The Shawcor Trifecta: Business is Booming, Profitability is Strong, and Valuation is Attractive

Shawcor Inc. (TSX: SCL) is a global energy services company specializing in technology-based products and services for the pipeline and pipe services and the petrochemical and industrial markets.  The company operates eight business units with more than seventy five manufacturing and servicing facilities worldwide.  Shawcor is active in all high growth segments, including Deepwater, Shale, LNG, Oil Sands, Enhanced Recovery, and Water.

Recent acquisition activity has brought new opportunities for the future.  For example, the acquisition of Socotherm’s joint venture in the USA Gulf of Mexico for a purchase price of $30 million has given Shawcor a strategically located facility in Channelview Texas which provides anticorrosion and advanced insulation coatings for offshore applications, including the Gulf of Mexico and West African markets.

The pipeline and pipe services segment accounts for 91.5% of revenue as of the first quarter of 2013.

Industry

The pipeline coating industry is in the midst of a boom, as new pipeline infrastructure is so desperately needed to transport new energy supply and existing infrastructure needs to be replaced.  There is a global backlog of pipeline projects currently planned or under construction.

Competitive Advantage

Shawcor is a market leader in the global pipe coating industry.  The company has 200 enforceable patents on its proprietary technologies, with many more patent applications covering key technology developments pending.

Latest Results

As an indication of the future health of the business, we can look to the current backlog, which reached a new record level of $875 million as at the end of the quarter.  EBITDA margins were strong, at 22.9% in the first quarter of 2013 versus 14% in the same period last year, and EPS increased 197% to $1.01 per share.

Outlook

The North American division saw continued strong demand for large diameter pipe coating.  Shawcor’s big clients in North America include TransCanada Pipelines (TSX: TCP) and Enbridge (TSX: ENB).  ShawCor is involved in TransCanada’s Keystone XL pipeline, which will support the growth of crude oil production in the United States, and as such it will benefit from the approval of this project.    Enbridge should also bring new contracts in the coming years, as it has been responsible for over 600 pipeline leaks from 1999 to 2008, and its pipelines need to be replaced.

Actually this is a problem that is not specific to Enbridge.  Over half of the pipelines in Canada were built before 1970 and have been subject to rust and corrosion.  It is only a matter of time before these pipelines will be replaced.

Furthermore, an increasing number of offshore projects in the Gulf of Mexico have positioned ShawCor to benefit from an expected increase in pipeline infrastructure spending to support increased North American oil and gas production.  Shawcor is also expanding to the growing shale plays of east and west Texas.

And the opportunities do not end with North America.  The company’s Asia Pacific division has experienced a rapid ramping up of production volumes.  In addition, according to the experts at Douglas Westward, deepwater capital expenditures are expected to be $223 billion over the next 5 years.  Also, global gas demand is expected to increase by approximately 40% by 2030 and will drive growth in LNG.

Peer Group

Shawcor’s peer group is the oil services group.  However, compared to the more traditional oil service plays, like Trican (TSX:TCW) and Calfrac (TSX:CFW) that are more exposed to cyclical drilling activity, Shawcor is a less volatile way to play this group.  Contracts are longer term in nature and more predictable, as evidenced by the company’s $857 million backlog, which represents a 30% increase versus the same quarter last year.  In addition, Shawcor’s net income over the past five years has offered a much steadier path than its oil service peers.

Shawcor is trading at 14 times trailing 12 months earnings, 10.3 times the consensus 2013 earnings estimate, and 12.4 times 2014 consensus earnings.  Trican and Calfrac are trading at roughly 11 times 2014 consensus earnings, yet profitability and visibility are both stronger at Shawcor. I would argue that this valuation gap should widen and Shawcor should see a lift in its P/E multiple.

Bottom Line

Given the visibility and the growth profile of Shawcor, this stock will probably not remain this cheap for long.  The growth in the industry is accelerating as existing pipeline must be upgraded and replaced, and due to the emergence of plays such as the shale plays and the LNG market, which are emerging to address the growing energy needs of the globe.

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Fool contributor Karen Thomas does not own shares in any of the companies mentioned.  The Motley Fool does not own shares of any companies mentioned.