This looks to be an interesting year in the energy capital equipment space, as large E&P companies like Petrobras, Total, and BP look to move forward with ambitious plans to develop deepwater fields. While order growth may not be as strong for companies like Cameron (CAM +0.00%), National Oilwell (NOV +0.48%), FMC Technologies (FTI +1.73%), General Electric, or Drill-Quip (DRQ +0.00%), it is definitely an opportunity to execute and show operational excellence. In particular, Cameron needs to show that its $11 billion backlog can be successfully converted into higher-margin cash flows.
Some progress, but expectations were low
Cameron had a decent first quarter, but expectations were pretty low going into the report.
Revenue rose 15% year over year and fell 17% from the fourth quarter, good for a small beat versus the sell-side. Sales in the large drilling and production systems (or DPS) segment rose 34%, while valves and measurement declined about 6%. Process and compression was down 13% year over year, due in part to divestitures.
Cameron's progress on margins was decidedly mixed. The company did a little better than expected, but the absolute levels of performance need to be better than this. Gross margin fell two points from the year-ago level, while EBITDA and operating income rose 11% and 5%, respectively. The company's 13.9% EBITDA margin was 10bp better than the Street expected, but still down 120bp from the year-ago level. DPS margins remain frustratingly low as the company works through delays in adding deepwater stack capacity and prior orders booked at very low margins ($750 million in BOP stacks at zero margins).
Margins need to improve, but they're not terrible
To add some context, it is worth noting that FMC's EBITDA margin in the first quarter was 14.5%, not exactly blowing Cameron out of the water. On the other hand, if Drill-Quip and National Oilwell Varco come in as expected, their margins will be on the order of 30.6% and 18.6%. These comparisons may not be strictly fair, but the reality is that the Street will ask why it should pay 10 times Cameron's EBITDA if FMC or Drill-Quip can offer positive momentum in book-to-bill and earnings growth.
Significant new capacity came online at Cameron's Berwick, LA facility in February, increasing the number of rig-up pads from four to 12. Provided that the company also has some supply chain issues ironed out, DPS margins should start to improve and really hit their stride during the second half of the year.
It's also worth noting that the company is still in the early days with its OneSubsea joint venture with Schlumberger and the margins appear to be only in the single digits. Neither company would likely have bothered if this was all the business could achieve and the JV has seen some start-up pains amid a sluggish environment for offshore activity.
Could orders surprise?
Looking a little bit ahead, Cameron should be able to leverage activity growth into better profits. Over 50 new offshore rigs are supposed to go into service by year end, and Cameron could also leverage a recovery in onshore North American drilling activity.
It may also be the case that order activity proves to be stronger than expected. Cameron's new orders were down 32% year over year in the first quarter, but management sounded more bullish on prospects for the full year. It's also worth noting that FTI saw surprisingly strong orders of around $1.9 billion for the first quarter.
Strong potential, tempered with a need to deliver
Cameron has strong share in subsea, surface, and rig equipment and good relationships with major E&Ps like Petrobras. The company's OneSubsea venture with Schlumberger should help build even more share in subsea over time, as it offers a package of integrated services and equipment that will be difficult for FMC or GE to match. It's worth noting that Cameron is relatively more leveraged to the Gulf of Mexico, where activity is expected to accelerate in 2014 after a prolonged lull.
Though the story for Cameron could be quite good, the burden is on management to deliver. Investors are not going to be patient if the company continues to flag margin and execution problems while rivals like FMC announce good results and service companies leverage improving dayrates and utilization.
The bottom line
The expected three-year growth in Cameron's EBITDA (around 13%) could arguably support a higher EBITDA multiple on par with FMC or Drill-Quip, but Cameron must first answer those questions about execution and generate earnings upside in excess of what it can buy with share repurchases. A 10x multiple to 2014 EBITDA expectations points to a fair value close to $67, with upside to both the multiple and EBITDA estimate if execution and order flow improve.
I am a Cameron shareholder and content to remain one, as I do believe there is worthwhile upside if the company executes at a higher level and raises the margin expectations for that large backlog of business. I do suggest investors shop around, though, as other equipment companies like FMC and offshore service providers also have something to offer these days.
