Tuesday, March 24, 2015

Hornbeck Offshore

Under normal conditions, I tend to avoid investing in anything related to energy and other commodities, precisely because they are prone to the type of manic price crashes that we have seen in the oil industry over the last couple of quarters. But following crashes, there may be opportunities to pick up some babies that have been thrown out with the bathwater. I believe Hornbeck Offsore Services (HOS) may offer just such a chance, with some downside protection to go along with upside as the price of oil eventually (even if it's many years away) reverts to the all-in cost of a marginal barrel.

Hornbeck operates and owns ships that provide services to offshore rigs (like say transporting people, chemicals, repair parts), with a particular concentration in the Gulf of Mexico. Despite the low oil price, the rig count in the Gulf of Mexico is expected to rise this year as new rigs, which are still being added because these rigs were already contracted to be built ahead of time, more than offset rigs that are being moved or retired.

Of course, that doesn't mean Hornbeck doesn't feel the pinch. Newly-arrived ships looking to service the area will put pressure on rates, as will delays and cost cuts by production companies looking to minimize expenses as they take in less revenue. Hornbeck has already stacked (i.e. taken out of service) a number of older ships in order to reduce operating costs.

But the good news for investors is that this company can be purchased for half of the book value of its ships! Furthermore, the debt to equity ratio is reasonable, with debt not expiring for several years. As the low-cost operator, Hornbeck should also remain cash flow positive throughout this downturn, with data from 2009 showing the company's ability to do so.

Previous shareholders funded a massive expansion program ($1.2 billion) that is still adding ships to the current fleet. New investors only have to pay what's left of the commitment ($250 million), which should be able to be done with cash on hand. As a result, Hornbeck has one of the newest fleets around, which means more functionality/productivity, which makes it more likely that a larger proportion of its fleet will remain in profitable service (and not have to stacked).

Even if oil dries up in the Gulf of Mexico forever (which is highly unlikely), these ships can be re-purposed to operate somewhere else. The company also recently sold 4 ships to the US military, for above their book values.

Recognizing that the company is cheap, management has been buying up shares for its own account as well as repurchasing shares on behalf of the company. As a result, the company's book value should continue to increase.

A short-term glut in the supply of oil means investment projects to drill for oil get shelved. But wells naturally deplete; as such, eventually the price of oil will have to revert to its approximate cost. When that happens, Hornbeck's services are likely to be back in demand. In the meantime, however, investors can purchase Hornbeck at a huge discount to book while the company slows down its capex program and benefits from its operating cash flow.

Disclosure: Author has a long position in shares of HOS


Adam said...

Good catch! I look forward to learning more about this company.

Anonymous said...

Any concerns that while the current stock price is back to 2010 levels, the current oil price is below 2010 levels?

Saj Karsan said...

Hi Anon,

Past stock prices don't play any role in my investment decisions.

Hank said...

Hi Saj, just thinking of the worst case scenario on HOS:

- re buying HOS for half of its book value, does this represent bv from financial statements or bv based on current "resale" values (e.g., comp to those sold to US military recently)? If it's bvs from company financials, what do you estimate the fleet is worth if liquidated?

- if the fleet is repurposed, how long is the downtime and how much (if any) capex is required for repurposing?

Saj Karsan said...

Hi Hank,

BV is from the financials. The company's presentations contain info on their estimate of liquidation values if you are interested. I don't know what downtime or capex would be if repurposed.

Anonymous said...

Hi Saj - wondering if you have an updated view on HOS. Got battered pretty good over the last few months. Thanks

Saj Karsan said...

Hi Anon,

I still like it. I recently bought more.


Anon said...

Hi Saj,

What do you think about the converts due 2019 selling at 70 cents and yielding 10%?

Saj Karsan said...

Hi Anon,

Looks like good value to me.

Unknown said...

Any further thoughts on HOS? Shares are about $4 now (versus ~$20 in 2015).

I randomly came across this while flipping through valueline but the name rang a bell...

Looks super cheap, I just wonder what the future prospects are like.

Saj Karsan said...

I still own it, though I believe I was wrong in my assessment of downside risk, which I now believe to be quite high. But I still own it because I believe it is an asymmetric bet. While the floor might be zero, the upside in the event of recovery is very high here in percentage terms (a few hundred percent, IMO!).

My opinion of management is also higher, as they took some nice steps to push the maturity date of their big debt payment out to 2020, providing more time for the oil market to recover, which is what is needed here for this one to work out.