Eneti: Cheap, Although Low-Hanging Fruit Is Gone (NYSE:NETI)

Introduction

Eneti (NYSE:NETI) is an owner and operator of Wind Turbine Installation vessels, with a fleet composed of five on-the-water vessels plus two additional newbuilds, set to be delivered between Q4-24 and 2025.

For more context on the company, I recommend reviewing the piece I published on NETI last March. Albeit stock price performance has been quite strong since then (up around 50%) and the low-hanging fruit is gone, the stock remains attractively priced if someone believes the wind turbine installation vessel (WTIV) market will be tight going forward.

Newbuild Charter Announcement

On December 19th, NETI disclosed it had “signed a contract with an undisclosed client to transport and install turbines for a project commencing in the first half of 2025”. The contract will be fulfilled by one of the company’s NG16000X newbuilds (the one to be delivered in Q4-24). Including mobilization fees (to start early in Q1-25), “the engagement is expected to be between 226 and 276 days and generate approximately EUR 60M to EUR 73M of net revenue after forecasted project costs”.

Although the ultimate payoff will depend on the contract duration, the day-rate is quite similar regardless of the minimum and maximum duration (€265,486/day and closer to €264,492/day respectively). Furthermore, it is relevant to note the contract proceeds are stipulated in euros (the day-rate comes in at closer to $282,225/day on USD at the current exchange rate).

We still lack a lot of information to exactly assess the FCF NETI will generate from this contract, but on a presentation dated May 2021, NETI provided EBITDA sensitivities to different day-rates, which can be used to extrapolate an estimation of daily operating costs.

This slide is most likely outdated, and inflation may have pressured daily costs higher since then, but I believe it to be a good starting point to assess potential FCF generation. Given the assumptions outlined on the slide, yearly operating expenses should amount to approximately $12.74M ($220k/day * 365 * 80% utilization – $51.5M in EBITDA), or $34,904/day on a 365-day basis (or $43,630 per operating day given the 80% utilization). Overall, I expect the operating costs number to ultimately come ahead of that guidance, possibly at closer to $45k/day-$50k/day.

To calculate FCF, we also must calculate interest expenses and debt amortization. Although the debt facilities for the newbuilds are not yet fully closed, management mentioned on the Q3 conference call they had:

“received an underwritten proposal from Crédit Agricole and Société Générale for a $436 million term loan facility to finance approximately 65% of the purchase cost of the companies two WTIV newbuildings under construction currently in Korea”.

Assuming a 7% interest cost on the facility, this equates to $15.2M/year per vessel on interest costs during the first year, whereas for the amortization we are potentially looking at a $14.53M/vessel scheduled debt amortization obligation if the facility is amortized over a 15-year term.

Overall, if the vessel does not secure any additional employment for the remainder of 2025, it seems reasonable to expect around $22M-$26M in FCF from just this one asset:

+€66.5M (or $70.7M) in revenue; mid-point of the low and high-end revenue ranges

-$17.3M in operating costs ($47,500/day times 365)

-$15.2M in interest costs

-$14.53M in scheduled debt amortization

=$23.67M in FCF

There are several assumptions embedded on these calculations; I’ve tried to be on the conservative side, but everyone can tweak and experiment with them if they believe they will come in either higher or lower.

Another interesting tidbit of the time charter contract NETI secured on one of its newbuilds was the duration; it is much shorter than the contract Cadeler (a publicly traded Norwegian WTIV owner) secured for one of its F-class vessels, where they fixed it on a period of up to four years for up to €330M if all options are exercised. Interestingly, it seems NETI decided to pursue a contract with a similar to slightly lower day-rate for a much shorter duration which should allow them to re-charter the vessel at higher rates if the market continues to firm. Only time will tell which decision is wiser, but NETI’s decision is in-line with management’s commentary on the overall market and the tightness they expect to see going forward.

Equity Portion for the Newbuilds

I believe NETI’s undervaluation over the past year and a half is mostly attributable to the market’s concerns regarding the financing for the equity portion of the newbuilds. However, after the recent contract addition, the sale of the STNG stake, and strong operating free cash flow generation, those concerns have been put (at least partly) to rest.

As of September 30th, the company had a cash and cash equivalents balance of $123.7M plus an additional $14M in restricted cash. Total debt outstanding under the $175M credit facility amounted to $68.75M, for a total net cash position of $55M (or $69M including restricted cash).

The remaining obligations under the two newbuild contracts amount to $589.3M, but $436M are expected to be covered by the debt facility from Crédit Agricole (OTCPK:CRARF) and Société Générale (OTCPK:SCGLY); therefore, the remainder of equity payments amount to around $153.3M.

Eneti is not fully out of the woods yet but considering their current financial position (and the availability of the $175M facility) and if additional contracts are secured for the Leviathan, Kraken, and Hydra in 2023, they should be able to pull it off without resorting to equity issuance at prevailing pricing. However, should pricing increase noticeably, I believe management would like to issue some shares to further solidify their position.

Contract Coverage

Eneti started 2022 on a weak note, posting mediocre first quarter results on the back of the meager charter cover the company had secured for the period, as can be seen in the image below. However, performance improved substantially throughout Q2 and Q3; Q4 is set to be weaker, but operating cash flow should remain solid, nonetheless, if optional periods are exercised (if they are not, we are potentially looking at another mediocre quarter).

Going into 2023, the Scylla and Zaratan are virtually booked out (management confirmed we should not expect any additional contract additions on the Zaratan given it will be demobilizing, transiting, and re-mobilizing), although there is still a ton of spare capacity on the smaller vessel classes.

Management acknowledged alongside Q2 earnings that they viewed the three older NG2500X as non-core, although no disposals have been announced so far. On the Q3 conference call, they mentioned they have not received attractive offers for the disposal of those assets, but also outlined that the outlook for that asset class has improved materially over the past year, with the contracts for the Hydra and the Leviathan in 2023 as proof of this improvement (considering the contracting window for these vessels tends to be much shorter than for their larger/more modern counterparts).

Share Repurchases

Management was cognizant of the discount to NAV and to normalized FCF metrics once the newbuilds were delivered and they ultimately decided to repurchase shares after disposing of their stake on Scorpio Tankers (STNG) for $83.3M (average price of $38.65/sh).

On August 31st, Eneti disclosed it had repurchased 2.3M shares for approximately $17M (for an average purchase price of $7.42/sh) from INCJ, Ltd., which received those shares in August 2021 as consideration for the acquisition of Seajacks (they were the previous owners).

Furthermore, on September 14th NETI disclosed its Board of Directors had authorized another share repurchase program for up to $50M (although it seems no repurchases have been pursued since then). Additionally, management provided some insightful commentary on their current view on share buybacks on the Q3 conference call:

“The company took a great opportunity in buying the blocks, and it did. Very good opportunity, nice price. And the priority right now in the company is to get the first newbuilding employed. Once that newbuilding gets employed, then we get a lot more flexibility, a lot more flexibility over finances, a lot more certainty. So I think it’s fair to say that we wouldn’t — we’re not looking to buy back stock at the moment in Eneti, obviously as we say to an affiliate has been doing so Eneti’s buyback. But things can change once we get the first employment announced on the newbuilding”.

Overall, I do not expect to see additional share repurchases in the near-term for two main reasons; for starters, share pricing has fared decently since the lows, so it makes sense for management to take a step back and await further developments, whereas they continue to need cash to fund the equity portion of their newbuilds.

Conclusion

The economics of the recently announced time charter contract on one of the newbuilds are quite attractive; the company can potentially generate FCF of $22M-$26M (or $0.60/sh-$0.71/sh) on just one of its newbuilds in less than a year; not bad considering they have another newbuild on order and five additional on-the-water vessels (two of which have decent specifications).

NETI is not yet fully out of the woods regarding the equity portion for the newbuilds, but if they secure some additional charter coverage on the smaller NG2500X, they should be able to cover the remainder of equity with organically generated cash flows. If the market was weaker than expected, management could resort to asset disposals (they have indicated they view the NG2500X as non-core), although so far pricing has not been attractive enough to pursue this path.

Overall, I believe the low-hanging fruit on NETI is gone, but the company remains a compelling vehicle on a growing industry if someone believes market balances will be tight going forward. I’ve personally reduced my exposure over the past few months, but remain long the name.