Bristow group has become too cheap to ignore – bristow group inc. (nyse_brs) _ seeking alpha

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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. Shares of Bristow continue to fall despite EBITDAR being essentially unchanged in the last year. EV/EBITDA ratios have collapsed due to the weak sentiment. We think this is a massive overreaction and that the shares are a compelling value compared to the underlying assets of the fleet and the UK contract. The company has been able to downsize significantly and improve liquidity in order to manage the downturn in demand. We highlighted Bristow Group (NYSE: BRS) as an oversold oil-related play back in early March as two-thirds of their contracts are unrelated to the price of oil. Given the oil and gas connection, investors have been quick on hitting the sell button, which has driven the shares down another 60% since our article.

This compares to the oil-services index falling only 16% over the same period. But we think the shares are now substantially oversold given the better contract structures compared to most of those oil-services stocks and recent acquisitions. Contract Structure Is Highly Favorable We believe the contracts that Bristow has engaged are insulated from the market movements, as they are primarily retainer-based with standing charges.

These allow the customer to have the helicopters on last-minute notice in the event of any issues that come up on offshore rigs. In addition, the company continues to generate positive net income compared to much of the oil services component companies who are in the red. We are not making the argument that the oil slump is not having an effect on a cyclical industry such as offshore oil service transportation. All operators in the space related to the oil industry are reporting very sharp declines in revenue and weak overall demand. The correlation between the decline in oil prices and demand for offshore helicopters is quite strong. With a drop in oil prices of a significant nature, rig utilization will fall, even if production continues on the rig itself. But in the latest quarter, just 20% of their revenue came from exploration end-markets, with 10% coming from development.

We think these are the vulnerable segments as the 60% in production is still generative in terms of revenue albeit at weaker rates. The company serves a significant amount of offshore production installations, of which there are approximately 8,000 worldwide, according to management.

Just 800-850 are offshore rigs, which leaves significantly less exposure to the development and drilling side of the sector. Their contract structure is highly predictable with two-tiered contracts including both a fixed monthly standing charge to reserve helicopter capacity (noted above) and variable fees based on hours flown with fuel pass-through. Bristow’s oil and gas contracts earn on average 65% of revenue not dependent on utilization. In addition, the UK search and rescue contract earns ~85% of its revenue independent of utilization.

Click to enlarge (Source: Investor Presentation) Cost-Cutting and Downsizing Becoming Leaner and Meaner The company is in the midst of becoming a much leaner operation, which we think will amplify their operating leverage once the price of oil rebounds. Over the past year, the company has kept itself ahead of the decline by taking strong measures at maintaining their market leading position until the eventual rebound in the industry. Management has instituted a capex deferral of approximately $100 million from their aircraft budget for fiscal 2016 with additional deferrals currently under negotiation. They now expect aircraft capex of approximately $100 million per year for the next two years and $50 million per fiscal year thereafter.

We think the investments they made in their modern fleet over the last five years means they need less renewal capex. The mostly owned fleet gives them critical optionality to sell aircraft or decline lease renewal options and return the un-owned aircraft reducing annual fixed cash costs. On the operating side of the business, they are targeting a $150 million reduction with 40% coming from workforce reductions, another 40% coming from direct costs, and 20% from the G&A and other lines.

Approximately 20% of these restructuring methods were in place by the fiscal second quarter call in early November with management pegging more by the second half of the fiscal year. In addition, we think the shares have moved lower due to the fears of an equity raise to bolster their UK search and rescue business. We think they will continue to borrow the money, which they did with a recent term loan of $200 million providing a significant excess liquidity cushion for a prolonged downturn – and taking the equity raise off the table. Some of the proceeds will be used initially to pay down an outstanding revolver and to fund capex and working capital needs. They also amended their bank debt covenants to provide additional financial flexibility.

UK Search And Rescue Segment Likely To Lead To Further Contracts When energy prices started to fall in the third quarter of 2014, they quickly shifted their focus towards other aspects of the business, notably search and rescue. The UK SAR contract is approximately ten years in term with an option for a two-year extension by the UK government.

These diversification efforts paid off when you look at their recently reported fiscal 2016 results. Although they showed a 96% decline in adjusted net income to just $1.3 million, from $31 million in the same quarter last year , adjusted EBITDAR was largely flat at $123 million when backing out the FX effects, lending to those diversification and restructuring benefits we noted. They have also used their recent acquisitions of Eastern Airways and Airnorth to create synergies and increase the point-of-sale logistics solutions.

Eastern alone is expected to contribute $120 million of operating revenue and $20 million to EBITDAR. Airnorth is expected to add between $80 and $90 million in revenue and another $20 to $25 million to EBITDAR. These are more logistical solutions in nature with less correlation to the price of oil. These acquired assets’ cash flows are creating a substantial buffer during the downturn in the main helicopter offshore oil rig business. Valuation With the shares around the $23 level, the shares are trading at 0.47x sales, 7x ttm EV/EBITDA and 0.52x of book. From a valuation standpoint, we estimate that the market is applying a ~$15 per share value for the UK search and rescue deal alone, due to the predictable cash flows and strong return on assets after they built out the infrastructure.

We think this will provide them a large competitive advantage with other search and rescue RFPs globally. The company also places a $50 per share value on their assets and $81 including the leased fleet. If you apply a $10 per share value to the UK SAR contract, that just leaves $13-$14 for the rest of the business, which implies that the market believes the true value of all their aircraft is just 28% or less of what management states. Click to enlarge (Source: Investor Presentation) We think cash flow from operations should increase on the back of the acquisitions and full ramp of the UK SAR contract.

Meanwhile, free cash flow should increase due to the lower capex expense as they reduce aircraft spend and lower renewals. We think free cash flow should hit $140 million next year as capex falls to $140 million while CFO rises to $275 million. We applied a 14.5x multiple to that figure, close to the historical full cycle average, which returns a $33 price target. Conclusion Shares of Bristow Group continues to get pummeled due to their relation to the oil and gas market, but we think the shares are a compelling value trading at a fraction of the value of the underlying assets.

We think management is making the right move in downsizing the company and creating a much leaner operation that should benefit from substantial operating leverage once the price of oil does in fact rebound. The market leader in the space is likely to benefit from the downturn as many of their competition are exiting the space and selling off aircraft. We think the shares are worth well above where they trade and you get upside optionality should the price of oil rebound.