The market is more negative on Subsea 7 compared to its peers
based on the large valuation discount. 2016 will undoubtedly be a tough year for Subsea 7 as deepwater oil spending is being cut dramatically due to oil prices at around $50/barrel.
However, the firm's Q1 earnings provided a glimpse of what makes Subsea 7 a great company. It managed to offset revenue decline by aggressive cost cutting preserving its attractive operating margin. The order intake and backlog looked good despite the Q1 revenue miss.
Our long position in Subsea 7 is our first attempt to increase exposure to the energy sector after being hesitant to join the rally until we got past the $50/b mark. The stock is the best high-beta play should oil prices continue to rally in 2016.
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Source: Saxo Bank
Subsea 7 is valued at 12-month forward EV/EBITDA 3.5, around a 50%
discount to global peers, which is one standard deviation below its historical average reflecting the industry’s negative outlook.
The valuation shows that substantial rewards lie ahead should the oil price continue to rally. We see 35-40% upside from current levels should oil prices go back to $75/b.
Management and risk description
Risks include a situation in which Saudi Arabia fails to negotiate a controlled supply constraint among oil-producing countries, leading to lower oil prices. Also, a weaker than expected Chinese economy would impact this trade.
Entry: buy Subsea 7 (SUBC:xosl) and hedge with OBX (NOR25.I) with
exposure 1:1 – so NOK neutral.
Time horizon: Holding period is expected to be a
couple of quarters as the oil market adjusts itself.
— Edited by Michael McKenna
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