Tidewater Stock: Robust Demand, Supply Constraints & Conservative Consensus Estimates

Investment Thesis

Demand for OSVs will remain robust as a result of healthy oil prices, peaking US shale production, and lower offshore breakeven levels. On the supply side, limited yard capacity, high newbuilding and secondhand prices, and ageing global fleet will retain day rates and utilization rates high. Lastly, we believe that the market is too conservative in anticipating TDW’s future revenue. Our estimated fair value is between $125 and $163 per share (22% to 59% upside potential), assuming a $1 billion adjusted EBITDA by 2025 (61% 2-year CAGR from 2023). Initiate with a BUY rating.

Introduction

Founded in 1956, Tidewater, Inc. (NYSE:TDW) is the leading offshore vessel (“OSV”) owner globally with 217 active vessels, including 141 platform supply vessels (“PSV”) and 54 anchor handling tug supply vessels (“AHTS”). OSVs are typically used for towing mobile offshore drilling unit (“MODU”), handling rig anchor, supporting offshore exploration & production (“E&P”) activities, as well as seismic and survey supports. Customers include national oil companies (“NOCs”), such as Saudi Aramco, and international oil companies (“IOCs”).

Following its emergence from Chapter 11 Bankruptcy after a weak market environment and mountains of debt, TDW acquired OSVs Swire Pacific Offshore Holdings Limited (21 PSVs and 29 AHTS vessels) and Solstad Offshore ASA (37 PSVs) in 2022 and 2023, respectively. As a result of these acquisitions, TDW is the market leader in total fleet with 195 OSVs and 22 other support vessels. TDW’s fleet average age is about 12 years of age, compared to the market’s median of about 15 years (built 2009).

TDW’s share price has increased ten times in just three years from $10 per share to over $100 per share. We believe this is attributable to favorable market conditions, such as high day rates and asset prices, and massive asset acquisitions.

Nevertheless, the market is concerned about a few things as follows:

1. Oil demand will structurally decline as a result of decarbonization and the proliferation of electric vehicles (“EVs”).

2. TDW’s “seemingly” rich valuations have prompted executives to sell their shares.

We believe that TDW still has an upside potential with our bull case presented below.

Robust Offshore FID Activity

We believe the start of an investment cycle in the offshore market will sustain the strong demand for OSVs. For starters, we will take a closer look at the dynamics of the previous cycles.

Between 2004 and 2008, oil prices had a steep increase, fueled by China’s rapid economic growth. Consequently, a favorable market environment prompted shipowners to contract newbuilds, leading to elevated orderbook levels. However, in the aftermath of the global financial crisis (“GFC”) in 2008, oil prices crashed, resulting in reduced oil and gas spending. But a massive influx of supply, contracted during favorable years, was still coming to the market as newbuilds typically require two and three years to be delivered. Despite a persisting oversupply issue, shipyards were still filled with speculative orders, in part because of favorable financing terms. During the peak cycle in mid-2008, the OSV to Rig ratio, a measure of the market’s supply and demand, was 3.4x. This figure jumped to 4.8x in early 2011.

From 2011 to 2014, the offshore rig market began to pick up, resulting in robust demand for OSVs and orderbook ramping up. But in mid-2014, oil prices had one of the biggest drops in history as US shale oil flooded the market with more supply. US shale oil production sharply increased from 0.4 barrels per day in 2007 to 4 million barrels per day in 2014. Tepid economic growth in oil-importing countries, such as the US and China, and in non-oil commodity exporting emerging markets also played a part in the oil price plunge, according to the World Bank. West Texas Intermediate (“WTI”) and Brent spot prices declined to below $50 per barrels, resulting in E&P capex cuts.

According to TDW, working rig count declined 40% from 2014 to 2017, while the oversupply issue remained since newbuilds contracted during the previous years were delivered. Additionally, scrapping an OSV does not economically make sense at this point, since scrapping value was less than $1 million to $2 million, not to mention the high transportation costs to scrapyards that made it financially difficult for smaller OSV owners. From 2016 to 2019, the OSV to Rig ratio hovered between 7x and 8x, while the healthy level is typically around 4x. AlixPartners’ research suggests that OSV owners had earned below the cost of capital since 2009 to 2018.

Finally, OSV owners began to see the lights at the end of the tunnel as the COVID pandemic abated. First, oil prices remained healthy at $80 to $100 barrels per day as OPEC+ announced sustained production cuts. Second, on the supply side, US shale oil production might be reaching a plateau after years of massive drilling activities. US crude oil output increase is expected to reach 170,000 barrels a day this year, the smallest annual increase since 2016 excluding the pandemic, as noted by the WSJ. Goehring & Rozencwajg, a research firm, also found that the productivity per lateral foot in the Permian Basin, which accounted for nearly half of US oil production, declined for the first time. This indicates that the Permian Basin is approaching its peak. As a result, oil companies will be looking for alternatives.

Lastly, the average breakeven levels for offshore projects have come down sharply, putting the average breakeven prices for deepwater projects below tight oil. So, oil companies are increasingly more interested in drilling offshore.

Consequently, Final Investment Decision (“FID”) activity for offshore projects is estimated to reach $103 billion between April and December this year. Further, Rystad Energy estimated offshore upstream capex to grow 10% for the year, driven by capex for deepwater projects. The energy research firm also anticipated 50 more deepwater and ultra-deepwater wells to be drilled than in 2023.

For example, Petrobras, a Brazilian NOC, anticipated a $73 billion of investments in E&P activities. Exxon Mobil committed $12.7 billion for Whiptail project, its sixth project on the Stabroek block in Guyana. Increased drilling activities in the Southeast Asia are estimated to take up 600 OSVs by 2026, while the current supply is about 500 vessels, mostly tied to long-term contracts.

Overall, as oil prices are trading at healthy levels, we believe that the offshore market will remain robust, especially as US shale production appears to be peaking. In addition, the breakeven levels of offshore projects have come down significantly, making producing oil more attractive economically. These factors have spurred robust FID activity.

Supply Constraints and Ageing Global Fleet

Strong demand and tight market have driven day rates and utilization rates to exceed the 2014 levels. According to S&P Global, 330 OSVs have been removed from the market from 2016 to June 2023 because they pivoted to non-energy sectors. On top of that, 160 vessels have been scrapped.

Amid a favorable market environment, shipowners typically look to contract newbuilds. However, the current situation is rather unique in that OSV orderbook remains limited. Previously, orders for 4,000 to 6,000 deadweight tonnage PSVs were piling up when long-term contracts were about $40,000 a day in 2014. As things stand, day rates have been around $40,000 to $45,000 a day with a low orderbook. This can be attributed to two main factors:

1. Less yard capacity for OSV newbuilds

Following the global financial crisis, shipyards have been consolidating, with a lot of smaller yards exiting the market. When the global economy began to pick up in 2021, shipyards were flooded by orders from containers and LNGs, meaning that there were capacity constraints. There are existing OSV orderbook, but a significant portion of that was actually orders from 2014 and 2015 that were either cancelled or put on-hold, S&P Global noted.

2. High Newbuilding and Secondhand Prices

Even if there is available capacity in shipyards, building a new vessel does not make perfect sense economically. TDW shows that a new vessel that costs $65 million is required to earn an averaged $44,000 per day for twenty years to achieve “NPV Zero.” Secondhand prices are also high. For example, a 10-year old commodity PSV was sold at over twelve times higher than the price in 2018. Rising newbuilding prices and limited financing alternatives resulted in few supply coming into the market.

We believe that supply constraints will persist at least in the two next years until the current orderbook, which typically takes two to three years, is delivered to the market. As things stand, a few owners have ordered new OSVs, but it was not until 4Q25 and 1Q26 that those vessels will be delivered. But that, too, is unlikely to fully offset the ageing global fleet, in our view.

High newbuilding prices and OSV day rates have resulted in owners avoiding scrapping their older vessels, leading to increasing market’s average age. According to S&P, approximately 25% of total OSV tonnage was from vessels older than 20 years, vessels that are typically ideal for scrapping. Oil companies usually prefer newer vessels, and maintenance and survey costs will be much higher for older ones. TDW shows that 41% of the global fleet will be older than 25 years by 2035.

Therefore, we believe that strong demand for OSVs, tight market with no significant supply coming into the market, and ageing global fleet will likely maintain day rates and utilization rates high.

TDW to Beat Consensus Estimates

TDW witnessed its realized day rates sharply increase since 2021 thanks to stronger demand and tighter market. Management explained how the company took an advantage of robust rates:

We consciously chose to forego certain immediate contracts to pursue higher day rate opportunities. And in some cases, we incurred frictional unemployment related to relocating vessels and waiting on customers for projects to commence.

On the 3Q23 earnings call:

The first of which is older contracts rolling off and re-contracting at prevailing market rates, allowing us to continue to mark-to-market our fleet. The second factor is that leading-edge term contracts continue to move meaningfully higher.

As a result, TDW’s average day rates have increased by around $1,000 to $1,800 per day sequentially and approximately $4,000 per day annually.

Management’s guidance for this year is as follows:

• $1.4 billion to $1.45 billion in revenue.
• 52% gross margin for the full year. Flat 2Q24 gross margin, 700 basis points margin expansion in 3Q24, and 56% margin in 4Q24.
• $104 million cash G&A expenses, including $13.6 million of non-cash stock compensation.
• $129 million drydock costs.
• $25 million capital expenditures.

We expect TDW to report $1.46 billion in revenue (~3% above consensus) and $668 billion in adjusted EBITDA (~4% above consensus). But even more importantly, we believe that the market is too conservative in anticipating next year revenue of $1.64 billion.

We expect 2025F revenue to be $1.85 billion (~13% above consensus), assuming 219 vessels, an 85% total fleet utilization rate, and $27,000 average day rates. Our rationale behind significant average day rates increases is that the leading-edge day rate composite, which refer to the average rate of the contracts longer than two months signed in that particular quarter, was nearly $31,000 per day. Logically, it makes sense for the realized average day rates to be near that figure as older contracts roll-off. For newer contracts, duration ranges from 6.5 months to 9 months. In case of inherited contracts below the market price, a significant portion of them will roll-off at the end of 2024:

Australian contracts that we inherited were definitely below market. I mean, we price it accordingly, but they were below market. So when they roll-off in the next year or year and a half, the — that should reprice quite nicely. And then it generally in the North Sea market it’s been fairly fixed, half of it’s going to roll over by the end of 2024, yeah.

We expect adjusted EBITDA to reach $1 billion in 2025F, assuming a 60% gross margin and relatively flat G&A expenses:

How will management utilize this incoming cash? Including the $18.1 million authorized for share repurchases in 1Q24, the maximum amount of the share repurchases will be $50.7 million, which will be updated quarterly, under the existing debt agreement. The lion’s share of the free cash flow will likely be allocated to asset purchases, especially those in the US and Brazil, as management has reiterated a lack of presence in those areas.

Valuation

TDW is trading at 8.7x forward EV/EBITDA, roughly at the same level as the multiple’s 5-year average. Assuming the stock will trade at 7-9x, a $1 billion 2025F adjusted EBITDA brings the estimated fair value to $125 per share to $163 per share (1Q24 $442 million net debt and ~1% decrease in share count from 1Q24). We believe that the stock’s upside potential is between 22% and 59%.

Investment Risks

The proliferation of EV will significant reduce oil demand

Electric vehicles are expected to lower oil demand structurally. However, global EV sales have been slowing down, with a lack of rapid-charging stations being one of the reasons. EVs overtaking conventional fuel vehicles might be taking longer than anticipated.

Reactivated cold-stacked vessels will increase supply

Approximately 22% of total global fleet or over 900 vessels laid up could re-enter the market. However, 90% of the laid-up fleet is low-spec, and those that have been cold-stacked more than five years have little chance to be re-activated.

Conclusion

TDW’s stock price has increased by ten times in just three years. We believe the stock still has an upside potential of between 21% and 58%. First, demand for OSVs will remain robust thanks to healthy oil prices, peaking US shale oil production output, and lower breakeven levels. On the supply side, limited yard capacity and high newbuilding and secondhand prices prevent significant supply from coming into the market. As a result, with virtually no new supply, a significant portion of the global fleet is ageing. We believe these factors will drive OSV day rates and utilization rates.

We believe that TDW could pencil in $1.85 billion in revenue by 2025, 13% higher than what the market is anticipating. The current share price implies a six times forward EV/EBITDA. If we assume a 7-9x EV/EBITDA, the estimated fair value is between $125 and $163 per share (22% to 59% upside potential).

Investment risks include the proliferation of electric vehicles that will curb oil demand and cold-stacked supply that could come into the market. However, we believe that EVs will take longer to overtake conventional fuel vehicles. And vessels that are laid up for over five years are unlikely to be reactivated.

Initiate with a BUY rating. If you have any thoughts, please do not hesitate to comment below.