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Company: Trico Marine Services (TRMA)
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  Geopolitical Risk Drives the Trend Towards Deepwater Production

Over 80% of the world’s oil and natural gas reserves are held captive by National Oil Companies. It’s widely known that there’s significant geopolitical risk associated with National Oil Companies, and the political regimes behind them. Think Iraq, Iran, Venezuela, etc. Most excess capacity resides with OPEC, but particularly with countries that have the most political instability (e.g. Sudan). As Chavez kicks out the Major Oil Companies from Venezuela and Putin nationalizes Russia’s O&G Machine, major oil companies have to look elsewhere to build out its reserves. Deepwater represents the last reserve frontier, yet doesn’t come with the incremental geopolitical baggage as land-based drilling. With oil north of $80, the economics are favorable to support continued build out of deepwater production systems. In fact, if oil prices drop 25 to 30% to $55 to $60, the pricing level where OPEC has historically cut production to defend a price floor, the economics continue to support deepwater exploration, and justify the investment in complex subsea systems.

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  Micro-cap well positioned to profit on oil prices

So oil tops $105 and you’re probably thinking it’s a good time to invest in Energy. The big boys like Schlumberger N.V. (SLB), Baker Hughes (BHI) and Weatherford International (WFT) probably turn you off though because of their recent price runs and rich trading multiples. So where should you park your money to cash in on strong commodity prices and ride out this Bull Run in Energy? Well, here’s a name that’s not heavily followed by Wall Street nor Energy Hedge Funds.

I introduce a micro cap favorite of mine called Trico Marine (TRMA). The company provides marine support vessels to the oil and gas industry in the Gulf of Mexico, Latin America, Southeast Asia and West Africa. Imagine an offshore rig, and all the equipment that needs to be transported there to support deepwater drilling activity. Think offshore platforms, crew cabins, drilling bits, fluids, risers, thousands of feet of seafloor cable, manifolds, pipes, pumps, engines, etc – you name it, it needs to get to the offshore rig somehow. TRMA supplies the vessels that have the infrastructure, equipment, and towing capabilities to create these offshore pseudo-islands. TRMA rents out the vessels and provides the support necessary to erect and maintain offshore drilling facilities – not many vessel companies in the world can do this. In turn, TRMA charges $20K to $25K day rates for its vessels. TRMA is a pretty simple business to understand.

So what’s to like about the stock? Well, here’s the skinny:

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  Geopolitical Risk Drives the Trend Towards Concept:Deepwater Oil Exploration|Deepwater Production

Over 80% of the world’s oil and natural gas reserves are held captive by National Oil Companies. It’s widely known that there’s significant geopolitical risk associated with National Oil Companies, and the political regimes behind them. Think Iraq, Iran, Venezuela, etc. Most excess capacity resides with OPEC, but particularly with countries that have the most political instability (e.g. Sudan). As Chavez kicks out the Major Oil Companies from Venezuela and Putin nationalizes Russia’s O&G Machine, major oil companies have to look elsewhere to build out its reserves. Deepwater represents the last reserve frontier, yet doesn’t come with the incremental geopolitical baggage as land-based drilling. With oil north of $80, the economics are favorable to support continued build out of deepwater production systems. In fact, if oil prices drop 25 to 30% to $55 to $60, the pricing level where OPEC has historically cut production to defend a price floor, the economics continue to support deepwater exploration, and justify the investment in complex subsea systems.

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  Attractive Cash Flow Characteristics

The company generated over $100M in cash flow from operations in 2006 alone. The company re-invested $24M of its cash in an aggressive fleet expansion campaign, while still adding cash to its balance sheet. Cash flow from operations funds 100% of the company’s growth capex, which allows the company to avoid incremental leverage altogether and avoid the attendant headaches associated with the rocky credit market. As the company continues to grow top line and expand margins, the free cash flow characteristics of TRMA will just get richer. Which brings me to my next point: “What does management intend to do with all its cash?”

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  Asset Base Ensures Downside Protection

You’re buying the company essentially at cash. With an enterprise value of $350M, your downside risk is minimal with this stock. Note that net assets plus cash alone represent $550M of value. Given its large vessel fleet and the fair market value of each vessel, a savvy buyout firm can make a killing by taking the company private, breaking up the fleet, and selling the vessels individually to its rivals. Not to say that the buyout is going to happen (KKR, are you reading this?), but merely to illustrate that the sum is currently valued less than the parts.

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  Strong P&L

Management has demonstrated consistently that it can grow the business in an up market or a down market. Between 2004 and 2006, Management grew the business over 121%. At the same time, it increased profitability from 28% gross margins to 57%, underscoring management’s commitment to diversify into higher margin business opportunities outside the Gulf of Mexico.

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  Strong Deepwater Fundamentals

Oil companies are drilling further out into the sea, deeper under the ocean floor, to tap into the last pockets of oil and natural gas to meet growing world consumption (think China). That was a mouthful, with quite a few variables at play in the sentence, so let’s break it down:

  • Deepwater Drilling Is the Next Big Oil Play As traditional oil producing basins have matured, particularly on land, Exploration & Production companies have started to look for new reserves in challenging, deepwater environments off the Coast of Africa and in deepwater Gulf of Mexico (beyond the Continental Shelf). In fact, deepwater oil production is supposed to increase from 4.5M barrel equivalents per day to 8M barrel equivalents in 2014. Same trend applies to natural gas – from 1M barrel equivalents per day to over 2.5M. Why the 2-fold increase in deepwater production?
  • Demand Exceeds Supply O&G is all about supply and demand, and we’re supply-constrained today, hence the skyrocketing commodity prices. Supply simply can’t keep up with growing worldwide demand. China and India are industrializing, and the energy consumption activities of these two countries will continue to increase exponentially, which will reinforce the long-term supply/demand imbalance. What does that mean?
  • The Days of Cheap Oil and Natural Gas are Over We’re talking about a new commodity price regime with significantly high price floors for oil (north of $55 per barrel) and natural gas (north of $5 per mcf).
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  Management is buying TRMA

In the second quarter, TRMA announced that it will use its cash to buyback shares – in the tune of $100M, or roughly 20% of the Company’s equity base. Management believes in the Company and is focused on redeeming shares to improve EPS, which underscores its commitment to unlocking shareholder value.

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  Cheap Valuation

If you’re not convinced yet, let’s talk numbers. The stock fell over 25% with the recent credit storm—not for any fundamental reason in the Company’s performance. What’s even more compelling is its relative valuation. TRMA trades at 3.5x trailing EBITDA. Its comps trade at rich premiums: GulfMark Offshore (GMRK) trades at 8x. Seacor Holdings (CKH) trades at 6x. Tidewater (TDW) trades at 6.5x. This means that TRMA trades at a 40% discount to its closest competitor.

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  Geographic Diversification

In 2006, almost 50% of its revenues came from the Gulf of Mexico. Wall Street penalized the stock after the company recognized record revenues from hurricanes Rita and Katrina, which wreaked havoc on the Gulf Coast offshore drilling platforms. Investors viewed the Gulf contracts as “one-time” and deemed them to be “non-repeatable.” Investors didn’t think the company could continue its strong revenue trajectory, given its geographic concentration, and that earnings would fall into the abyss as hurricane-related business dried up. Well that’s changed quite a bit and revenues continue to grow. The Company has successfully diversified its footprint into other deepwater plays, particularly in the North Sea and West Africa. The company is expanding its footprint further in the Chinese offshore drilling market. Nearly 70% of its business today is outside the Gulf, underscoring management’s ability to diversify geographically and to realign its core growth with the most rapidly growing deepwater O&G plays.

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  Day Rates Increasing

Day rates increased 37% between 2006 and 2007. Management maintains high utilization levels despite jacking up prices, and customers continue to line up for more. This speaks to the heart of the supply and demand imbalance within the offshore transportation universe supporting Big Oil. Big Oil understands it’s a race to the last deepwater reservoirs, and they’re willing to pay up to make sure they finish that race first. Why the race, you ask…

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  High Vessel Utilization

Customers are lining up for TRMA’s vessels. Take a look at their utilization rates: 90% for their North Sea vessels; 88% utilization for their supply vessels; and 86% utilization for their crew handling vessels. Management has maintained near-100% utilization for the past 2-3 years, underscoring the long-term demand fundamentals supporting top-line.

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