Turnaround Tale

The Stock

What to trade: Buy Helix Energy Solutions (NYSE: HLX) < 16.50 with a stop-loss @ 10.50.

Why Now: Helix Energy Solutions’ core subsea contracting services business will benefit from increased spending on offshore and deepwater energy production. The planned sale of its oil and gas production operations will serve as a major catalyst for the stock.

The Story

Lounging at his personal office in Old Town Alexandria, Elliott scans his weekly market commentary for Personal Finance before he files it with his editor. A knock at the door interrupts his reverie.

Elliott: Come in.

Yiannis: Nice digs. Where are we going for lunch?

Elliott: Good timing, I’m putting the finishing touches on this article about the civil unrest in Libya and oil prices. You want a drink? I’ve got coffee or a Tanqueray No. 10 and tonic–upper or downer?

Before Yiannis can answer, Elliott pulls a tumbler from the top of a small bar and takes the lid off the office ice bucket.

Yiannis: T&T it is. With lemon, please.  

Elliott produces a fresh lemon from his top desk drawer and pours a gin and tonic for Yiannis and a glass of Barolo for himself.

Yiannis: Wait, you keep lemons in your desk?

Elliott:  And limes. This is a nice change from coffee. I’ve been working here since 6:00 am, so I’ve already chased my two double espressos with a pot of coffee. It’s time to wind down with a glass of wine.

Yiannis: You seem a bit wired–what’s going on, man?

Elliott: Oil prices continue to climb. Between Muammar in Libya and corporate earnings season in the US, I’ve had no shortage of reading material over the past few weeks.

Yiannis: Calm down a minute–you’re going to have a heart attack. Didn’t you just celebrate a birthday? You’re getting older, young man. You can’t stress yourself out like this.

Elliott: Forget that. The wine will calm me down. And I think you’re going to like my next pick for Stocks on the Run. The company is leveraged to the boom in energy prices and accelerating spending in offshore oil exploration. It’s called…

Yiannis: Let’s go somewhere to eat before you start your lecture. You never answered my question about where we’re eating lunch.

Elliott: Jackson 20 at the Hotel Monaco. We can walk there and the food is solid.

Yiannis: Let’s do it. No market talk on the way over. You need to relax a bit, man. Some fresh air will be good for you.

Twenty minutes later Elliott and Yiannis have ensconced themselves at the bar with a bottle Duckhorn Vineyards’ 2007 cabernet sauvignon. A large metal bucket filled with fries has Yiannis’ full attention, while Elliott hungrily eyes the crab cake appetizer as it touches down in front of him.

Elliott: Wait, which one of us is at risk of a heart attack? Your realize those chips you’re devouring are fried in duck fat. They also come in a trough because they’re intended to feed a party of three.

Yiannis: Oh, you want some? Help yourself, man. No need to be passive aggressive about it.

Elliott: I wouldn’t want to steal food from an old man. Remember, despite my recent birthday, you’re still several years my senior.

Yiannis: Older and wiser.

Elliott: Right. Let’s get down to business. I have a fat stack of earnings reports waiting for me at my office. You can keep inhaling those fries while I talk; I’d like to keep the interruptions to a minimum this time.

Yiannis: Fire away, professor. I’m all ears.

Elliott: Helix Energy Solutions (NYSE: HLX) operates two business segments: offshore contracting services and exploration and production (E&P). But management continues to shift the company’s focus to its subsea services operations, a good move for the firm’s long-term growth.

Yiannis: Ok. I have to interrupt you. What do offshore contracting services entail? Is Helix Energy Solutions a driller?

Elliott: No, the firm specializes in offshore construction and maintenance services, including the installation of subsea pipes and cables. Much of the equipment used to flow oil and gas from deepwater wells rests on the seafloor. This output is transported via subsea pipeline to a riser, a pipe that carries the hydrocarbons to the surface. Helix Energy Solutions owns three vessels that install pipelines, risers and related equipment.

Also, do you remember the Macondo spill in the Gulf of Mexico and the frantic efforts to plug the blown-out well?

Yiannis: How can I forget? You spent an hour on the beach in Mykonos blathering on about the spill and all of the investment opportunities–I felt as though the oil from the Gulf of Mexico had polluted the Aegean.

Elliott: That was a great chance to pick up high-quality energy stocks at bargain prices. Would you have rather discussed Greece’s financial difficulties or impending struggles at the World Cup?

Yiannis: I think we’ve beaten those subjects to death.

Elliott: Right. Remember those dramatic videos of oil gushing from the well into the Gulf? Those images were captured by remote operating vehicles (ROV), remotely controlled robots that monitor the conditions of wells, pipelines and other subsea equipment and infrastructure. ROVs aren’t just voyeurs; these units can also repair and adjust deepwater wells. Helix Energy Solutions owns 40 ROVs of varying capabilities and sophistication.

The company’s fleet also includes four vessels that can perform some well work at a lower cost than hiring a rig. For example, operators can use these floating platforms to plug and abandon wells or perform basic repairs on existing wells. Producers traditionally use drilling rigs for some of this work, but deepwater rigs can cost up to $600,000 per day and are in short supply. Demand for this lower-cost alternative should pick up.

Yiannis: All right, but what’s the near-term catalyst for the stock? Is this pick all about oil breaching $100 per barrel?

Before Elliott can answer, the bartender delivers two hanger steaks with chipotle butter and more fries.

Elliott: Looks fantastic. Yiannis, you sure you want more chips? I could just ask them to bring you a bowl of duck fat and a side of bacon.

Yiannis: Look, are we here to discuss my eating habits or this issue of Stocks on the Run?

Elliott: I see three potential catalysts for shares of Helix Energy Solutions. First, higher oil prices have prompted the big producers to spend more on oil exploration and field development. Much of these capital expenditures will occur into offshore operations–especially those in deepwater–as these plays are among the biggest discoveries of the past few decades. This trend should translate into higher demand for Helix Energy Solutions’ subsea services.

Yiannis: Fair enough. But aren’t you concerned about the Obama administration’s moratorium on drilling in the deepwater Gulf of Mexico? I know from your commentary in The Energy Strategist that you don’t expect the region’s drilling activity to recover until at least 2012. You also mentioned that new safety regulations could make drilling prohibitively expensive in the Gulf.

Elliott: I expect regulators to approve a few permitting requests in 2011, primarily as a political move; the government doesn’t want to be blamed for higher oil prices or reducing US production. But activity is unlikely to normalize for at least 12 to 18 months.

Helix Energy Solutions doesn’t operate exclusively in the Gulf of Mexico, and spending on offshore projects in the North Sea and West Africa remains robust. In fact, the company has performed work in the Jubilee field, a deepwater play offshore Ghana.

And the moratorium hasn’t killed all activity in the Gulf. Helix Energy Solutions’ Q4000 vessel was used extensively in efforts to stanch the blown-out Macondo well. Although this high-margin work is completed, the vessel now has a backlog of projects to work through–mainly repairs or adjustments to existing wells. This maintenance and work-over activity enhances field production and isn’t prohibited by the moratorium. The company’s other well-intervention vessels are also close to full utilization.

That brings me to my second catalyst: The potential for a gradual recovery in drilling activity in 2012. With all three of Helix Energy Solutions’ pipe-laying vessels stationed in the Gulf of Mexico, the firm has faced significant headlines. But up until the Macondo oil spill, the deepwater Gulf of Mexico was one of the world’s most exciting offshore oil plays. The market has priced in these challenges, and Helix Energy Solutions could stack these rigs until drilling activity eventually picks up in the Gulf.

Yiannis: You lost me. What is stacking?

Elliott: Helix Energy Solutions could store the rigs until drilling resumes in the Gulf of Mexico. Such a move reduces operating costs. And that’s not the only option. The company could partner with a larger player or relocate the ships to other markets. Analysts don’t expect the company’s pipe-laying business to contribute much to 2011 earnings, so any activity in the Gulf of Mexico would be an important upside catalyst for the stock.

Editor’s Note: Days after Yiannis and Elliott met to discuss Stocks on the Run, regulators approved the first well in the deepwater Gulf since the oil spill. Operated by Noble Energy (NYSE: NBL), the well is located under 6,500 feet of water. Drilling will get underway in April.

Yiannis: I like the turnaround story, but what about the company’s financial position? A lot of smaller companies took on too much debt and got burned during the 2008-09 recession and financial crisis.

Elliott: Helix Energy Solutions definitely falls into this category. But that’s another element in the company’s turnaround story–and another potential upside catalyst. Management has sought to sell the company’s exploration and production business for some time, though the Macondo spill and subsequent drilling moratorium temporarily quashed those plans. In the interim, rising oil prices have provided a welcome revenue boost.

The start-up of the Phoenix field, in which the firm owns a 70 percent working interest, drove revenue growth in the fourth quarter. This Gulf of Mexico play came online in October 2010 and now produces 12,000 barrels of oil equivalent per day. More important, this new property dramatically shifted the company’s production mix: Whereas natural gas accounted for almost 60 percent of the company’s output in the third quarter of 2010, oil now represents two-thirds of production.

The ample free cash flow generated by the E&P business has enabled Helix Energy Services to pay down its debt, while this strong performance makes increases the operating segment’s appeal to potential acquirers. Management should be able to sell the firm’s E&P operations at some point this year, unlocking considerable value for the company. Management has emphasized that it will use the proceeds to reduce its debt burden. The sale of the E&P business would be a major catalyst for the stock.

Yiannis: How much of a catalyst?

Elliott: The stock is relatively volatile, so the move could happen quickly. I expect the stock to break through resistance at $17 and climb into the mid-$20s–a potential gain of 50 percent or more.

Yiannis: I like the story. Let’s do it. I’ve been eyeing a small-cap Canadian gold producer, but I’ll save it for our next meeting.

Elliott: You know where our next meeting will take place? It’s a perfect venue for discussing a gold-related stock.

Yiannis: I’m stumped.

Elliott: Vegas, Baby! We’ll be at the Mandarin Oriental in Las Vegas for Investing Daily’s Wealth Society Conference–the setting should provide plenty of inspiration for next month’s pick.

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