Broadly defined, there are three primary ways to play energy cycles – exploration and production companies (ranging from tiny wildcatters to huge international behemoths), service companies, and equipment companies – and they all have their own cycles and quirks. In the case of equipment companies, it's often the case that the stocks make the biggest moves early in the cycle as orders are announced only to taper off as those orders actually turn into revenue and earnings. To that end, while Cameron (NYSE:CAM) appears to have meaningful untapped margin leverage, as well as significant revenue and cash flow growth prospects, it hasn't always been a smart move to hang around after the big order announcements.
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But The Orders Keep Coming In...
To that end, while Cameron reported a relatively disappointing first quarter a little while ago (below many analysts' expectations and at the low end of company guidance), most of the talk focused on the strong incoming orders.
Revenue did climb 17% from the year-ago level (and fell 13% sequentially), but orders jumped 41%. Cameron exited the quarter with a backlog of about $10 billion – an all-time high for the company. Better still, many of these orders are involving more products per order (more components, controls, etc.), which should help margins. What's more, aftermarket demand is improving and that should offer a boost to subsea margins for Cameron (as well as FMC Technologies (NYSE:FTI)).
Speaking of orders, even with this surge Cameron's backlog relative to capacity is not all that large when compared to FMC or General Electric's (NYSE:GE) Vetco business. As this process rolls on, then, I'm curious to see how bidding activity will evolve – will GE and FMC continue to bid aggressively (and risk over-building capacity and hurting margins), or will Cameron be able to take advantage of less incremental capacity at these rivals?
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Big Things Expected From OneSubsea
Almost every sell-side analyst covering Cameron already seems to expect big things from OneSubsea – the company's 60/40 joint venture with Schlumberger (NYSE:SLB) for subsea equipment and systems. I can understand the enthusiasm; the combination of the two companies' expertise and technology should be compelling, and could very well vault Cameron ahead of FMC Technologies in emerging markets like subsea separation.
The combination should also broaden Cameron's customer base. Right now Petrobras (NYSE:PBR) is about half of the company's subsea backlog, and a handful of other large players (BP (NYSE:BP), Chevron (NYSE:CVX), Husky, and Petronas) making up another quarter. With Schlumberger's capabilities in reservoir characterization, artificial lift, pumps, and so on, OneSubsea should attract customers that otherwise would have gone with GE or FMC, and that should fill out the company's subsea manufacturing capacity.
Will The Cycle Disappoint?
The energy sector being what it is, of course there are execution risks that could derail Cameron's prospects. The multinational energy companies are at least talking about being more restrained and disciplined in their project plans, eschewing “drill baby drill” for a greater focus on economic returns and cash flow. If that leads to a more restrained spending cycle, it won't be helpful for the big equipment companies like Cameron, GE, FMC, and National Oilwell Varco (NYSE:NOV). That said, global energy prices are still offering good incentives to continue exploring and producing, and Cameron and National Oilwell can continue to benefit from rig equipment demand (particularly as a large number of floaters and jack-up go into service in the coming years) and onshore demand in areas like fracking and pressure pumping.
The Bottom Line
If Cameron's reported order book keeps growing at a faster than expected rate, the stock should do well. That said, investors would do well to remember that Cameron (as well as National Oilwell and FMC) don't tend to look so good from a long-term cash flow perspective. Consequently, these are not particularly good buy-and-hold stocks for investors who are looking for multi-year positions.
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Cameron's median EV/EBITDA multiple falls in the 9x to 9.5x range, with the recent OneSubsea venture implying a double-digit multiple for the subsea business. Using a 9.5x multiple for the next 12 months (as this is still the order-growth phase of the cycle), Cameron's fair value looks close to $70. That's a worthwhile move from today's prove, particularly as these stocks tend to overshoot when the cycle gets going. As a result, I still think there's time to buy Cameron and enjoy the benefits of improving order growth, but I'd be careful about holding this stock through the actual delivery of those orders, even if the prospects for margin leverage and cash flow generation are looking better than in past cycles.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.