Superior Returns From a Superior Company
The stock market tumult of recent months has surely caught your attention. So with all of the gyrations, you must be wondering if there are still any relatively safe parts of the investment landscape left in which to entrust your funds. At Outstanding Investments, we have some criteria for just that situation:
1. -- We avoid sectors that are subject to wild market swings, such as the currently volatile housing and housing-related finance arenas.
2. -- We are looking for companies with real assets or skills that are always in demand; we avoid firms that sell the proverbial “vaporware” or operate under business models that revolve around intangible paper assets backed merely by more paper assets.
3. -- We are looking for well-managed, safely run businesses that can operate profitably in good economic times and bad.
4. -- We are investing for the long haul.
So with this in mind, it should come as no surprise that we believe there are few businesses in this world that are more “long haul” than the oil and natural gas business. Over the life of any given hydrocarbon province, exploration may take many years, if not decades. Development proceeds in stages, with widely varying scales of risk, and again may last for decades. Extraction operations may last for many decades as well, with some oil or gas wells yielding product for a century or more. (For example, there is an old oil well just north of Pittsburgh -- called the McClintock No. 1 -- that has been in continuous operation since 1861.) However, virtually all wells eventually deplete the reservoir to the point of no return and then have to be “plugged and abandoned” (P&A). This term, P&A, means that the down-hole equipment and casing is pulled out of the ground and the hole is filled and sealed with concrete. And the many systems associated with oil and gas extraction, such as gathering pipelines, pumps, trunk pipelines and downstream refineries, also have time frames measured in many decades.
These elements of the oil and gas business constitute highly complex industrial processes. To make it all work, oil and gas companies have to invest large amounts of money to build out and create capital, whether it is the basic geologic prospecting and acquisition of seismic exploration data the process of drilling the wells or installing the massive valve systems and pipes or the pumps to push the product down the lines. And the wells, pipelines, pumps and other systems require constant servicing and maintenance, up through and including the process of P&A.
According to some studies, over the entire life cycle of a typical oil field or larger hydrocarbon province from exploration to eventual P&A, about 70% of the funds that are spent go toward later-stage field development, long-term extraction and enhancements to development wells, plus eventual P&A and the winding up of operations. Put another way, only about 30% of the total life cycle cost is up front with the relatively high-visibility exploration and discovery, plus appraisal and early development.
So this long-term process, in which 70% of funds are spent, is the focus of our Outstanding Investments stock pick of the month, Superior Energy Services Inc. (SPN: NYSE) of Harvey, La. In the early stages, oil and gas companies explore, gather the data and drill their wells. Then, sooner or later, they pick up the telephone and call Superior Energy Services.
Superior Business Model
Superior is one of the few service companies in the Gulf of Mexico (GOM) capable of providing all of what are called the “post-wellhead” products and services necessary to extract product from and maintain offshore wells, from initial lift through enhanced recovery phases and up to and including P&A services at the end of the life cycle of the well. In an industry that is generally short of both people and equipment, Superior has the assets, personnel and abilities to provide its customers with multiple services, and to coordinate and integrate the cost-effective delivery of the services, as we will explain below. Over the past few years, Superior has significantly expanded its geographic scope of operations and the range of production-related services it offers. Superior has done this via internal growth as well as strategic acquisitions. And in the aftermath of the devastating hurricanes in the GOM in recent years, Superior has had no shortage of work, and, in fact, is still making money helping to repair damage caused by hurricanes Katrina and Rita in 2005. But this gets ahead of the Superior story.
Let’s expand the Superior story by looking at its history. In the early 1990s, Superior, then a privately held company, focused its efforts on P&A of older wells in the GOM. In fact, Superior perfected what is called the “rigless” P&A concept, employing five-man crews cross-trained in mechanical wireline, electric line and pumping services to plug uneconomical wells in the GOM. The P&A business has always been -- and remains -- environmentally sensitive and subject to strict state and federal regulation. So performing P&A operations requires much attention to detail and is very labor-intensive. P&A decisions are sensitive to hydrocarbon pricing, as well as other industry and seasonal cycles. But despite these challenges, the profit margins for P&A have historically been good, and in and of themselves, could sustain internal growth. So with cash flowing, Superior began to expand beyond just P&A operations.
In the mid-1990s, Superior entered into the rental tool market, offering a continuously expanding inventory of specialized tools for drilling, production and well workover activities. These items include such basic equipment as drill pipe, tubing and handling equipment, as well as other advanced sorts of devices used on both the drilling rig floor and down-hole tools. Not to get overly technical, but some of the names of these devices are quite colorful: power swivels, power tongs, casing jacks, flow iron, drilling check valves, capping assemblies and blowout preventers. Superior offers many more critical devices and associated services, but we do not have space to list them all. Suffice to say that Superior offers a comprehensive range of machinery and services that are absolutely necessary to well drilling and maintenance.
Superior’s early business model in all of this was to balance the labor-intensive P&A services with the more capital-intensive rental tool equipment, and thus moderate its business risk. With this background, Superior went public in December 1995.
In July 1999, Superior merged with Cardinal Services, a private company that held the leading market share in mechanical wireline services in the GOM and also owned and operated the largest fleet of “liftboats” in the region. These are the tough, rugged ships that haul the heavy equipment around the GOM and often carry cranes and other large machinery to sites where offshore platforms or pipelines are being constructed, such as the one seen below...
This Cardinal merger was a natural fit for Superior’s P&A skills, as well as a complement to the rental tools business. Thus, by 2000, Superior could offer its customers every tool, service, trade skill or discipline typically required during the life cycle of an offshore well, as well as the world’s largest fleet of liftboats to deliver its service and rental tool packages.
But in the late 1990s and early 2000s, the prices for oil and natural gas were at or near historic lows. Non-OPEC sources of oil were shaping and influencing the world’s oil markets at the margins, and hence doing much to set the world price. For example, we know now that oil extraction in the British sector of the North Sea peaked in 1999, and it is no coincidence that oil was selling for nearly $12 per barrel in that time frame. And in consequence of low world prices, in the GOM, the exploration and production trends were declining to the point where some wags referred to the place as the “Dead Sea.” Still, there was an inventory of wells in the GOM dating back to the 1940s, and these had to be serviced and maintained, if not designated for P&A. So despite the generally hard times in the worldwide hydrocarbon industry, Superior was able to remain profitable and grow its business through opportune acquisitions of assets, even in a severely negative business climate. By bundling its service offerings, Superior gained additional efficiencies, increased its market share and began to be considered a “go-to” company for the more complex, higher-margin endeavors.
In August 2003, Superior acquired a rental tool business based in Aberdeen, Scotland. This provided Superior with immediate access to the North Sea, Europe, the Middle East and West African markets. The rental tool business helped create international awareness for the Superior brand and paved the way for potential service opportunities. To the south of the GOM, Superior expanded its presence into Mexico, Trinidad and Venezuela.
Also, Superior had the managerial foresight to use the “down” business climate of the early 2000s to order new equipment, including larger-capacity liftboats, at discount prices from struggling shipyards. Thus, by early 2004, Superior owned five of the industry’s largest liftboats, with unique specifications and features, such as large cranes, wide deck spaces, helipads and housing for up to 50 people. These liftboats could perform traditional bundled service projects and remain on station for long periods of time. So Superior began to get the calls to participate in large-scale, high-visibility construction projects such as platform removals and pipeline tie-ins. And in the aftermath of the devastating hurricanes of 2005, Superior was positioned to reap significant gains from a full book of business repairing damaged offshore platforms, wells and subsea systems. Even two years later, in 2007, only a fraction of the damage from the 2005 hurricanes has been repaired, and Superior is still busy making money in the GOM. Here is a chart of Superior’s estimated 2007 revenues (for the full report click here ):
And note the segment in the chart of Superior’s revenues from international operations. This is Superior’s fastest-growing business segment, because maturing oil provinces and aging infrastructures worldwide require more and more of the kinds of equipment and services that Superior offers. In addition, there are worldwide markets for Superior’s equipment and services in the emerging offshore and deepwater trends, as well as in parts of the developing world, where shore-based infrastructure is sparse and whatever you need has to be hauled in on a liftboat. Superior has an aggressive campaign to market its services in the booming oil patches of the Middle East, Russia and the Far East.
In another aggressive business move, earlier in the decade, Superior formed a subsidiary called SPN Resources to acquire mature GOM properties that require the kinds of wellhead intervention services, tools and disciplines that Superior typically employs for its customers. Superior’s strategy in this regard was twofold.
First, Superior had (and still has) a strong balance sheet and experience working on mature properties. So the offshore leaseholders that wanted to dispose of an aging, high-maintenance well, platform or field could transfer title to Superior and keep an override royalty, thereby remaining in the chain of title throughout the life of a property while passing the day-to-day work off to Superior and ensuring low-recourse risk.
Second, Superior was the only company in the industry possessed of the in-house services, tools and disciplines that are required throughout the life of a well. So Superior was and is uniquely positioned to service properties during their producing and decommissioning phases.
From the perspective of Superior, the strategy of getting into the ownership and operation of older wells is designed to maximize the benefits the company receives from employing its sometimes underutilized assets. That is, Superior capitalizes on the fact that no matter how good the oil business is, especially offshore, it always seems to be somewhat cyclical and seasonal. In addition, the low incremental cost of bundling operations allows Superior to pursue production enhancement projects on its own properties that others simply could not perform economically. For example, a traditional energy producer may face the fact that a certain scale of well workover is simply too costly. But that same workover may offer an affordable extraction enhancement opportunity to Superior as the field owner or operator.
So to sum things up, we believe that the past is also a prologue to the future. Superior was proactive when times were bad and grew when others were defensive. Superior took advantage of industry cycles and leveraged off of its existing business base. For all the tragedy and damage that the hurricanes of 2005 brought, a company such as Superior was in a unique position to fix the damage and get paid for doing so.
And through it all (and we like this very much at Outstanding Investments ), the company has a culture of safety. Superior’s health, safety and environmental policy states, in no uncertain terms, “No one gets hurt; no environmental damage is acceptable; and nothing is more valuable than our employees’ health and safety.” To that end, according to company policy, every employee has “stop-work authority” and is expected to use it when appropriate. Much of what occurs in and around the oil patch is inherently dangerous. That is why you have to be safe.
The Financial Numbers
Here are the financial numbers, which are favorable if you are inclined to invest in Superior Energy Services. The stock is trading in the range of $38 per share with a 52-week range of $21.50-42.00. So yes, Superior has been rising this past year, along with most everything else related to the oil service sector. The company recently reported earnings of $3.08 per share, thus its price-to-earnings ratio is still a reasonable 12.5. The company is growing earnings at a rate well in excess of 30% per year, with international revenues growing well. Profit margin is over 17%. Market capitalization is about $3 billion, with over 90% of shares held by institutions.
Compare Superior’s numbers with those of a peer competitor such as Oceaneering Intl., with a market cap of about $4 billion, a share price over $62, a price-to-earnings ratio of 24 and a profit margin of 9%. Oceaneering is a great company in its own right, but we believe that Superior is a better buy right now with more room to grow on the upside.
Action to Take
Action to take: Buy Superior Energy Services, Inc (SPN: NYSE) up to $45 per share. Accumulate on any market retreats. Be prepared to hold for the long haul. Superior is a strong company, well positioned in the sweet spot of the oil service industry. We expect this stock to increase to over $60 per share within two years.
