Helix Energy Solutions Group, Inc. (HLX)

[frenchee]

A Double-Barreled Energy Stock
By NAUREEN S. MALIK

HELIX ENERGY SOLUTIONS GROUP'S ambitious double-stranded approach to playing the robust energy sector has left many investors a bit antsy over its business model.

However, the big push by the provider of offshore contracting services into a second business of developing deepwater oil reserves could start to yield some gushing returns next year.

Helix shares tumbled to a one-year low early this year on continued concern over last year's $1.4 billion acquisition of Remington Oil & Gas for its deepwater oil properties in the Gulf of Mexico. Management's initial robust expectations gave way to downward revisions in guidance due to production cuts.

Exploration-and-production now makes up 40% of Helix's business with the remaining 60% coming from its service business, including seismic modeling and leasing its pipe-laying vessels. Helix locks in contracts for about 50% of its production, allowing it to play commodity prices.

The stock has already started to rebound in recent months, gaining more than 60% since January, amid rallying commodity prices, strong demand for energy services and news of oil discoveries in the Remington assets.

These factors should continue to drive stock returns in the near term.

In the fourth quarter, Helix will also be receiving delivery of a marine vessel that has been upgraded with the ability to lay pipes underwater. That will allow the company to contract the ships at higher prices. Helix expects to acquire three additional new vessels next year.

Late next year, Helix's free cash flow is expected to hit an inflection point and become positive once these vessels and three new projects in the Gulf of Mexico come online.

Helix Chief Executive Officer Martin Ferron says that Helix has been "spending more money than our Ebitda [earnings before interest, taxes, depreciation and amortization] for the last couple of years due to the investment programs, and by the middle of 2008 we are expecting that to turn."

Once that happens, the company could step in to buy back stock or offer a dividend.

At a Glance
Helix Energy Solutions Group

Stock Price: $45.65
52-Wk High: $47.35
52-Wk Low: $27.89
Market Cap: $4.17 billion
Est. 2007 EPS: $3.12
2007 P/E: 14.7x
Est. Long-Term EPS Growth: * 25%
Est. ('07/'06) EPS Growth: 47%
Revenue (trailing 12 months): $1.58 billion
Dividend Yield: None
Chief Executive Officer: Martin R. Ferron
Headquarters: Houston, Texas

* Based on analyst estimates looking ahead three to five years.
Sources: Yahoo! Finance, Thomson First Call, Thomson Financial/BaselineStill, there is further 20%-30% upside in the stock over the next 12 to 18 months. Helix is trading at a discount to its peers in both industries and should outperform next year as it starts to reap investment returns and as investors appreciate its business strategy, says Ahovi G. Kponou, a vice president at Para Advisors, a special situations/event-driven hedge fund.

Helix is trading 9.9 times the 2008 consensus earnings estimate while service and E&P peers are going at price-to-earnings multiples in the mid-to-high teens, notes Kponou.

Helix's valuation is "being unfairly penalized because investors usually prefer pure plays" and they are discounting the competitive advantage of Helix's two-sided strategy, says Kponou.

The tight services market is "the biggest catalyst" for the stock, along with its $1.8 billion backlog, says Kponou. In this environment, having an in-house service business means Helix can monetize its growing E&P business "much faster than a regular E&P company" that faces greater costs and longer waiting periods for third-party contracts.

CEO Ferron views E&P as a critical component "to achieve steady growth" of 25% a year. This diversification should stabilize earnings when the services business eventually softens. Outside firms contract 90% of Helix's services. "We could easily do 30% internal work" during cyclical downturns, adds Ferron.

The service segment has been a platform for international expansion, allowing Helix to "establish a good reputation" before buying reserves, says Ferron.

Helix has a contrarian approach to its business, operating in areas that are considered oil-and-gas relics abandoned by big oil, such as the Gulf of Mexico.

With oil at around $89 a barrel and natural gas at $7-$8 per British thermal units, Kponou says "all of a sudden these marginal reserves are quite profitable" and Helix can acquire them at reasonable prices.

The weak dollar has also made the Gulf of Mexico "less attractive" to Helix's mostly European competitors, thereby improving pricing power, notes CEO Ferron.

Stanford Group energy analyst Philip Dodge expects Helix to announce more lucrative contracts that expand its backlog during the third-quarter earnings report in two weeks.

After much skepticism over the Remington acquisition, Ferron says that now all 19 of the wells drilled have "found very encouraging initial success this year." In the second half of 2008, three fields -- Danny, Noonan and Phoenix -- should "roughly double the company's run rate on production," says Kponou.

Ferron says that as oil prices trade at record highs, the company will be shifting away from its operations of shallow water and natural gas to offering services and drilling for deepwater oil. "I think it's very early in the deepwater cycle" that could last decades globally, he adds.

This shift should expand margins from deepwater operations amid a "tremendous recovery" that will continue for a few years, says Dodge.

Meanwhile, Ferron views the Gulf of Mexico shallow water opportunities as "our ATM machine that pays for deepwater, which takes longer to put into production."

Helix's debt level -- with a 43% debt-to-capital ratio -- has raised concerns, but that is now being offset by strong cash flow, Dodge says.

The company could raise cash by liquidating noncore assets in partnerships or its 73% stake in Cal Dive International, the unit that provides diving support services that went public late last year, says Ferron.

Earnings per share are expected to grow from $2.91 in 2006 to $3.10 in 2007 and $4.60 in 2008, according to Thomson Financial data. That could jump to $5-$6 in 2009, says Stanford's Dodge.

He pegs Helix stock at five times enterprise value/Ebitda; it is selling below E&P firms (seven times) and service companies (9.5 times).

To be sure, a pullback in energy prices, a drop in demand for services or production glitches could take the steam out of Helix's growth story.

But the company has become more cautious about its guidance and is emerging from a heavy investment phase. These should help propel the shares higher over the next couple of years.