Energy’s ‘Picks and Shovels’ – Dresser-Rand (DRC)
The oil and gas world hasn’t been getting a lot of attention lately; let’s take a look at an equipment supplier’s results and see if it’s time to get interested again.
From the company website – “For more than 100 years, Dresser-Rand has been among the largest global suppliers of rotating equipment solutions, with field-proven centrifugal and reciprocating compressors, steam turbines, expanders, gas turbine packages, and control systems. Dresser-Rand is positioned to deliver a complete package of solutions, from initial concept to equipment retirement for the worldwide oil and gas, chemical, petrochemical, and process industries.”
As noted in the description above, DRC supplies machinery and services to the upstream (exploration and production), midstream (pipeline) and downstream (refining and processing) segments of the oil and gas industry. Although oil and gas business dominate DRC’s order book, renewable energy represents a growth opportunity since biofuel processes, geothermal energy and many of the energy storage technologies supporting wind and solar power use a lot of the same type of equipment. DRC publishes a newsletter called Insights focusing on their renewable energy projects.
Earnings and Backlog:
For the first quarter of 2009, DRC reported 42 cents a share vs. 32 cents for the same quarter last year. Hey, a company that grew earnings! There were some one-time adjustments, but even after backing those out, earnings still grew compared to the year-ago quarter. Revenues were up and share count was down due to a share buy back program.
There’s always bad news mixed in with the good. Bookings for the quarter were down over 2008’s first quarter and the backlog decreased slightly to just over $2 billion - still roughly equal to the market cap. Not too shabby.
DRC’s breaks the business down by new unit sales and aftermarket sales. Aftermarket operates at much higher margins (~26-28%) than new unit sales (low double digit) and most of the quarter’s income came from aftermarket. In the press release, CEO Vince Volpe stated, "We are also pleased with the aftermarket bookings of $246 million, which is approximately 4% above the first quarter 2008 level. As we previously indicated, we expect continued steady bookings in this segment, which, by nature, generates the majority of the Company's operating income. This is an inherent strength of the Dresser-Rand business model."
DRC reaffirmed full year 2009 guidance for operating income of $320 - $360 million. First quarter operation income was $64.2 million and the company estimates the second quarter will be 25-27% of the year’s total. That means the business activity will need to pick up in the second half of the year to meet guidance. DRC has been talking with their customers and many projects are seeing delays, but very few are being canceled. The sizeable backlog gives DRC pretty good near-term visibility for the business.
A key strength for DRC in weaker economic times is their flex manufacturing approach. Through subcontracting and outsourcing, DRC can flex their capacity by 30-40%. That probably costs them some profitability in boom times, but is very helpful when orders are soft.
DRC is expanding overseas to help focus on their national oil company customers. The earnings report address a cooperative agreement with Saudi Aramco and joint ventures with Al-Rushaid Petroleum Investment Company of Saudi Arabia and the King Fahd University of Petroleum and Minerals.
Currency translation has been a hit to income for a number of companies with international operations. DRC controls currency risk by entering into forward agreements when contracts are signed. In the earnings call, they said it isn’t hedging for accounting purposes. But, to a non-accountant, it sounded like a way to hedge currency exposure.
Customer credit risk is minimal for DRC. Most of their customers are major integrated or national oil companies that can self-finance their projects and equipment service contracts.
Based on Yahoo Finance’s analyst estimates, at $25 per share, DRC is trading for about 10.5 times 2009 earnings. If I take the $320 - $360 operating earnings projection, subtract out a quarterly $7 million net interest expense and use the first quarter’s tax rate for the full year, I get a 2009 PE range of 8.5 – 9.7. I’m probably missing something.
DRC ended the first quarter with $160 million of cash and $370 million in debt for a net debt position of $270 million.
Enterprise Value to EBITDA is 6. That’s in a range where someone might consider buying the company, but I wouldn’t buy the stock hoping for a buyout.
DRC doesn’t pay a dividend.
The 2009 low was a little over $17 a share back in Jan, 2009 high was $28 in mid-April.
Increasing earnings over the year ago quarter is impressive in this economy, particularly with a customer sector that’s seen declining demand and prices.
If you think oil prices are going to fall and that energy companies will start canceling projects, DRC would be a poor choice. If you think oil and gas will continue to be key energy sources for the foreseeable future and that prices will stabilize or increase, DRC offers a good way to get some exposure to the sector.
Disclosure – Long DRC.