Vallourec SA vs Tenaris SA
The OCTG battle, Centralized vs Decentralized, Focus vs Diversified
*for learning purposes only, I have no stake in the companies mentioned below
VALLOUREC SA - EUR 13.34, TENARIS SA - EUR 14.77
2024 February: Vallourec SA vs Tenaris SA
Vallourec and Tenaris both produce and sell seamless and welded steel tubular products and related services for the oil and gas industry, and other industrial applications. in Europe, North America, South America, Asia, the Middle East, and internationally.
Their main products are Oil Country Tubular Goods (OCTG) which are piping products that are applied in the oil and gas production (drilling activities).
The main differentiating point between the two is that Vallourec is a much smaller company trying to maintain a smaller manufacturing footprint (North America, South America, Saudi Arabia, France and China) to focus on premium OCTG product and services while Tenaris tends to operate more manufacturing sites providing a fuller range of product and services.
Overall, there is something to like about the tube industry.
It is in a business where failure is not tolerated, thus the most demanding customers will buy from the biggest and the most reputable.
Oil and Gas will continue to form the bulk of the energy consumption in the coming years, and they should continue to grow.
Tubes need to get longer (more tonnage sold) to get to more hard to reach areas.
Tubes need to get stronger (higher pricing power) to ensure they get there.
COMPARISON:
Since OCTG are used for drilling activities, both of their results fluctuate according to the number of operating rigs in operation. If your assumption is that oil prices will stay high and the number of operating rigs will remain high, then this singular metric should point towards a rosy environment for both of them and the whole industry.
Tenaris began in Argentina as the sole producer of seamless steel pipe products. Since then it has grown organically and through strategic acquisitions to become a global network of pipe finishing, distribution and service facilities with a direct presence in most major oil and gas markets and a global network of research and development centers. It is through this vertically integrated operation, disciplined in extracting decent gross and net margin across its product group while keeping its balance sheet clean that has allowed Tenaris to be constantly profitable through every cycle. Their sharp deal making and ability to develop a comprehensive range of new products to meet their local and global markets has served them well.
Vallourec on the other hand has been saddled with high debt from inopportune investments and unprofitability at various market cycles. Just prior to the collapse of the oil prices in 2014, Vallourec increased its production capacity by building mills in Brazil and Ohio, acquiring three tubular businesses in the United States and Saudi Arabia and concluding with the agreement with Tianda Oil Pipe to distribute Tianda products outside China. In early 2016, in response to accumulating losses, Vallourec announced a $1 billion capital increase, more than half of which was provided by a French government fund and Nippon Steel and Sumitomo Metal Corporation.
Since then, Vallourec new management has been using Tenaris’s gross margin as a bullseye to cycle-proof Vallourec’s business by paying down debt, reducing operating cost by consolidating manufacturing bases and focusing on only premium OCTG products.
A clearer focus will likely lead to better products and services, but will it be enough to cycle-proof a business which is inherently cyclical while maintaining a lesser manufacturing footprint with a top down direction of Vallourec’s French office?
VARIANT PERCEPTION:
The market seems to be skeptical of Vallourec’s plans.
Vallourec FY2023 numbers have improved significantly due to the supply and demand imbalance in the US market (high price and high volume). That meant that FY2023 numbers were elevated and most likely will not be repeated.
Listening to the 2023 investor day conference call, it seems that every analyst wants to know what is the baseline case for Vallourec on a normalized level.
While the conference call models mid-cycle earnings, the question that is hanging on everybody's mind is if it is already post-cycle.
FINANCIAL:
Valued at EUR 3,064m, Vallourec is selling at 6.88x PE. While net debt seems high at EUR 580m, the company could come close to turning net cash from their projected EUR 450m annual cash flow.
Tenaris is also valued at 6.99x PE with no need for a turnaround, share buybacks and a pristine balance sheet.
Vallourec is currently underperforming Tenaris by a huge margin. Excluding FY 2023 which is an exceptional year for both companies, Tenaris usually runs on an average 30% gross margin, while Vallourec could hardly manage an average 20% gross margin in their best years..
RISK:
For both, the immediate risk for investors now is not being able to know how bad the US tube market will be in FY 2023.
The longer-term risk is the level of competitions and the normalized margin for the higher end customized product and services.
TRADE-BET-INVESTMENT:
Vallourec should easily pay down net debt by 2025. Their move towards Tenaris’s gross margin on a sustainable level still seem questionable as of now. The capital allocation exercise that will come after the net debt pay down may be the catalyst to re-rate the share price.
Vallourec is a trade-bet that the management will use this window of opportunity of higher prices, lower supply to right their operating cost. That will ensure that they will have a decent gross and net margin to work through all types of cycles. This is also a singular bet on the continued growth of more premium pipes drilling.
Tenaris is a trade-bet on the industry - that there will be a continued excess demand of their products and services within the industry which requires an amalgamation of manufacturing facilities that have been built through the years.
CONCLUSION:
If the conclusion drawn from the above is that higher gross margin is going to stay, then it may be best to bet on Tenaris.
If the conclusion drawn is that a decentralized operation is more favorable than a centralized model, then Tenaris should be favored over Vallourec and vice versa.
If the conclusion drawn is that Vallourec focus is going to dominate the premium segment of the market and allow them to earn excess returns even during downcycle, then Vallourec will be the horse to bet here.
As for now, I am reaching no conclusion and will just watch this industry from far.