Ergin Yalcin/E+ via Getty Images
Ergin Yalcin/E+ via Getty Images
The welded production in the United States will increase as the energy production and midstream activities ramp up in the US. While the growth can be slow for Tenaris S.A. (NYSE:TS ) in this region, in many other parts, a spurt in shale oil and offshore production can push pipeline demand sharply in 2022. It has various tailwinds due to the energy market recovery and its positioning to benefit from it. The company has received a long-term contract to supply premium products in the Middle East. The company has an advantage in many regions due to its extensive local manufacturing and service capabilities.
While the company is increasing prices and volume, the rising input costs and relatively long lead time led to a higher inventory level. As working capital requirements rose, its cash flows tumbled in Q1. However, because of a robust balance sheet and low leverage (debt-to-equity), I do not see anything derailing its outlook in the short term. Relative valuation-wise, the stock has a slight negative bias. Nonetheless, investors with a medium-to-long-term view might want to hold the stock.
The global commodity demand and supply have undergone a locus shift following the supply chain disruption and the Ukraine war in the past few months. As Europe prepares to replace Russian energy, the long-term effect of renewables in the energy market cannot be underestimated. However, over the medium term, we can expect investment in traditional energy to increase, and prevalent supply falling short. In this backdrop, drilling activity in the Middle East is improving after the pandemic-led slowdown. There have been new projects in the Black Sea and the Eastern Mediterranean, although they may take a few months to come online. In Sub-Saharan-Africa, we see new short-cycle gas projects in Congo and Mozambique.
Please about TS's product strategies, read my previous article here. In the past year until March 2022, the US iron and steel price index has shot up by 36%, which may affect its margin adversely. As rig count increases, the market for welded pipes will expand, thus offsetting expenses. At the same time, the company's overall pricing improves. Due to the disruption in the supply chain, the cost increase is substantial. However, the management is confident that it can transfer the increasing cost to its client in this environment and may continue to do so in the coming quarters, thus allowing for margins to expand.
The company's management sees new pipelines developed in the Mediterranean and Black Seas as Europe moves away from energy imports from Russia. With manufacturing plants already producing in Italy and Brazil, Tenaris can fast-track the projects. Recently, it has supplied the Sakarya pipeline project while the Cassiopeia pipeline project is due in 2022. The company's somewhat underwhelming results in Q1 in the Middle East should reverse as higher energy prices drive fresh investment. It is set to receive a long-term (10-year) contract from Saudi Aramco to supply premium products.
Tenaris S.A.'s Filings
Tenaris S.A.'s Filings
In Argentina, Brazil, Colombia, and Mexico in Latin America, where there are deepwater and shale reserves, Tenaris has an advantage over many of its peers due to its extensive local manufacturing and service capabilities. Among its premium products, TS offers high specialty pipes using Dopeless technology. Its Bay City mill is now operating at total capacity. After the pandemic-led stoppages, it has also started operations at some other facilities.
In the US, the company's welded production will ramp up slowly. The company is focused on the surface casing that could be supplied by welded pipeline. It expects that by Q4, increased pipeline activity in Latin America will see higher demand for its welded component. One of the major markets is in Vaca Muerta shale in Argentina.
Tenaris S.A..'s Filings
Tenaris S.A..'s Filings
TS's tube sales in Europe and Asia/Pacific-Oceania regionally outperformed in Q1 with 39% and 25% revenue rises. North America was not far behind (20.5% up) during the same period. Higher prices in North America and higher shipments of line pipe in Europe caused the topline to spike. However, sales dropped in Middle East/Africa primarily because of continued destocking.
In Q1, TS recorded $627 million in EBITDA, up by 30% quarter-over-quarter, due to increased pricing. For Tenaris, the average selling price increased 12% sequentially. Despite higher energy and raw material costs, the price hike resulted in an EBITDA margin expansion in Q1.
TS's cash flow from operations (or CFO) turned negative in Q1 2022 (-$27 million). Despite revenues doubling in the past year, a steep rise in working capital requirements decreased cash flow. So, free cash flow also turned negative in the past year. While the company is increasing prices and rising volume, it is also building up inventories. A relatively long lead time and a higher inventory level can lead to higher working capital. The company aims to reduce the days of operative working capital in the coming quarters.
Cash & cash equivalents exceeded total debt. As a result, TS's net debt was negative $321 million as of March 31, 2022. TS pays a dividend of $0.54 annualized, which amounts to a dividend yield of 3.77%. Hunting PLC's (OTCPK:HNTIF) dividend yield amounts to 2.16%.
Author created, Seeking Alpha, Baker Hughes, FRED Economic Research, and EIA
Author created, Seeking Alpha, Baker Hughes, FRED Economic Research, and EIA
Based on a regression equation between the industry indicators (crude oil price, US rig count, and Iron & Steel price index) and TS's reported revenues for the past seven years and the previous eight-quarters, I expect revenues to remain nearly unchanged (modest increase) over the next two years.
Author created and Seeking Alpha
Author created and Seeking Alpha
Based on the regression model using the average forecast revenues, I expect the company's EBITDA to jump in the next twelve months (NTM 2023). EBITDA can continue to expand in NTM 2024 but at a decelerated rate.
Author Created and Seeking Alpha
Author Created and Seeking Alpha
Returns potential (37% downside) using the forward EV/EBITDA multiple (6.7x) is higher than the past average (51% downside). However, Wall Street's sell-side analysts expect much higher returns (25% upside) from the stock.
The company's EV/EBITDA multiple (10.3x) is much higher than its peers' (HNTIF, TMST, and X) average of 1.8x. The forward EV-to-EBITDA multiple contraction means its EBITDA can expand more sharply than its peers. This typically results in a higher EV/EBITDA multiple compared to peers. So, the stock seems reasonably versus its peers at the current level, although I think it can be slightly overvalued.
Tenaris has various tailwinds due to the energy market recovery and its positioning to benefit from it. The drilling activity in the Middle East is improving, while new projects are coming up in the Black Sea and the Eastern Mediterranean. It is also likely to receive a long-term contract from Saudi Aramco to supply premium products. The company has an advantage over many of its peers in the international markets due to its extensive local manufacturing and service capabilities. So, the stock price outperformed the SPDR S&P 500 Trust ETF (SPY) in the past year.
However, as reflected in higher Pipe Logix, the rising input cost puts pressure on the margin. The cash flows have turned negative in Q1, spelling worries for the investors. A relatively high inventory level can lead to higher working capital in the near term. The balance sheet is robust because the company has low debt versus shareholders' equity. At this level, I think the stock has a marginal downside.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.