Subsea 7 SA.’s (OB:SUBC) Poor Growth Outlook Brings Concerns

Subsea 7 SA. (OB:SUBC) is a company I’ve been following for a while, and the biggest I see is around the sustainability of the business going forward. SUBC seems like a robust company at first glance – strong financials, meaningfully undervalued. However, the company doesn’t check all the boxes for me. SUBC doesn’t seem to be an outstanding business, and here’s why.

Firstly, a quick intro on the company – Subsea 7 S.A. operates as a seabed-to-surface engineering, construction, and services contractor to the offshore energy industry worldwide. Founded in 1993, it currently operates in Luxembourg at a market cap of ØRE34.54B.

The first thing that struck me was the pessimistic outlook for SUBC. A consensus of 25 NO energy equipment and services analysts covering the stock indicates that its revenue level is expected to decline by -3.34% by 2020, negatively impacting earnings, with a bottom-line annual growth rate of -17.36%, on average, over the same time period. With top line and bottom line expected to decline over the next couple of years, there is high uncertainty around the sustainability of its current operations.

OB:SUBC Future Profit Mar 28th 18
OB:SUBC Future Profit Mar 28th 18

Limiting your downside risk is an important part of investing, and financial health is a key determinant on whether SUBC is a risky investment or not. Subsea 7’s balance sheet is healthy, with high levels of cash generated from its core operating activities (0.74x debt) able to service its borrowings. Furthermore, SUBC’s debt level is at an appropriate 4.79% of equity and has been declining over the past five years from 24.17%. SUBC also generates income from lending its cash which, in turn, is able to cover its annual interest payment to its debtors. The company shows the ability to manage its capital requirements well, reducing my concerns around the sustainability of the business going forward. SUBC has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities, as well as long-term commitments. SUBC has managed its cash well at a current level of US$1.11B. However, more than a fifth of its total assets are physical assets and inventory, which means that in the worst case scenario, such as a downturn or bankruptcy, a significant portion of assets will be hard to liquidate and redistribute back to investors.

SUBC currently trades at ØRE105.35 per share. At 326.51 million shares, that’s a ØRE34.54B market cap – which is too low for a company that has an upcoming 2018 free cash flow figure of US$386.74M. Even with an expected negative FCF growth rate of -14.80% (source: analyst consensus), the target price for SUBC of US$138 is still higher than the current share price. This indicates that the stock is currently priced at a non-trivial 23.38% discount. Although, comparing SUBC’s current share price to its peers based on its industry and earnings level, it’s trading at a fair value, with a PE ratio of 9.81x vs. the industry average of 10.01x.

SUBC checks a few boxes for me – it has strong capital management and it seems to be undervalued intrinsically. But I’m not a fan of its future outlook. Like above, I would rather invest in a company that checks all the boxes – an outstanding business – than a mediocre one. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.