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Swim Against the Tide for This Stock Pick

Offshore drilling service company Tidewater has taken a beating, but the decline has been unwarranted says Morningstar's Adam Fleck.

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Erik Kobayashi-Solomon: Hi. I am Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor. And today it's my great pleasure to welcome Adam Fleck, who is a senior equity analyst on the industrials team.

Adam, thanks for coming.

Adam Fleck: Thanks for having me, Erik.

Kobayashi-Solomon: Okay. So the other day, I saw something in the Morningstar best ideas list about a little company called Tidewater, and frankly I'd never heard of Tidewater. I read the thing and I thought this is a great idea for a bullish option strategy.

First, I don't think a lot of our viewers know what Tidewater is. What does Tidewater do? What kind of a company is this?

Fleck: Sure. Tidewater is sort of in what I like to call an invisible industry. It's a company that owns boats, vessels, about just over 200 vessels that it uses to ship crew, supplies, and eventually tow offshore oil rigs.

Kobayashi-Solomon: Okay. So, it's offshore drilling supply.

Fleck: Right. Absolutely.

Kobayashi-Solomon: And of course, the BP news, it's been getting a lot of play, right?

Fleck: It's absolutely hammered the stock, and I think, it's rather unwarranted, and for that reason I think the stock is pretty cheap right now.

Kobayashi-Solomon: So tell me a little bit about Tidewater's – the business that Tidewater is in; its competitive position; what do they look like in terms of their industry?

Fleck: Sure. It is the largest of the players in the industry, like I said, it has over 200 vessels. There's around 2,600 or so in the industry, so it's getting pretty close to about 10% market share, whereas the closest competitor is actually under 5% market share.

Kobayashi-Solomon: So it's a pretty fragmented market then?

Fleck: Very fragmented market, but Tidewater does enjoy some advantages, in that they can go out and provide boats much more quickly, and they are very well known in the industry, terrific track record, and…

Kobayashi-Solomon: Because they have got such a large fleet?

Fleck: Absolutely. And they have a – very safely they have had very few recent incidents that have caused any kind of delays.

Kobayashi-Solomon: I see. But on the downside though, these guys are very small fish serving the needs of whales, right?

Fleck: Sure. Absolutely. Over almost two-thirds of their revenue is derived from super major oil companies and national oil companies. Their largest…

Kobayashi-Solomon: So they don't have any negotiating power when it comes to that?

Fleck: Very little. Their largest customers would be Chevron or Petrobras. So they are at the mercy of supply and demand in the industry.

Kobayashi-Solomon: Right. I see. So I mean, on the good side, they have got a very strong balance sheet. I think, they have got a good reputation and a long operating history.

Fleck: Yup.

Kobayashi-Solomon: But on the other hand, they've got kind of an older fleet I think.

Fleck: They do. They've been doing a good job I think since the early part of this decade, since about 2000 of really renewing that fleet, and they've brought the average age down. They have what they call new boats and traditional boats in the industry. There was a technological shift in the late '90s that actually make the new boats much more profitable for the company.

Kobayashi-Solomon: Much more efficient to operate in other words?

Fleck: Absolutely. For the entire industry really, but for Tidewater as well. They've done a nice job and they have continuing capital expenditure program that I think is fully funded, like you said, they have a terrific balance sheet, lots of cash, terrific availability on the revolver, and very cash flow positive.

So I think they're going to continue to reduce that average fleet age. Right now, I think, it's in the high teens. I would expect that in the next few years to get actually under 10 years on average as they replace ships in their fleet.

Kobayashi-Solomon: I see. Okay. So we've got the basic idea of this industry and this company.

Fleck: Sure.

Kobayashi-Solomon: The thing that I liked when I saw this idea at first was, first of all, it's a $2 billion market cap company. It's kind of, like you say, an invisible – kind of one of these invisible industries. So that means not a lot of sell side attention to the stock. The other point is that it's involved in offshore oil drilling. And so, everybody hears the BP news and immediately hits the sell button.

Fleck: That's right.

Kobayashi-Solomon: Now, what is the market misunderstanding about Tidewater?

Fleck: I think there are two major issues. One you said, and we said right at the beginning, I think that the news of the BP oil rig disaster is obviously horrible, but Tidewater has very little actual exposure to that. Less than 10% of their boats are operating in North America. Places like West Africa and South America are far more important for them.


Kobayashi-Solomon: So they've got little Gulf of Mexico exposure then?

Fleck: Very little. Some other competitors like a Hornbeck or someone like that would have much more direct exposure to a lack of drilling in the Gulf. Now, obviously, down the road if the U.S. government decides that, long term we don't want drilling in the Gulf, some of those boats that are operating here by competitors could find their way internationally. But I think that Tidewater is very much insulated from that problem.

Kobayashi-Solomon: Kind of well positioned anyway. They've already got the contracts overseas, right?

Fleck: Exactly. And the reputation overseas.

Kobayashi-Solomon: And you mentioned one other factor that maybe the market is misunderstanding about Tidewater.

Fleck: Sure. I think, right now, if you look at across a lot of industries where there is ordering of ships, maybe international bulker or container shipping, the order book or backlog of ships that are scheduled to come online is massive. And it's the same thing in Tidewater in this industry. But I think for a lot of people to see is 20% of the world's fleet right now is on order. In other words, the industry is slated to grow another 20%. It's a big number. But I think what's important to remember is over a third of the industry is over 25 years old. Again, Tidewater…

Kobayashi-Solomon: So there will be decommissioning in other words.

Fleck: Exactly. Tidewater is refreshing its fleet. The industry is refreshing its fleet. So we'll actually increase the amount of new ships, like I talked about earlier, that are operating. But I think the insulating factor from retirement of traditional vessels is going to mitigate that growth quite a bit.

Kobayashi-Solomon: So you've got growth of 20%, shrinkage of 30%, something like that. So, net-net, we're down about 10% in terms of…

Fleck: Right. Now, again, the shift is more towards new boats, which may hamper some of the utilization there.

Kobayashi-Solomon: Right.

Fleck: But nonetheless, far less scarier than some of the other shipping industries we've looked at before.

Kobayashi-Solomon: I see. Adam, it's a fascinating story and I really like it for a bullish idea. Thanks for coming.

Fleck: Thanks for having me, Erik.

Kobayashi-Solomon: And thank you for joining us. Please stop by the Morningstar OptionInvestor website where we have many more great ideas based on Morningstar's fundamental research.


Erik Kobayashi-Solomon does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.