MMA Offshore: Positive industry tailwinds set to continue

Business overview

MMA Offshore (ASX: MRM) is a provider of marine and subsea services globally. The main asset of the company is a fleet of 20 vessels that perform a range of services for sectors including: oil and gas, offshore wind, government defense, and de-commissioning of offshore projects. Vessels have an expected life span of ~25 years, with MRM’s fleet being 9-10 years old, which is relatively young vs industry peers. MRM is based in Perth and also has offices in Singapore, Taiwan, Malaysia, Dubai and the UK.

Vessels are chartered out to clients on contracts that can range from as short as 1 month to much longer term (i.e. 3-4 years). Contracts typically include annual adjustments for any wage and CPI changes. Typical day rates vary depending on vessel size and specification - are in the range of A$30-50k per day.

MRM’s cost base is relatively fixed. Whilst to some degree, higher activity levels will flow through to higher costs, the main earning drivers for MRM in the next few years will be higher utilisation of its vessels, and higher day rates, which should not result in a significant increase in the existing cost base.

Whilst the company has expanded into offshore wind in recent years, MRM is still heavily exposed to oil and gas spend. It should be noted that MRM is a cyclical stock so whilst the earnings outlook currently is very favourable, investors need to be aware the current strong conditions will not last forever, albeit we believe the next few years looks positive. We discuss the investment risks in more detail later in this article.

The business has three segments:

Vessel services – charters or rents out vessels at agreed day rates to the oil and gas and offshore wind sectors (largest earnings contributor at 80-90% of group EBITDA)

Subsea services – provides a range of services to companies operating in subsea environments including fabrication, surveys, and repairs and maintenance of equipment

Project logistics – project management of large marine projects including logistics

Earnings outlook

On 18th of November 2023, MRM issued a profit update where it advised it expects 1H24 EBITDA to be in the range of $55-60m. MRM called out strength across vessels, subsea (which is having a particularly strong half) and projects logistics divisions as all delivering better than expected earnings. We believe this guidance was 40%-45% ahead of analysts’ expectations, so a very material upgrade.

The ongoing recovery in oil and gas spend combined with emerging growth from offshore wind farms was a key factor, along with the lack of supply of vessels vs global demand. This is seeing vessel day rates continue to move up.

We believe utilization of its fleet is currently in the low 80% range. As the demand/supply equation continues to become more favourable to the vessel owner, we believe utilization for MRM will continue to improve.

Of the fleet of 20, 5-6 are on contracts over 12 months and hence not fully benefiting from current market rates. One example is the “MMA Privilege” which is operating in West Africa (providing accommodation services) on a multi-year contract and is well below market rates. The rest of the fleet are on shorter-term contracts (4-6 months) which are constantly being chartered out to market and hence are benefitting reasonably quickly from the improving market conditions.

Another positive point for the business currently apart from higher day rates is that new vessel contracts are being written with more favourable terms and conditions to the vessel owner (i.e. giving the client much less ability to cancel without financial penalties). In the previous downturn, clients were often able to cancel contracts on 30 day’s notice with minimal financial penalties.

In the next 12-24 months, we expect all parts of MRM’s earnings to grow:

• Oil and gas construction
• Oil and gas project de commissioning
• Government services
• Offshore wind

Earnings risks

The main earnings risk for MRM in our view is if the industry returns to building vessels in material size (vs demand growth), which could potentially reduce day rates globally for vessels. Note, the time between ordering a vessel and taking delivery is currently ~3 years. At this stage, this does not appear to be happening, but it is an ongoing issue for investors to monitor.

Industry players such as MRM and US-listed Tidewater (NYSE: TDW) do not believe day rates are currently at a level to incentivize new builds, however if day rates move up over the next 12-24 months the likelihood of new supply coming on will increase.

Another clear risk to MRM’s earnings would be a material downturn in oil and gas spend, the likely trigger being a sharp and prolonged fall in the oil price. Whist this can never be written off, given the ongoing demand for oil globally combined with what we believe to be insufficient exploration spend - our view is that the most likely scenario is an oil price that is at least healthy enough to encourage continued investment by the energy industry (i.e. US$60-80 per barrel).

Whilst MRM’s fleet is more highly specified than many of its peers (which typically translates to higher day rates), there is not huge product/service differentiation (compared with other industries) with demand/supply conditions for vessels being the key driver of day rates.

Rising construction costs of offshore wind projects

Offshore wind as a segment is now ~25% of MRM’s revenue. One issue that MRM investors need to monitor is the rapid increase in construction costs of offshore wind projects which are impacting financial returns to the project developers. One recent example was on 1 November 2023, where Danish offshore wind farm developer Orsted, announced the cancellation of two large offshore wind farms off the New Jersey coast (US) citing “high inflation, rising interest rates, a lack of an OREC (offshore renewable energy certificate), and supply chain bottlenecks.”

This was not an isolated situation, with offshore wind projects around the globe facing cost inflation that is impacting financial returns for the developer.

There is no doubt this issue is a risk for offshore wind demand for MRM, however we believe that as the offshore wind industry continues to mature (noting it is still early in its life cycle), the cost of building wind farms will become more efficient, i.e. key items like wind turbines will reduce and the global supply chain will improve – however the financial profitability of wind farms is an issue for MRM investors need to monitor. Also tariffs will need to move up to properly reflect the higher capital cost of building offshore wind farms, which may be politically difficult in the current environment.

On balance, we believe there is considerable political support for offshore wind as an energy source which will ultimately see the continued growth in the segment, however the cost inflation being experienced is an issue that needs to be monitored.

Why is the industry not building new vessels?

A key risk (probably the main risk) for MRM’s earnings is a material increase in the supply of vessels, which would likely lower day rates. Despite the rally in day rates for vessels in the last few years, it does not appear that the industry is building new vessels in any material way currently.

Our best estimate is that day rates need to increase by another ~30% vs current levels before we see prospective returns on capital high enough to incentive new builds (noting the cost of a new build is much higher now due to steel costs, general inflation, etc). At current day rates, the return on capital to build a new vessel is only around 6-8%, also noting with the rise in bond rates this has pushed up the cost of capital considerably (we believe vessel owners would be facing a cost of capital of 12-14%).

Given what we have discussed above, we believe there will be minimal new builds for the next 12-18 months, which will support continued appreciation in day rates for the global fleet of vessels.

It should be noted to date, the industry is acting much more sensibly than in previous upturns. In the last boom for new builds, there was as much as ~300 vessels being built per annum. Also, debt financing available to build vessels has tightened considerably since the last upturn.

Whilst it is likely in the medium term the industry will return to building vessels in more size, for the time being we believe many industry players have clear memories of the recent downturn and hence will have a preference for maximizing returns and cashflow out of their existing fleet rather than risk shareholder capital by building new vessels.

Also, given the significant concern around emissions, the issue of what fuel will power the vessel is acting as a deterrent to new supply. Vessel owners are cautious about building new diesel powered vessels (which is a 25 year investment) given there is risk around future regulatory changes that might be particularly negative for or even potentially don’t allow diesel powered vessels. To date the industry does not have consensus on what type of vessels will be used in the future but the uncertainty is a factor in making vessel owners reluctant to build new vessels. Ethanol has been suggested as a possible alternative to diesel but currently can’t be purchased in sufficient scale.

Financials & Valuation

In the next few years, MRM should be a strong free cash flow generator. The company has a high fixed cost base, hence increases in day rates should flow through to profit margin expansion and free cashflow. With a strengthening market, we expect utilization to increase as MRM and other industry players better manage their fleet with shorter periods of inactivity (i.e. not being chartered out).

Maintenance capex for the fleet of 20 vessels is ~$15m pa, which is much lower than MRM’s depreciation expense of $40-45m pa. In terms of growth capex, we don’t expect MRM to embark on aggressive purchases of new vessels but wouldn’t be surprised if the company adds a modest number to its fleet over the next 12-24 months.

Following the recent earnings upgrade, analyst consensus for FY24 is for EBITDA ~$120m, growing to ~$130m in FY25.

At a stock price of $1.74, MRM’s market cap is ~$650m, with net cash of $50m-$60m. Hence the stock trades on an FY24 EV/EBITDA multiple of just ~5x.

• In terms of asset value-based metrics, at 30 June 2023, MRM’s net tangible assets (NTA) per share was $1.30.
• It is worth noting that MRM paid ~$700m for the current fleet which is now written down to a value of $430m. Given cost inflation in the industry, we believe the replacement value of MRM’s fleet is over $1B.
• Compared with the last cyclical upturn, neither MRM’s current price to NTA nor its profit margins look particularly stretched

Summary - why Glenmore is positive on MRM

• Simple, easy-to-understand business model
• Good visibility into the supply/demand dynamic for vessels
• Strong demand from both oil and gas and offshore wind
• Attractive valuation
• Special dividends or at least a material step up in ordinary dividends – is a genuine possibility in FY24-26 in our view
• Any indication the industry is materially building new vessels would be a catalyst for us to review the investment case in MRM
• One issue for investors to be aware of is the stock’s positive attributes are now well known and the stock is very much in favour with Australian small/mid cap fund managers - it is not a hidden gem. With that said, we believe the combination of attractive valuation and earnings outlook for the next 2-3 years positions MRM well to continue to deliver for investors.