Vallourec: a half-full glass

– Q1 19 results were decent on the P&L front
– Volumes, prices and savings have helped
– However, cash consumption thus net debt still a worry
– Management reaffirmed no issue to take place in FY19
– We are less confident and any market downturn would leave no other choice
– In short: not bad but still some way to go

Vallourec released Q1 19 results. Revenues reached €1,025m (+19% yoy and -7.2% qoq), EBITDA €67m (vs €-5m), EBIT €-19m (vs €-130m) and net income €-90m (vs €-170m). Net debt at the end of Q1 19 reached €2,125m (vs €1,783m in Q1 18 and €2,058m at year-end 2018). The group confirmed its targets for FY19, i.e. a strong increase in EBITDA, a continued improvement in working capital requirements (measured in number of days) and capex of around €180m. Based on current and economic trends, the group would respect its covenant by year-end 2019.

Q1 19 is decent

The results are improving, there is no doubt about it, from a very low level though. In Q1 19, they were driven by volumes (+11% yoy) and prices (+8%), although volumes are significantly down qoq (almost -18%, on seasonality). This came obviously from the Oil&Gas segment, with a 27% increase in revenues yoy (+23% at CER), due to EMEA and North America, while South America was slightly down yoy. Industry (23% of revenues) was also markedly up (+31% and +34% at CER) with a flat Europe and a sharp rebound in Brazil, driven by the mine operations (keeping in mind that Vallourec is a net seller of iron-ore).

Power generation (5% of revenues) was again strongly down (-48% yoy), due to the decline in coal-fired conventional plants. As a reminder, this business is up for sale (needless to say that it will difficult to find a buyer at a decent price). EBITDA is up €75m yoy, not too bad, while all parameters contributed: volumes, prices, FX, savings from the transformation plan. This implies a 6.5% margin (vs 4% in FY18 and the 10.5% we expect for FY19).

The balance sheet situation still a worry

On the debt side, a crucial point for the stock, the cash consumption has decreased yoy (thank God!), but the net debt level is still increasing to €2,125m, including the €79m impact of IFRS16. In Q1 19, cash flow from operations was €-29m, while the increase in WCR was €113m and capex €17m, leading to a €126m increase in net debt (taking into account minor other cash inflows). Altogether, the net debt/equity ratio (as calculated in the banking covenant) is now 78% (vs 72% in Q4 18 and with a limit at 100%). In other words, there is no real relief from Q1 19: yes, things are improving, but no, the peak in net debt has not been reached.

Management asserts the covenant will be respected by year-end 2019. This is actually possible. That said, we are still cautious. First, the improvement mentioned in WCR is not obvious to read in Vallourec’s accounts, we argue. The annual average was 112 days in FY17 and 113 in FY18, while it is 117 in Q1 19. Second, capex was rather limited in Q1 (€17m out of €180m planned for FY19). Third, profitability remains low, even if improving (not on Q4 19 though). Lastly, and not very kind of us, we agree, we can’t say that management’s track-record is fantastic when it comes to fulfilling commitments in the past few years.

To believe or not to believe

So what? In fact, and despite the solid level of oil prices, we are still cautious. On the one hand, higher oil prices are helpful, for sure. On the other, current prices are more linked to geopolitical tensions (ask Donald) than to a higher level of demand. We are not convinced that this will be enough to trigger a much higher capex from oil majors as such. On top of this, shale in the US will probably not be a strong support yoy, after the strong rebound witnessed since FY17. Further cost savings will occur (redundancies in Germany and Brazil), but we are, in this matter, quite surprised that it is still going on, years after the real problem started in the industry and well after the trough too.

We do believe in a recovery in O&G in EAMEA, which will help the group while South America will probably not improve before next year at best (understand off-shore drilling in Brazil), but it seems to be a bit early to swear on it and, as a reminder, any delay in the timing would hurt Vallourec’s balance sheet further. Also, as is always the case in such cases, management does take a number of precautions in its statements, insisting that its targets assume a rather supportive environment. We are not sure this is obvious given the macro news as of late and the escalation in the US/China trade dispute.

As a conclusion: yes, things are improving, but the pace is slow. No, we can’t already conclude that there will not be a capital increase at some stage, triggered by the banking covenant. In short, Q1 19 has not really helped decide whether the group will be able to avoid another issue, particularly if its markets were to show some signs of weaknesses in the quarters to come. The stock is still a bet.

We will fine-tune our numbers after this Q1 19 release. At first sight, our numbers are too high for the current year at the profit level. That said, the point is rather to know the shape and timing of a real recovery of the group’s margins as opposed to this year’s level of EBITDA. The market seems to have considered the glass as half-full on the release…