A Closer Look At Tidewater (NYSE: TDW)

The undisputed leader of Offshore Support Vehicle (OSV) market

I’ve been researching stocks to play the offshore thesis and recently added a position in Tidewater (TDW). The sharp sell off post Q3 earnings provided an attractive entry point in my view. TDW owns a fleet of ships known as OSVs that service and support the offshore oil industry. These ships typically have a ~30 year useful life and are chartered by E&Ps on a contract basis for a few months to sometimes more than a year. OSV contracts are typically shorter than drilling ship contracts (TDW’s contract duration is usually 6-10 months).

If you’re bullish on the offshore industry and want exposure to inflecting dayrates, it’s a good idea to have some OSV exposure as OSV companies will enjoy repricing of their vessels to market rates well ahead of the drillers (a company like Valaris for e.g. has a significant portion of its fleet contracted out to 2025 at rates significantly below the spot market). On the other hand, there is a lower barrier-to-entry to the OSV market. While the entire offshore industry supply chain has been decimated, and we are still far from the start of a newbuild cycle, OSV newbuilds are likely to restart more quickly given the lower capital costs ($65mm for a newbuild PSV vs. $1bn+ for a drillship) and lower technical specs.

There are two major types of OSVs:

• Platform Supply Vessels (PSVs) - these are designed to supply building material and cargoes such as fuel, water, drilling fluids, cement etc. to offshore drilling platforms.

• Anchor Handling Towing Supply Vessels (AHTS) - these are designed to offer mooring and towing operations to offshore rigs.

TDW owns the largest OSV fleet in the world with a total of 223 vessels (197 OSVs, of which 141 are PSVs and 56 are AHTS, and 26 other vessels including crew boats, maintenance vessels and tug boats). More importantly, TDW has been focusing on upgrading its fleet by adding more high specification ships (deck space of >700m^2 and AHTS with >16K BHP) through accretive acquisitions.

Tidwater acquired 49 vessels from Swire Pacific Offshore’s (SPO) fleet for bargain basement price of US$190mm in 2022, and in March this year, acquired 37 vessels from Solstad Offshore PSV (SOFF), all of which are high-spec (>700m^2), for US$577mm. TDW paid ~$16mm per vessel for Solstad (average age ~10year), while recent high-spec OSV transactions have closed at significantly higher prices. For example, Standard Supply (STSU) just sold 3 large PSVs for $72.2mm with an average age of ~12 years (~$24mm / vessel). Compared to the offshore drilling market, the OSV market has more distressed assets trading at very cheap valuations which gives TDW the opportunity to do more accretive deals.

As a result of upgrading its fleet, TDW is now well positioned to take advantage of the inflection in charter rates. As I mentioned during my prior discussion on Transocean (RIG), high spec vessels have the highest sensitivity to inflecting dayrates and companies like TDW and RIG will benefit disproportionately as the bull market cycle progresses.

Q3 Results Were Solid

If you knew nothing about TDW and just watched the stock sell off after Q3, you would have guessed that the company posted disastrous results. However, after digging through the numbers, I think Q3 was a solid quarter and that the sell off had more to do with positioning (the stock had a strong run up into earnings) and overall macro uncertainty (recession fears, weaker oil prices, lack of clarity on OPEC+ decision) vs. fundamentals.

During the quarter TDW experienced a 22% increase in its leading edge dayrate to $28.6K. Actual earned dayrates were significantly lower at $17.865k; this is because the vessels acquired from Solstad have below market contracts for the next 15 months. The company earned $117mm of EBITDA vs. $52mm in Q3 2022. LTM EBITDA is ~$300mm vs. ~$167mm for the full year 2022. EBITDA margins have steadily increased from the low to mid 20s in 2022 to now high 30s. Cash flow from operations for the 9mos ended Sept 30th jumped to $57.5mm vs. cash outflow of $5mm for the same period in 2022, while capex increased from $11.7mm to $23.3mm. Utilization increased from the low 70s in 2022 to 79.4% in Q2 2023 and 82.1% in the most recent quarter. Management is guiding to 84%+ for 2024.

2024 revenues are expected to be US$1.4bn and gross margins 52% per management guidance. This should equate to EBITDA of ~$500mm+ for next year, and an exit run-rate EBITDA of $750mm in Q4 of 2024. Next year will also involve heavy drydock costs as the Company integrates the Solstad vessels into its system. Drydock expenses are expected to be $125mm and capital expenditures $23mm.

TDW currently has $762mm of debt and $275mm cash, representing net debt of <1x next year’s EBITDA. The debt includes $175mm 8.5% senior secured notes due 2026, $250mm 10.375% senior unsecured notes due 2028 (used to fund the Solstad acquisition), $325mm senior secured term loan and a supplier credit facility agreement. This implies $75mm of interest per year. The term loan amortization requires $100mm of pay down next year, $75mm in 2025 and $50mm in 2026, which should be comfortably handled given the rising cash flows and healthy cash balance.

Looking Beyond 2024 - Bridging To Leading Edge Dayrate Earnings

Over the next 12 - 15 months, TDW vessels will roll over their contracts into higher rates reflecting the current market environment. Given the fixed cost structure, any increase in day rates falls directly to the bottom line. At the current earned day rates of $17.865K, the company is earning $117mm EBITDA per quarter. What would this look like if contracts rolled to current spot / leading edge rates?

Using current composite leading edge day day rate of $28.6K, each vessel would earn a spread of $10.735K. Multiplying this by 223 vessels, and assuming an 80% utilization rate implies an additional $172mm of EBITDA, or $289mm of EBITDA per quarter, or $1.2bn of EBITDA per year. Interest expense of $75mm (likely lower due to debt amortization / paydown), drydocking costs and maintenance capex of $85mm (drydock costs of $70mm, maintenance capex of $15mm, post Solstad integration) would leave free cash flow of around $1bn (excluding debt amortization / repayments). At today’s stock price of $62, and fully diluted share count of 54.5mm, you’re paying $3.4bn in equity for these results (or a 29% cash flow yield). Also keep in mind that by the time these contracts roll over, day rates will likely have increased even more.

The slide below from TDW, which sensitizes EBITDA for various day rates, shows that at a $27.5K day rate the company makes $1.368bn in EBITDA. This is significantly higher than my estimates because it assumes an aggressive 90% utilization rate vs. the current rate in low 80s.

Newbuilds Won’t Ruin The Party Anytime Soon

I mentioned earlier that OSV build cycles are shorter than drillers, however I would like to re-iterate that we are still in early stages of the cycle and, in my opinion, at least 3-4 years away from new builds starting to impact the supply / demand balances. The current OSV newbuild orderbook is a measly ~2.5% of the outstanding OSV fleet vs. 40-45% at the peak of the last cycle. Financing is also hard to obtain. Some of the biggest maritime lenders such as HSH Nordbank, Commerzbank, RBS, Lloyds, have either privatized or exited the shipping business all together.

In my offshore industry overview piece, I had emphasized that newbuild parity levels for semisubmersibles were 50-100% higher than the current dayrates for 10+ years. The situation for OSVs is not as extreme, but we are still nowhere close to newbuild parity. TDW estimates newbuild parity to be $38K / day at 90% utilization over 20 years to earn a 14% hurdle rate / cost of capital. It’s important to note that financing costs for the industry are steadily coming down as players deleverage and dayrates inflect upward, but there is still a lot of room for dayrates to move up for a lot longer before newbuilds become economical.

Conclusion

• TDW’s post Q3 sell off was an overreaction; dayrates are inflecting upwards, Solstad acquisition is already 50%+ accretive based on vessel market values.

• Higher earnings and cash flow will follow after integration is complete and old contracts roll over in the next 1 - 1.5 years.

• The OSV market is facing a similar supply / demand dynamic as the offshore drillers, but the OSV market cycle will likely be shorter.

• TDW has the largest, highest spec OSV fleet and is well positioned to take advantage of the tightening market.

• The company should be earning $1bn+ EBITDA and 20%+ FCF yield starting 2025, based on current leading edge day rates and contract rollover cycle.