Ergin Yalcin/E+ via Getty Images
Ergin Yalcin/E+ via Getty Images
Tenaris SA (NYSE:TS ) has a few stumbling blocks in the near to medium term. The subdued drilling activity in the Middle East and the company's business model transition in the UAE will keep the demand for contracts low in the next few quarters. The other critical issue would be to keep up working capital, especially when rig count and drilling activity are on the rise in the US.
For the topline, the company has struck various projects worldwide in recent times. Although iron and steel pipe input cost has increased tremendously over the past year, the hot-rolled coils price can go down in 2022. With a rising market share, increased energy industry activity, and sales price hike, I think the overall effect will be positive on the EBITDA margin. On top of that, it has started implementing carbon intensity reduction projects which can drive its business in the long term. The balance sheet remains out of danger because of no debt and sufficient cash balance. Nonetheless, the stock price run-up has outstretched its valuation on a relative scale over the past year. So, I think investors might want to sell at this level and re-enter at a lower price point.
Despite the volume growth and various cost control exercises, the rising input cost remains a challenge for TS, as reflected in higher Pipe Logix. In the past year until December 2021, the US iron and steel price index has shot up by 87%, according to Federal Reserve Economic Data. A steel and iron ore price hike affects margin adversely TS because it uses iron ore to manufacture seamless steel pipe products. The company expects the hot-rolled coils price to go down in 2022, while OCTG (Oil Country Tubular Goods) price can increase, which can drive up the facilities cost. As rig count increases, an increasing market for welded pipes will offset expenses while the company's overall pricing improves.
Nonetheless, the volume surge alone can decrease overhead costs, expanding the margin in Q4. As customer demand rises, the management will feel more confident in passing on the cost hike through market price increases. So, the company is ramping up its production in the US and deploying the Rig Direct services. In Q3, it reopened the Ambridge seamless pipe facility to cater to higher demand while production at the Bay City mills continued to increase. To know more about TS's product strategies, read my previous article here.
The company's management expects revenues to increase by mid-teen percent in Q4 compared to Q3, primarily by the North American recovery. Although the crude oil price remained nearly unchanged in Q4 after going up steadily in Q3, the US rig count continued to march forward in Q4. The drilled but uncompleted wells have continued to decline since the start of 2021.
The subdued drilling activity in the Middle East became a cause of concern for the company in Q3. While it has mildly recovered since the beginning of 2021, it's still way off the pre-pandemic level (35% down). In reality, the OPEC production upliftment is effectively happening slower than expected. The slackness, however, can change in the middle of 2022 as new rigs are being contracted and drilling activity accelerates. One project in Kuwait already looks uncertain, being either called off or deferred.
The other key challenge for TS in UAE is the Rig Direct model transition and its effects. Because of the lag between the old and new contracts, demand has reduced and will continue to move slowly in the next few quarters. This has resulted in destocking. So, I think the company's overall sales will remain flat until 1H 2022. However, things may start to look up in the second half as Saudi Aramco (ARMCO) reactivates some offshore expansion projects. Also, the outlook in UAE can change, too, with a slew of natural gas explorations in Ras al Khaimah and Sharjah.
Tenaris S.A.'s filings
Tenaris S.A.'s filings
A key project expected to move TS's topline forward is a five-year stainless steel pipes supply contract with Sandvik. Here, the company offers high specialty pipes using Dopeless technology. Qatar has received a $330 million welded and seamless pipeline contract for gas supply. As I discussed above, the project will significantly boost the pipeline demand in the Middle East after it slowed down in 2021. The company also extended a five-year contract in Argentina.
Early in 2021, the company disclosed its carbon intensity reduction target by 2030. Following energy companies' emphasis on ESG initiatives, it is looking to acquire or invest in renewable energy in Italy, Argentina, Romania, and the US. Currently, it is involved in a couple of renewable energy projects involving sales of hydrogen storage vessels in Europe and the supply of line pipes for hydrogen development in Saudi Arabia. TS's investment in a medium diameter rolling mill for pipes up to 18 inches should boost carbon emission savings.
Tenaris S.A.'s filings
Tenaris S.A.'s filings
As the industry moved forward, tube sales in South America outperformed all other regions in Q3 with a 36.5% quarter-over-quarter revenue rise. North America was not far behind (27.6% up) during the same period. However, sales slowed down considerably in other regions (17% down in Europe and 12.7% down in the Middle East/Africa) primarily because of continued destocking.
In Q3, TS recorded $379 million in EBITDA, up by 26% quarter-over-quarter, due to increased sales volume and better pricing. For Tenaris, the average selling price increased 6% sequentially. Not only that but also higher volume helped the company contain operating costs, resulting in an EBITDA margin expansion in Q3.
TS's cash flow from operations (or CFO) nearly dried up in 9M 2021 ($73 million). This was steeply lower (94% down) than a year ago. Despite an 11% revenue rise during this period, a steep rise in working capital requirements led to decreased cash flow. As a result, free cash flow turned negative in the past year.
A negative net debt indicates low financial risks. TS's net debt was negative $458 million as of September 30, 2021, due to cash & cash equivalents balance (includes investments) exceeding total debt. TS now pays a dividend ($0.54 annualized), which amounts to a dividend yield of 2.20%. In comparison, Hunting PLC's (OTCPK:HNTIF) dividend yield amounts to 2.80%.
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 and TS's reported revenues for the past six years and the previous eight-quarters, I expect revenues to increase moderately over the next three 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 2022). The model also suggests it can continue to expand in NTM 2023 but may stagnate in the following year.
Author created and Seeking Alpha
Author created and Seeking Alpha
I have calculated the EV using the forward multiple and the past average multiple. Returns potential (21% downside) using the forward EV/EBITDA multiple (11.2x) is higher than the past average (40% downside). Wall Street's sell-side analysts, however, expect higher returns (19% upside) from the stock.
The company's EV/EBITDA multiple (13.3x) is much higher than its peers' (HNTIF, TMST, and X) average of 2.9x. TS's forward EV-to-EBITDA multiple contraction means its EBITDA can expand less sharply than its peers. This typically results in a lower EV/EBITDA multiple compared to peers. So, the stock is overvalued versus its peers at the current level.
One thing that has remained nearly constant for TS has been the rising input cost, as reflected in higher Pipe Logix. Although this can typically put pressure on the margin, the hot-rolled coils price can go down, leveraging higher average sales price, it can push EBITDA margin up. Recent contracts, including the five-year stainless steel pipes supply contract with Sandvik and a $330 million welded and seamless pipeline contract in Qatar, will drive revenues in the medium term. So, the stock price outperformed the SPDR S&P 500 Trust ETF (SPY) in the past year.
Tenaris has zero debt and robust liquidity. However, there are a few stumbling blocks for the company in the near to medium term. Demand for contracts has reduced in the UAE will remain slow in the next few quarters, resulting in destocking. Also, the US' increased rig count and drilling activity have drained out the company's cash flow from operations, leading to negative free cash flows. So, I think the stock has a downside at the current level.
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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.