When Subsea 7 (OB:SUBC) reported second quarter results recently, the share price had doubled in the span of five months. Between February and June global oil prices had risen from $28 to just over $50, and investors had extrapolated that the cycle had turned. With rising oil prices, Subsea 7 would be sitting in the catbird seat.
But a funny thing has happened in the last month. The oil price has fallen 20% to around $40 a barrel. Among the factors that have contributed to this decline are rising storage volumes and an uptick in the North American onshore rig count, bucking recent trends. Both are bearish for future oil prices, but the latter more directly impacts Subsea 7. It indicates that North American shale drillers will increase drilling at relatively low oil prices, potentially crowding out activity from Subsea 7’s deepwater clients. A more worrisome inference is that low oil prices could last longer than the market had expected.
During the quarterly call, management was very bearish on the state of client spending—which makes sense given the return of lower oil prices recently. Over the next couple of years, the company will have to work through a backlog of contracts that were signed in the depths of this downturn with very sharp pricing. Earnings are likely to be ugly.
Investors are looking right over these hurdles. They see past an upturn in the oil price cycle and past the years it might take to flow through to Subsea 7’s results, given long contract lead times. But with oil prices lower again and perhaps down for a while, they might be in for a shock.
Disclosure: Needless to say, the Forager International Shares Fund sold its stake in Subsea 7 recently at around current prices.
6 thoughts on “Subsea 7 is Divorced from Reality”
Interesting takeaway on the onshore rigs recommencing due to the oil price recovery and ramifications those servicing the offshore rigs e.g. Subsea 7.
I was just wondering how you are therefore now thinking about for Matrix Composites, which the domestic fund owns, given they also service the offshore market (Subsea 7 actually being a customer of Matrix)?
Does the very cheap valuation of Matrix (e.g. 0.4x NTA) adequately reflect these risks and this perceived deterioration in the end markets?
Thanks. Appreciate your candid updates.
Hi Shane. It’s surely hard to see demand for Matrix’s products and services increasing anytime soon. But the company has little debt enabling it to wait a relatively long time for a recovery in the oil price. If the oil price recovers this business should earn good money as its competitive position has strengthened during these hard times. A lower $AUD would help too. If the oil price doesn’t recover significantly though, this is likely to prove a poor investment. But the key difference here is price. While Subsea’s share price at NOK95 had rallied hard and implied a certain level of optimism for an oil recovery. The share price of Matrix hasn’t been as buoyant. Please treat this as a general comment not a recommendation.
I think there’s a widespread belief that U.S. tight oil is a lot cheaper than it actually is. Company executives are misleading investors by not including all costs, the claims in their glossy presentations to shareholders are not supported by cashflows and are flatly contradicted by impairments taken.
How can it be that when Pioneer declares it’s assets in the Permian are lower cost than Saudi Arabia no-one calls B.S? Only the odd lone contrarian voice.
Rig Counts have risen slightly but not yet enough to arrest the terminal decline in U.S. production. Technological improvements can reduce drilling costs but the majority of savings have come from cutting exploration budgets and squeezing suppliers. There are physical constraints that will limit how much more can be achieved from poor quality rock.
It will be interesting to see how this plays out – I don’t think the 5% of tight oil is going to be able to cover depletion of the other 95% at around 3% per annum. I wouldn’t write off deepwater just yet though times may remain tough for a while yet.
Good points Sam and I tend to agree … given the lead times in offshore it is going to be very interesting to see where the supply comes from in ’19 and ’20. We’ve taken a bit more exposure to actual oil prices rather than services over the past six months as I think it is a slightly more straight forward way to profit.
I am also mainly in producers for the same reason. The service providers need an oil price recovery then as you allude to there will be a lag to spending.
It’s an absolute minefield out there, many companies still overvalued – as you have clearly found.
Timing I am never sure of, if a business can deliver survivable results in what I consider a worst case operating environment then I can hold for three years or longer. I am always surprised by the exact timing of when sentiment toward a stock changes.
Forager Funds seems to be doing well by their clients – I don’t need to give them picks. Have y’all considered offering Kiwisaver, us NZers have a serious lack of investing options with our superannuation.
All the best with Shawcor.
I’ve noticed a huge shift in market sentiment towards extractive industries’ (EI) services stocks more broadly over the past few weeks without any obvious change in business fundamentals.
I can’t comment on Subsea 7, because I don’t know it, but the other EI services stocks that I hold still seem cheap despite the fact that they are generally up more than 100% from their trough valuations. Although obviously far less so than a few months ago.
I’ve got shares in Shawcor (SCL), which seems to be one of the stocks that has missed out on the changing sentiment thus far. If you want to maintain exposure to a pickup in deepsea drilling at a cheaper price, then SCL might fit the bill.