shale activity topics, including, 1) “DUC exhaustion” in-focus near YE20, 2) a 4Q19 ‘bottom’ for frac utilization(?), and 3) recent US productivity gains through E&P retrenchment, but near/medium-term thesis still intact (productivity headwinds/rollover).
Wednesday AMC, we launched on four additional OFS names, OII (OP), DRQ (UP), WHD (PP), and PD-CA (PP). For OII, pushback came primarily on modest margin growth modeled in Subsea Projects & Products, although investors generally agreed with the better-than-expected FCF premise based on ROV pricing. For DRQ, the key concern was whether our ‘subsea integration’ downside risk (to SPS growth) could be viewed as M&A upside risk for the core wellhead/connector offering (we agree, but valuation is perhaps still a bit rich, despite earnings moving off bottom). WHD is a sellside/investor favorite (for good reason, solid mgmt/cap allocation), although pushback on N-T Products growth was muted given the wait-and-see IOC qualification. PD is a familiar story for most folks, although the timely AlphaAutomation commercialization is a catalyst worth revisiting. We are around today/next week, so don’t hesitate to reach out on any of this.
DRQ is an oilfield equipment provider principally focused on subsea pressure/flow control technology. It is particularly exposed to the deepwater wellhead market following several decades of R&E leadership within the subsea equipment space. A clean balance sheet and conservative management team underpin DRQ as relatively defensive leverage to the later/stickier parts of the offshore cycle (for those patient investors), but in our view the sustained lack of deepwater visibility, and minimal N-T shareholder return upside (beyond a $100M repo), position DRQ as a relative UP for now.
Subsea remote operated vehicles (ROVs) is OII’s most margin/returns accretive businesses (by far), representing less than 25% of consolidated revenue and nearly 50% of segment adjusted EBITDA. Given its leading share of a relatively consolidated ROV market, OII has seen fleet utilization (~60%) recover roughly half of downturn losses (~85% FY13 to ~45% FY17) without much improvement in pricing (yet). Most importantly, forward demand growth will largely be driven by offshore drilling/tree volumes, versus well design/OFS mix. The ROV segment is a defensible niche, given the capital barriers and technical expertise required, and perhaps improves the takeout case for OII should a diversified subsea peer wish to enter/consolidate the ROV market.
WHD is an oilfield equipment provider primarily focused on NAM land pressure/flow control technology ($500M IPO in 1Q18). Int’l expansion remains nascent, and although WHD has exhibited rapid share growth across both its drilling-driven Product (wellhead) segment and frac-driven Rental (flow control) segment, N-T USL deceleration remains a ubiquitous OFS overhang. WHD could navigate N-T weakness through further technology-led wellhead share gains and frac rental equipment expansion (intro “new products”). Our primary reservation at this point is margin stability in a ‘lower growth’ US shale market, relative to ests, valuation, and what we see as potentially uncertain E&P/frac consolidation trends.
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