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From The Survey: Dresser-Rand
Dresser-Rand (DRC) is an equipment and services provider, primarily serving the oil & gas, chemicals, power generation, and environmental markets. The company specializes in manufacturing rotating equipment, such as compressors, engines, and turbines. Dresser-Rand offers its products and services in over 32 countries, with 49 service and support offices, 13 manufacturing plants, and six R&D facilities.
The company serves most large Exploration & Production companies (E&Ps), national oil companies (NOCs), refiners, drillers, engineering and construction firms, chemical makers, and pipeline operators. The list of clients is numerous, with Chevron (CVX – Free Chevron Stock Report), BP Plc. (BP), and Statoil (STO) being some of the major players. The manufacturer supplies its equipment and services to many of the world’s major onshore and offshore oil basins. Indeed, the company is also quite diversified, with North America accounting for 33% of sales; Europe, 25%; Latin America, 16%; Asia, 15%; and the Middle East and Africa, 11%. Currently, Dresser-Rand is expanding its manufacturing footprint in Brazil and Saudi Arabia to take advantage of the longer-term growth trends in the surrounding areas.
The supplier reports revenue under two segments: New Units and Aftermarket. Both have historically contributed to the top line equally. However, the Aftermarket division has accounted for 70%-80% of the firm’s total operating income over the past couple of years. Aftermarket margins are generally higher thanks to the premium paid by the owners to avoid the alternative of equipment breakdowns. The Aftermarket business is also more consistent and generates predictable cash flow, as it is less sensitive to the business cycle than the New Unit segment. There are also inherent risks for equipment owners to not properly servicing or repairing parts in a timely fashion (production shutdown).
The New Unit manufactures and sells compressors, turbines, and expanders and control systems. The company builds standard equipment for lower-intensity work or highly specialized customizable equipment for clients. This custom-engineered equipment provides the bulk of orders in this business, servicing everything from deepwater wells to LNG and refining facilities.
The Aftermarket division delivers maintenance and repair services on previously installed equipment. The products and services include replacement parts, technology upgrades, and project management services, to name a few. Due to the long-life cycles of energy infrastructure, there are significant opportunities to service these parts. In addition, we believe more operators, from the upstream to downstream markets, are increasingly outsourcing their ancillary work to firms like Dresser-Rand.
The company is developing a small-scale LNG plant that could be widely utilized for various applications in the upstream and downstream markets. The finished product is expected to be released in the first half of 2014, after its prototype facility successfully produced LNG in December of last year. The typical plant, called LNGo, will be able to produce about 6,000 gallons of LNG a day. We believe these types of facilities could provide a decent longer-term opportunity for some short-cycle work. The plants could be used to help E&Ps turn gas now flared into saleable product in many of the various remote shale plays in North America. Additionally, the increased production of LNG could fuel their trucks and even the energy needed for the drilling process.
Another promising technology that Dresser-Rand has been developing over the past couple decades is the Compressed Air Energy Storage (CAES) technology. The process requires a salt cavern or underground cave, in which a fossil-fuel or clean tech utility can store energy during the non-peak hours and then release that power during the peak hours. Dresser-Rand’s SMARTCAES business provides all products and services for the lifecycle of the endeavor. The technology is especially promising considering the emergence of solar and wind generation, which can be quite sporadic and unsuitable for peak-hour power generation.
In July of last year, the company received a $200 million contract to supply the equipment for a 317 megawatt CAES facility in Texas to be constructed by Apex. Management believes the CAES market could deliver some favorable results to the bottom line going forward, driven by a ramp in wind and solar developments. In fact, the company thinks there could be roughly 40-50 CAES projects awarded over the next five to ten years. We believe Dresser-Rand is well positioned to benefit from this growing trend, given its expertise and market leadership in this industry.
We expect overall global demand for oil to remain strong in the coming years, as developing nations continue to build up their economies. We believe that there will be a number of different growth drivers, including;: A North American shale and offshore drilling boom, energy infrastructure buildout, the emergence of a North American LNG export market, a rise in global deepwater drilling activity, and a ramp up of chemical facilities.
Although Dresser-Rand’s longer-term outlook is quite favorable, this could be a transition year for the New Units division. We believe project delays and working capital concerns ought to remain headwinds in the interim. However, good performance in the Aftermarket business should help offset some of the weakness, growing the top line at a mid-to-high single-digit clip in 2014. As such, we still are forecasting earnings to rise nearly 30% in 2014, to $3.90 a share.
The stock has trailed the broader market averages ever since it reported earnings in June of 2013. Investors were expecting a much stronger showing in bookings last year that never materialized. Too, some of the execution problems and project delays dampened investor sentiment, in our view.
Consequently, we believe the stock’s current quotation, coupled with the strong 3- to 5-year capital appreciation potential, creates a favorable entry point for longer-term investors.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.