KCA Deutag - Waiting for the inevitable
All,
Please find our updated model on KCA Deutag here.
We have eventually succumbed to updating our model and analysis on KCA Deutag, previously pausing, thinking a refinancing was just around the corner. The credit story is not an interesting one, and with the bonds callable at current trading levels, we maintain our view that the Company should and will address its capital structure in 2024. However, we had expected an announcement after the publication of the FY23 results earlier this year, and then post Q1 numbers, but now it distinctly looks like it will be a post-summer event. The Saipem acquisition's final phase will be completed by then, but this last component is not a major concern for the overall business.
Investment Rationale:
- We initially took a position in KCA Deutag pre-restructuring (2nd restructuring) in 2020 and have maintained the position as the operations improved. The position has not been without setbacks, with the Ukraine war and subsequent Russian sanctions leading to KCA Deutag withdrawing and abandoning its 17 rigs in Russia.
- In respect to the bonds, we see very limited downside, with leverage at 1.6x and significant visibility from its substantial order book. But given its call features, there is no upside except for the carry, either 9.875% on the fixed notes or c. 14% on the 3month $ plus 9% on the floating.
- As outlined above, we strongly expect a refinancing imminently. However, the Company continue to allude to a larger transaction, including potentially a listing post-completion of the Saipem acquisition. We are a little perplexed at the delay, but with operations continuing to improve we are happy to maintain our position.
- The equity story is a little more complex. The restructuring in 2020 was the second restructuring the business required in quick succession, and that is despite two equity injections prior to the first restructuring, which highlights the need for caution in relation to leverage and this industry. KCA Deutag derives nearly all of its business from emerging market territories and it is not obvious where a potential listing would take place.
Recent Results:
- Strong set of results, as the business continues to benefit from the integration of the Saipem acquisition. Integration run rate synergies currently at 91% of the upwardly revised target (already hit the previous target).
- KCA Deutag managed to add over $650m of contract wins in the quarter, plus an additional, post-quarter win of $400m, pushing the backlog up to $5.5bn.
- Land Drilling utilisation in Q1 is at 62%, but more importantly at 76% in the core Middle East region.
- Offshore also improved its operations, with 22 platforms (out of 31) now operating with overall sentiment boosted by Equinor’s contract renewal on 5 of its existing platforms and an additional contract wins on two further platforms in the region.
- Engineering business sees steady demand for its products across the spectrum of energy transition and traditional oil and gas.
- There was the normal seasonal working capital outflow in Q1, but despite this, cashflow stayed relatively the same (increased by $3m). Leverage reduced from 2.4x Q1 2023 to 1.6x Q1 2024 on the continuing improving EBITDA.
So what is next?
- We were going to title the email - waiting for Godot - but as you probably know Godot never arrives. We remain convinced that a refinancing will happen in FY24 but if it doesn’t materialise investors, and us, will also be contemplating the meaning of life. Or at least, why KCA Deutag missed the opportunity.
- KCA Deutag have no upcoming maturity until December 2025 when the two Senior Secured Notes fall due. The PIKs have a maturity of December 2027, but given the high coupon on the bonds (c. 10% and 14%) and the PIK (15%) the value leakage from equity to credit is substantial. However, for KCA Deutag, this is broadly the same investor base, but there are some differences.
- The only reason we can construct for the delay is to receive final clearance for the acquisition of the 6 rigs in Argentina, Kazakhstan and Romania but honestly, the contribution of these 6 versus 138 already part of the business is de minimis. The business has largely achieved its synergy goals, and although further gains are expected, they too are on the small size.
Ultimately, we are at a loss as to why there is a delay, but in the meantime, we continue to enjoy the c. 9% carry.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk