Stena AB : Sailing through choppy waters

>Strengths / Opportunities - Business diversification. Stena operates in five different sectors: Ferry Operations (40% of sales, Offshore Drilling (15%), Shipping (16%), Property (8%) and Investments (21%). Revenues generated in the Ferry and Property segments are more stable, counterbalancing the volatility and cyclicity of the Offshore Drilling and Shipping businesses.A conglomerate with a stable ownership structure. Stena AB is part of the Stena Sphere group, controlled by several members of the Olsson family since its creation. Thanks to their long-term vision, we think that shareholders are more inclined to support the group’s various businesses if they run into difficulty.Adequate liquidity. Even though results will probably continue to weaken this year, the group has sufficient liquidity (SEK 15.4bn on an adjusted basis at 30 September, 2017) to cover its debt maturities until 2019.Weaknesses / Threats - A persistently unfavourable environment in Offshore Drilling. Results in the Offshore Drilling business have suffered since 2016 from falling investment in the oil sector following the slump in oil prices. Despite a slight improvement in conditions in this market, the majority of Stena’s contracts are about to expire. We do not think any improvement will be visible before 2019, while new contracts are likely to be negotiated on far less favourable price terms because of overcapacity in this sector.The Shipping business suffers from overcapacity. Historically focused on the shipment of oil products, Stena’s shipping business suffers from overcapacity caused by strong growth in market supply in recent years, exacerbated more recently by the slowdown in oil production. The freight part is partly mitigating today the erosion of results, which should now stabilise.High leverage. Together with high financial expense and capex, FCF will be impacted by the sharp drop in EBITDA forecast in 2017 and 2018. Further substantial asset disposals can be expected, but they will be insufficient to stop debt and leverage from rising (estimated at 6.8x in 2017 and 8.5x in 2018).Credit opinion: Negative / Market recommendation: Neutral - While the Ferry Operations business will benefit from solid growth in tourism in northern Europe and the Property business will be boosted by a dynamic economic environment, the group’s results may continue to suffer in the next two years from overcapacity in Shipping and unfavourable conditions in Offshore Drilling as a result of weak capex in the oil sector. In these conditions, we expect credit metrics to deteriorate in 2017 and 2018 because of a sharp erosion of margins, a significant increase in leverage and a reduction in liquidity. Liquidity should nonetheless be sufficient to cover the redemption of the 2019 notes with no refinancing. The redemption of the 2020 paper, if no refinancing occurs, depends on a number of factors whose probability seems relatively high to us but not certain: 1/ a gradual recovery in the Offshore Drilling business from 2019; 2/ compliance with covenants on credit facilities; and 3/ their renewal. Asset sales and dividends paid by the property segment to the restricted group are also beneficial for liquidity and could facilitate the redemption of the 2020 bonds.