What Comes After “Great” for Oceaneering International?

The worst thing I can find to say about Oceaneering International (NYSE: OII  ) is that I think the company is on a beat-and-raise carousel that eventually has to end. Oceaneering has an excellent ROV fleet that is in position to take advantage of increasing deepwater drilling and production. The company also has a strong products and projects business that will extend the company's growth past the point where subsea hardware orders start to decline. The only problem is that the good times won't last forever, and I'm starting to worry that the Street is already applying peak multiples to the stock.

ROVs are going to be busy
Remotely operated underwater vehicles (ROVs) are an essential part of the offshore energy chain, as they facilitate deepwater drilling and construction and also provide inspection, maintenance, repair, and intervention services. Oceaneering is not the only game in town when it comes to ROVs -- companies like Saipem, Chouset, and Helix also operate fleets -- but the company is definitely a leader.

When it comes to drilling support, Oceaneering has historically claimed 75% to 80% share in deepwater, but recent awards suggest that Oceaneering is capturing close to 90% of orders outside of Petrobras-related projects. Oceaneering isn't quite as strong in floaters (50% to 60%), but that's still an impressive level of market share. The company does see more competition in the vessel call-out and construction support markets, where Subsea 7 and Chouset are more formidable rivals.

Given the order books at the major drillers, I believe Oceaneering's ROVs are going to be occupied for a while. Although Transcocean (NYSE: RIG  ) and Seadrill (NYSE: SDRL  ) recently expressed some caution about trends in the Gulf of Mexico (which is part of the reason I believe these shares sold off recently), I think regions like the Gulf of Mexico, North Sea, and West Africa are still going to be looking at multiple years of double-digit growth in activity. Along those lines, Helix's recent guidance update suggests strong demand for ROVs in a quarter that normally sees some seasonal sluggishness.

ROVs are just the beginning
I believe that a key to the Oceaneering story over the next three to five years is the extent to which the company smoothly proceeds from drilling-based ROV business growth to Subsea products and projects growth.

Subsea products generates almost as much revenue for Oceaneering as ROVs, where the company offers build-to-order subsea hardware like umbilicals, connectors, and so on. This business tends to be tied to undersea tree/equipment awards, and companies like FMC Technologies (NYSE: FTI  ) and General Electric (NYSE: GE  ) have been logging significant awards that will have to be installed in the coming years.

Another part of the recent sell-off, I believe, comes from a worry that 2014 is going to be the peak for undersea awards, suggesting a declining market for Oceaneering's Subsea products business. I don't think so. First, this segment tends to lag the subsea market by a year or two. Second, Oceaneering has been rolling out an array of new services like hydrate mediation and acid injection/stimulation that should make the company less reliant on the new equipment order cycle, particularly as the company's stimulation services should be considerably more cost-effective than rig-based intervention.

Subsea projects should also see good revenue trends in the coming years. Rivals like Chouset and Subsea 7 have a sizable international presence here, while Oceaneering has been more focused on the Gulf of Mexico (and West Africa to some extent). The company needs assets to compete in this space, and recently commissioned a new support vessel that should be available in 2016. While this business has traditionally been driven by subsea tree installations, I expect a greater focus on the company's deepwater intervention capabilities should lift this segment in the coming years.

It won't last forever...it never does
The challenge for any company in the offshore energy space is managing its business through the cycles. Deepwater development has always been cyclical and it likely will always be. The key, then, is to own these stocks as the cycle is turning up and through the point where you start to read "it's different this time" or "this cycle will be longer."

I don't think we're necessarily there yet, but I will note that a lot of the analyst chatter about companies in the deepwater space is starting to move from order recovery/order growth to execution. Oceaneering is certainly building and running its company for the long term (as that new support vessel won't even be ready for another two years or more), but that intrinsic volatility is something to keep in mind – particularly given the run this stock has already enjoyed.

The bottom line
I am not convinced that subsea tree orders are destined to fall after 2014, but I certainly acknowledge the possibility. More to the point, though, I think the challenge for Oceaneering is to prove to the Street that it can transition more or less seamlessly from an ROV-heavy profit mix to one that centers more around the products/projects businesses. I believe they will, and I believe that balanced model can sustain double-digit growth through 2016/2017.

The problem is what to pay for that. I'm OK with the idea of assigning a 10x multiple to 2014 EBITDA, as I believe the company will deliver that double-digit growth. Unfortunately, the shares are trading at a 9.5x multiple to 2014 numbers already, so it is not as though that 10x number generates an appealing fair value. I note that many analysts are already starting to use peak multiples (12x 2014 EBITDA get you to about $96, which is the average price target reported on Yahoo! Finance), and while I'm not willing to state that Oceaneering won't get there, I'm not willing to buy the shares on that expectation.

Oceaneering is a well-run company with strong near-term growth prospects that is priced exactly like what it is. There are definitely worse ways to play the energy sector today, but this is definitely no hidden gem at this point.

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