To recap, the company provides the energy industry with marine seismic equipment and, in particular, a technology called Portable Modular Source System (PMSS™). This equipment is installed on vessels to provide a seismic source to enable oil and gas exploration and production companies to perform life-of-field seismic studies or permanent reservoir monitoring.
It is an area I have been keen on for sometime and I first advised buying Thalassa shares at 135p less than six months ago ('Potential for seismic gains', 19 March 2013). I then reiterated the advice at the start of May when I noted that executive chairman and former banker Duncan Soukup had been on a massive buying spree when the price was 141p ('Small-cap stock picks', 1 May 2013), and again at 168p six weeks ago (‘Expecting seismic gains’, 1 August 2013).
The good news is that we are all massively in profit here. Moreover, after some hefty earnings upgrades this morning there is still scope for more significant share price upside.
Prospects for seismic profit growth
The positive reaction of investors is hardly surprising either, after Thalassa revealed that the company has made significant progress in fulfilling its obligations under customer contracts.
These include a contract with SMG Ecuador, the Ecuador business of State Sevmorgeo Company, the Russian geological sea survey company, which earned the company $6.7m (£4.4m), or almost half of Thalassa's revenues in 2012, in the first half alone. A second phase of that contract, relating to surveys which start next month and continue until April, is worth between $4m and $5.4m.
The future pipeline of work is equally promising - based on order enquiries and tenders submitted, Thalassa has well over $100m of work in the bid pipeline for delivery in 2014-15, up from only $38m at the same stage last year. I understand that the historic conversion rate of tenders in the pipeline to firm contracts is over 80 per cent, a trend that has been more than achieved in the past six weeks since my last update.
Included in the order book is a major contract with Statoil ASA (NO: STL), potentially worth $65m over eight years, to provide seismic acquisition services for reservoir monitoring of the Snorre and Grane oilfields in the Norwegian sector of the North Sea. Statoil is also purchasing a bespoke dual portable modular source system (D-PMSS™), which Thalassa will maintain and operate throughout the duration of the contract. The proposed value of this contract is $19.8m (£13.2m) and delivery of the system is due next month.
As a result of the current high conversion rate of orders, Thalassa board is now "becoming increasingly optimistic in the company’s ability to convert a record level of enquiries into increased revenue in 2014 and beyond." This also means that analysts have massively raised earnings estimates for this year and next.
Earnings upgrades
For the current financial year to end December, oil analyst John Cummins at brokerage WH Ireland has lifted his 2013 gross margin assumption from 23 per cent to 26 per cent on sales which are set to more than double from $14m to $30.6m.
On this basis, pre-tax profits estimates have been upgraded by a third to $3.6m, a heady 200 per cent higher than the $1.2m reported in 2012. Factoring in the extra shares in issue following a placing of 4.5m shares at 120p in April, adjusted EPS rises by a third to 20.1¢ (or 13p a share), up from the 10¢ reported in 2012.
Moreover, taking a conservative assumption that only 25 per cent of the tender pipeline will be converted into firm contracts, Mr Cummins has increased his 2014 revenue forecast by $14.5m to $36.5m which in turns has led to a 60 per cent upgrade in pre-tax profit forecasts to $5m. On this basis, EPS rises again to 25.2¢, or the equivalent of 16p a share.
It’s well worth noting that the company's low-yielding cash pile equates to 67p a share, or a quarter of Thalassa's share price. Strip net funds out and the shares are trading on a modest 13.7 times earnings estimates for 2013, falling sharply to 11 times 2014 forecasts. For a company that is set to treble profits this year, and conservatively raise them by almost 40 per cent in 2014, and potentially more if more contracts are won, that is hardly an exacting valuation. Moreover, the risk to earnings is still on the upside.
That’s because Mr Soukup points out that his company is finally reaping the benefit of its early recognition of a previously untapped growth area in the marine geophysical market. Admittedly, recognition, even from within the industry, of the benefits of "production enhancement" techniques has been incredibly slow prior to this year. However, this is clearly "changing rapidly". Indeed, industry experts estimate that the market has potential to grow to $20bn over the next 30 years.
Bearing this in mind, it's therefore reassuring to note that Thalassa had net cash of $16.8m (£11m) at the end of June, which provides the working capital needed to service an increasing number of contracts as tenders in the pipeline are converted into firm contracts. It also offers reassurance to clients that the £41m market cap company has the resources to deliver on these contracts.
Target prices
My previous target price was 200p, but this has been completely obliterated this morning with Thalassa shares now trading on a bid-offer spread of 240p to 245p.
However, the share price is still well shy of WH Ireland newly upgraded target price of 310p. That price target doesn’t seem unreasonable to me as it equates to a 2015 earnings multiple of 12.5 times earnings estimates of 30.8¢ net of cash. This is based on a further rise in revenues to $41.6m to drive pre-tax profits up to $6.1m.
So, taking the earnings upgrades into consideration, and the good news on the conversion of tenders in the pipeline to firm contracts, I have upgraded my year-end target price by 50 per cent to 300p. Needless to say, I continue to rate Thalassa shares a strong buy.
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