Tuesday, January 20, 2015

Deep Down (Nasdaq - DPDW) -- Engineers Success

Deep Down (DPDW $0.75) is a leading provider of engineering services for the offshore drilling industry.  The company has expertise in several niches, enabling it to land key sub-contracting work.  Deep Down currently is supporting 90-95 offshore projects.  Customers include private energy corporations, sovereign oil companies, and larger service providers that hire Deep Down for specific tasks.  The company also designs and manufactures unique products tailored for individual projects.  Deep Down recently has been able to re-use some of those designs, accelerating turnaround time and profitability.  Backlog stands at $30-$35 million.  It was $33 million at the end of September.  December quarter results have not been published yet.  Despite the fall-off in crude oil prices no orders have been cancelled or deferred to date.  Offshore oil development customarily takes 2-3 years to complete.  Production lasts 20-30 years.  Unlike onshore fracking operations, output can't be shut in temporarily without impacting long term flow rates.

Deep Down was poised to participate in the offshore bonanza in 2010.  Sales were booming.  Orders were accelerating.  The outlook was bright because huge offshore reserves had been discovered both in the Gulf of Mexico and internationally.  The British Petroleum spill brought development to a screeching halt.  Deep Down's sales slipped by a third over the next three years.  The company controlled costs and remained marginally profitable.  But it was challenging to keep its labor force busy and overhead paid for.  The offshore industry spent those years improving processes and technology.  Legal liability was established.  New drilling opportunities were identified with software analysis.  Break even prices declined to $50-$60 a barrel.  Projects came back to life in 2013-2014 as crude oil prices traded in the $90-$110 a barrel range.

Deep Dive rarely had a backlog in the past.  It performed business as it came through the door and was happy to get it.  Project activity surged in 2014, though.  That lifted backlog to $33 million at the end of the September quarter, essentially securing a full year's activity.  Additional orders were obtained in the December period despite the decline in crude prices.  Deep Down also is bidding on $300-$350 million in additional orders.  Those contracts won't be issued until the customers need the work done.  And there's no guessing what percentage the company might win.  The orders span two years, perhaps a little more given the current environment.  It appears the sunk costs on these projects already are high.  So the break even on moving forward at this stage could be $25 a barrel or less.  Considering the longevity of the reserves, most if not all are likely to go to completion.  Deep Down is well positioned to thrive over the next two years no matter what OPEC does.

The risk in the stock is that oil prices remain low 2-3 years from now.  In that case new offshore projects probably won't be pursued.  Deep Down might thrive for a few years.  But if new orders aren't forthcoming the company would be sure to struggle.

We don't know the answer to that.  The way we see it, the world has 7 billion people today.  About 5 billion are poor.  They all aspire to an American lifestyle.  That will create tremendous environmental pressure.  But gasoline is by far the best transportation fuel on earth.  Electricity, heating, desalination, and other requirements may be satisfied with cleaner solutions.  But we think oil is here to stay.  As cheap reserves are depleted new ones will have to be developed.  Offshore is a great opportunity.  Deep Down could be a big winner over the next decade, perhaps longer.

No comments:

Post a Comment