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Morningstar | SUBC Updated Forecasts and Estimates from 05 Sep 2018

Oil and gas engineering and construction companies TechnipFMC, Saipem, and Subsea 7 released mixed second-quarter results, with near-term declines in financial performance being contrasted with a more positive forward-looking picture. Our fair value estimates and no-moat ratings for each of the companies remain unchanged.

Each of the companies' Subsea E&C-focused segments (generally the largest segment for each in terms of operating profit) has seen deteriorating near-term financial performance as low-priced contracts signed during the downturn comprise a larger portion of each companies’ working portfolio. Revenue declined an average 25% versus the prior year. Trailing 12-month average operating margins (which we track because of the very high quarter-to-quarter volatility in margins) are still trending down, with the exception of Saipem which has delivered impressive performance in the last three quarters despite previously being a laggard. We note that operating leverage is only part of the story behind lower margins, as vessel utilization has remained solid. Instead, the primary driver has been deteriorating pricing, caused by the lower-priced contacts.

However, the outlook for the Subsea E&C market has become much more positive, as each of the companies have seen a large uptick in new orders. Average TTM book/bill has increased to 1.1 times. We think an environment of healthy order inflow will be sufficient to create a positive pricing trend, given the consolidated nature of the subsea E&C industry. In particular, we still expect TechnipFMC and (to a lesser extent) Subsea 7 to outperform in terms of financial performance, owing to their emphasis on integration of the full subsea scope (both equipment manufacturing as well as E&C).

TechnipFMC is already demonstrating the value proposition of its integrated approach on the first wave of projects, including Shell’s Kaikias tieback project, which it just completed one year ahead of schedule and at a reported break-even cost of below $30 per barrel.

Outside of Subsea, TechnipFMC has distinguished itself with continually very strong margins in its onshore/offshore segment (which focuses chiefly on onshore oil and gas E&C projects). Adjusted operating margins have averaged 12% over the past 12 months--very high for a capital-light E&C business. We are still doubtful on whether that strength will persist once the revenue stream coming from the successful Yamal LNG project dries up in 2020. In the past two quarters, TechnipFMC has done an excellent job at replenishing its order book (with book/bill averaging 1.4 times), but most of the new orders are not for LNG projects, which have been most lucrative for TechnipFMC in the past.

In contrast to TechnipFMC’s success, Saipem has faced continued weakness in its Onshore E&C segment. Even excluding the impact of the recent Algeria arbitration settlement, adjusted operating margins have averaged just 2% over the past 12 months. More encouragingly, book/bill has risen to 1.4 times. This has included a large slate of projects in the Middle East, a very strong market for Saipem over the 2004 to 2012 period, but which also contributed to the company’s catastrophic losses over the 2013 to 2016 period.