Subsea E&C: Under water in the medium term

With the swift and severe fall in oil prices over the past year or so, the energy sector as a whole has been trying to adjust

Arguably, given the relatively higher breakeven oil price of offshore developments, subsea E&C players have been in the eye of the storm, with aggregate offshore backlog for the three companies that we cover in this space down some 34% since peak. But the industry has not sat still, with fleet reductions, headcount reductions, and asset rationalisation across the piste. However, the key question on investors’ minds is whether this is enough? To address this, we present an in-depth analysis of the offshore capability supply/demand balance, using proprietary databases and rankings. As such, we find the subsea installation market is still over supplied in the near term and without more significant changes to either supply, through vessel retirements or industry consolidation, or demand through additional project work out to 2020, the industry could stay this way for the medium term. For investors we believe backlog is an ever critical backstop and view Technip as best placed to make it through this period, with Subsea 7 at the other extreme. Our analysis for now includes Petrofac, our Top Pick in the wider sector, although after recent announcements it may not actually be venturing into the subsea space. Our preferred subsea play remains Technip trading on only 10x 2016F PE vs the sector average on 12x, and we downgrade Subsea 7 to Underweight with an unchanged price target of NOK84/share, since it offers only 13% upside, vs the sector average of 33%.

Supply is not just a vessel: While we rank vessels by what we believe is the effective capacity given a series of key metrics including pipelay ability, lift capacity, speed, age, and size, we feel having a high quality fleet is just one part of what makes a player competitive. Engineering skills, integrated offerings, global scale, and high quality project managers are another piece of the puzzle, and much more difficult to quantify. Thus, while our proprietary rankings exclude these considerations, we discuss it in depth in bottom up analysis throughout the note.

How to quantify demand: In an ever changing environment, demand can be a spurious concept. In order to best approximate demand we use a few different methods, first of which is our own proprietary projects database, discussed in our recent note (European Oil Services & Drilling: Industry in flux, 6 October 2015 ), which points to an average 19% over capacity out to 2018F. As such, competitive pricing could continue near term and thus backlog and execution will remain key for all subsea E&C players.

Two special situations: In our analysis we include Petrofac, which may be in the midst of changing its proposed participation in the space, and Saipem, which will be updating the market at the end of the month on its long-term strategy and thus our analysis is predicated on the current state of affairs, rather than a new structure.

Mick Pickup, Haley Mayers – European Oil Services & Drilling – Barclays