MRC Global Stock Price Dip Represents Good Opportunity To Buy

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Investment thesis

MRC Global (MRC) has shown signs of weakening in the last decade as a result of a series of headwinds in the energy industry at a time when the company was deep in debt after an aggressive M&A strategy. Until now, the company has been in deleveraging mode and almost finished paying off all of its incurred debt, and has significantly reduced the number of outstanding shares, thus not having enough resources to improve its operations, either in terms of expansion or optimization.

The current situation is very different as interest expenses have been greatly reduced while the company’s capacity for new acquisitions has been greatly expanded thanks to its reduced debt. Despite all of this, and the fact that the company has remained profitable year after year, the share price remains ~66.5% below the highs reached in 2013. Therefore, I believe that the upside potential of MRC Global is very wide at this point.

A brief overview of the company

MRC Global is a global supplier of pipe, valves, fittings, and other infrastructure products and services for the diversified energy, industrial, and gas utility end markets. The company’s products are used for the storage and distribution of natural gas, crude oil refining, petrochemical and chemical processing, general industrials and energy transition projects, exploration, production and extraction of oil and gas, and gathering, processing, and transmission of oil and gas.

MRC Global Overview

MRC Global (MRC Global Investor Relations)

The company was founded in 1921 and its market cap currently stands at ~$880 million, employing ~2,600 workers worldwide. It supplies products and services to major players in the energy sector, including Shell (SHEL), Exxon Mobil (XOM), BP (BP), Chevron (CVX), ConocoPhillips (COP), The Chemours Company (CC), BASF (OTCQX:BASFY), Phillips 66 (PSX), Marathon Oil (MRO), The Williams Companies (WMB), Schlumberger (SLB), and others.

The company isn’t a dividend payer as it is currently in a deleveraging stage after a shopping spree that took place until 2014 with the aim of expanding its operations internationally. Instead, since the end of 2015, the company performed a series of share repurchase programs on an ongoing basis as a strategy for rewarding its shareholders, which has been recently paused in part as a result of the coronavirus pandemic crisis. In this sense, the company has spent $397 million in share repurchases since 2015 and this, together with the payment of the debt, has put growth and optimization strategies on hold for a few years.

MRC Global stock
Data by YCharts

Currently, shares are trading at $11.23, which represents a 66.68% decline from all-time highs of $33.70 on May 21, 2013. This drop in the price of shares is a consequence, as we will see throughout the article, of multiple headwinds that took place at a time when the company was over-indebted as a result of various acquisitions that were carried out to expand MRC Global’s operations. The company has been reducing its level of debt and the number of shares outstanding for a few years, and this has begun to seriously weigh on operations, which should pick up again now that the balance sheet is much healthier.

An aggressive M&A strategy shot up the company’s debt

One of the keys to understanding why the company has suffered a deterioration in its sales and margins in recent years lies in its international growth strategy, through which the company carried out an aggressive M&A process, which enormously increased its debt pile. Next, I am going to summarize the acquisitions that took place between 2009 and 2014, which took the debt to levels above $1.5 billion.

After one acquisition in 2009 (Transmark Fcx Group) and two acquisitions in 2010 (South Texas Supply and Dresser Oil Tools & Supply), in May 2011, the company acquired Stainless Pipe and Fittings Australia, the largest distributor of stainless steel piping products in the southern hemisphere through operations in Australia as well as Korea, Italy, United Kingdom, and the United Arab Emirates. Later in the same year, in July 2011, the company acquired the valve distribution business of Curtiss-Wright (CW). The acquired business provides valve and valve automation solutions to the energy and industrial markets.

In March 2012, the company acquired OneSteel Piping Systems, a leading provider of pipe, valve, and fitting products and services for the oil and gas, mining, and mineral processing industries in Australia, for $67.7 million. Later in the same year, in June 2012, the company acquired Chaparral Supply, a provider of pipe, valve, and fitting products, as well as oilfield supplies for its parent company, SandRidge Energy, Inc. (SD). With this acquisition, MRC Global became a supplier of SandRidge Energy through the acquired division.

In January 2013, the company acquired Production Specialty Services, Inc., a U.S. supplier of pipe, valves, and fittings for the oil and gas industry. Founded in 1990, the company had projected revenues of ~$127 million in 2012. Later, in July 2013, the company acquired Flow Control Products, a provider of pneumatic, electric, and electro-hydraulic valve automation packages and related field support with operations in the Permian Basin energy industry, including production facilities, pipelines, and plant operations. The acquired company was founded in 1981 and reported revenues of $28 million in 2012. The shopping spree continued in December 2013, when the company acquired Flangefitt Stainless, an England-based pipe, flange, and fitting distributor for the oil and gas industry with annual revenues of ~$28 million.

The last three acquisitions that culminated the international growth strategy in 2014 began as early as January of the same year, when the company acquired Stream AS, a Norway-based distributor and provider of pipe, valve, and fittings, for ~$260 million. The company provides flow control products, solutions, and services to the offshore oil and gas industry on the Norwegian Continental Shelf. Stream had estimated revenues of ~$273 million in 2013. Later in the same year, in May, the company acquired MSD Engineering, a major distributor and service provider of valve and valve automation solutions with operations in Singapore, Brunei, China, Malaysia, Indonesia, Thailand, Vietnam, and Taiwan, generating sales of ~$26 million in 2013. A month later, in June 2014, the company acquired Hypteck AS, a Norway-based provider of instrumentation and process control products to the offshore, marine, and onshore industries with a focus on the Norwegian Continental Shelf. Hypteck was established in 1903 and generated sales of $38 million in 2013.

Since then, the company has been serious about reducing its debt and stopped acquiring companies, entering a deleveraging phase in the second half of 2014 in order to pay down its debt pile and reduce interest expenses on the debt incurred.

Sales are ready to take off thanks to debt reduction

The company’s sales have experienced high volatility in the last decade. After a steady increase until 2014 thanks to aggressive acquisitions, in 2015, sales declined by 24% due to lower activity levels in the upstream sector. A strong dollar also caused a $162 million impact. Then, the company sold its U.S. Oil Country Tubular Goods business during the first quarter of 2016 to Sooner Pipe, LLC, for $48 million, as the company’s strategy was to reduce the company’s upstream drilling business volatility and focus on higher-margin businesses (mainly valves and fittings). The sold business had sales of ~$305 million in 2015 and, alongside reduced customer spending across all segments and sectors for the year, caused a further revenue decline in 2016. After two years of improvement in 2017 and 2018, in 2019, lower demand in U.S. and Canada caused a revenue decline of 12%. All these headwinds have occurred while the company had to focus on paying down its debt pile.

MRC Global sales

MRC Global sales (10-K filings)

The coronavirus pandemic crisis deepened the sales decline of 2019 by another 30% as most of the world’s economies suffered paralysis as a result of the restrictive measures to stop the spread of the coronavirus. But still, in 2021, sales recovered very slightly by 4.14%.

The company has historically signed supply contracts with various companies operating in the energy sector, taking place the last major agreement in February 2022 when the company announced a major equipment supply contract with Aker Solutions to provide valves, instrumentation, piping, tubing, and fittings for its Sunrise Wind offshore wind power project in Long Island’s Montauk Point, located in the New York state.

Looking forward, a noteworthy fact is that 2021 ended with a backlog of $520 million vs. $340 million in 2020 and $509 million in 2019, so it looks like sales are poised to start a recovery cycle in 2022. This is happening at a time when the company has massively reduced its debt pile, opening up a lot of new financing possibilities to continue making acquisitions and investments. In addition, the interest on the debt has dropped considerably, which is freeing up large amounts of cash each quarter that the company could not count on until now.

MRC stock PS ratio
Data by YCharts

Currently, the price to sales ratio stands at 0.348, which means the company generates $2.87 in sales for each dollar held in shares by investors, annually. Looking at the chart, it can seem that investors are showing a lot of enthusiasm and the turnaround is already priced in, but we have to keep in mind that this ratio is currently tainted by very depressed sales. Even so, the recent surge suggests that it would be a good idea to save an extra bullet for the mid-term since it is true that the market, in this sense, is anticipating an increase in sales that has not actually been materialized yet, which could generate disappointments, thus causing further falls in the share price that would ultimately give investors even better opportunities to continue adding shares to their positions at lower prices.

Despite international expansion in the last decade, most of the company’s sales still take place within the United States. In this sense, sales in the United States were 82%, 79%, and 81% in 2021, 2020, and 2019, respectively. Sales provided by operations in Canada were 5%, 5%, and 6% in these periods. The rest are provided by operations in other countries.

The company is profitable

The company’s gross profit margins have been fairly stable over the years, dancing around ~15%. This has made it possible for the company to generate positive cash from operations on an ongoing basis.

MRC gross profit margin and EBITDA margin
Data by YCharts

Still, profit margins were weak during the last quarter as the gross profit margin of 15.60% was lower than the trailing twelve months’ margins. EBITDA margins were also affected as they stood at 1.90% during the last quarter vs. trailing twelve months’ EBITDA margins of 1.95%. Labor shortages, supply chain issues, and increases in the cost of raw materials are causing a direct impact on margins, but increasing pricing should help margin stabilization in 2022 because the inflation experienced in the last year has been too abrupt and the production costs always take a while to be transferred to the customers. Despite inflationary pressures, the company reported EBITDA of $146 million, which represents a significant improvement of 51% compared to 2020, and generated $56 million of cash from operations despite having increased inventories significantly, which is a strong sign that the company continues to be profitable.

The company uses vast amounts of steel, and iron ore, which is used to make steel, soared above $200 in June 2021. After falling back to $100 in November of the same year, it is rising again at a breakneck pace in 2022 and is already above $150 again.

Iron ore commodity price

Iron ore commodity price (tradingeconomics.com)

This should continue to put pressure on profit margins in the coming quarters, although this does not represent a very serious problem for the company in the long term, as it has already demonstrated that even in a year characterized by high inflationary pressures, it is capable of generating positive cash from operations.

Cash generation is positive

Despite the drop in sales that the company has suffered in recent years, it has remained profitable. The cash from operations generated by the company over the years is very high compared to interest on debt and CAPEX, and this is demonstrated by the fact that it has managed to pay off most of its debt pile in recent years. Negative cash from operations in 2014, 2017, and 2018 have been offset by a wide margin in subsequent years. This is because each of these years saw a very significant increase in inventories ($215 million in 2014, $140 million in 2017, and $96 million in 2018), without which cash from operations would have been highly positive. As we can see in the table below, cash usage for interest expenses and CAPEX has remained at very low levels year after year.

Year 2013 2014 2015 2016 2017 2018 2019 2020 2021
Cash from operations (in millions) $324 -$106 $690 $253 -$48 -$11 $242 $261 $56
Interest expense (in millions) $61 $62 $62 $35 $31 $38 $40 $28 $23
Capital Expenditure (in millions) $22 $20 $39 $33 $30 $20 $18 $11 $10
% of cash used 26% 15% 27% 24% 15% 59%

Source: 10-K filings

Low cash usage for interest expenses and CAPEX is what has made it possible for the company to clean up its balance sheet to this day. This also shows that the company is essentially viable as its operations are essential to the functioning of the energy sector of the countries in which it operates, which ensures the long-term survival of the company.

The debt is one step away from zero

Over the last decade, the company has taken seriously the need to get rid of its debt pile in order to maintain a healthy balance sheet and, thanks to this, today, the debt is at a completely manageable level and interest expenses have dropped considerably. Only two times the company experienced increases in debt during the last 10 years: in 2014 due to the acquisition of three companies, and in 2017-2018 as the company expanded inventories while performing aggressive stock buybacks. For the rest of the years, the company has demonstrated its ability to generate cash, which has materialized in its debt reduction.

MRC Global balance sheet
Data by YCharts

In this sense, the company decreased its debt pile from over $1.5 billion in 2012 to $300 million in 2022. This is very important because it has two fundamental meanings for MRC Global: the first is that the drop in sales in recent years (apart from the difficulties in the energy sector in 2015 and 2016, the sale of its Oil Country Tubular Goods business and reduced customer spending in 2019 added to the coronavirus crisis in 2020) has been the result of the company entering a new stage of deleveraging that is now about to end. The second fundamental meaning is that the company is essentially profitable, and now that almost all of the debt has been paid off, the company is ready to return to a new stage of growth, either through further acquisitions, which should start soon, or by expanding its manufacturing capabilities.

In addition, this reduction in debt is accompanied by a reduction in interest expenses of more than $100 million per year.

MRC Global total interest expense
Data by YCharts

This greatly expands the company’s ability to generate cash and heralds a new era of growth and much lower risks. Now that interest expenses are low and the company can use its cash for other issues than debt, I expect share buyback programs to get back on track as the company thumbs through potential acquisitions.

Buybacks will expand investors’ positions

Since 2016, the company has significantly rewarded shareholders through share buybacks, which have significantly reduced the number of outstanding shares. This means that each share represents a larger and larger portion of the company, which improves per-share metrics in the long run. Although it is true that these rewards have not translated into capital gains due to the difficulties of recent years, these buybacks should begin to be felt as soon as the company manages to reverse its negative trend.

In November 2015, the company announced the first share repurchase program of up to $100 million, from which the company began to reward the holders of its shares. In November 2016, the company announced another $125 million share repurchase program. It was a year later, in November 2017, that the management announced a new share repurchase program of up to $100 million. And the last $150 million share repurchase program was authorized in October 2018.

MRC shares outstanding
Data by YCharts

Thanks to these share repurchase programs, shares outstanding declined by 19% until the coronavirus pandemic in 2020 ultimately forced the company to pause buybacks indefinitely due to declining sales and margins and increasing uncertainties. But now that the debt is almost paid completely, I expect new share buyback programs in the short-to-medium term while the company begins a new round of acquisitions.

Risks worth mentioning

One of the main risks that I would like to mention is that of the phase change for the company. It is true that the balance sheet has improved tremendously over the last few years thanks to debt reduction, but it is also true that this time, the management will need to resume the M&A strategy much more carefully than before so as not to have to re-enter in a new deleveraging process so long that the operations end up showing prolonged signs of weakness as a result of not being able to invest cash in growth initiatives.

Prices of iron ore, which is used to make steel, are soaring again after a respite at the end of 2021. Also, labor shortages and supply chain issues are expected to continue to impact operations in 2022. This means that the company’s profit margins could take a hit in the coming quarters, which would limit the company’s ability to generate cash.

The US dollar is becoming more expensive relative to the Canadian dollar and the euro, something that could continue the trend in the case of the euro as a result of the current war between Russia and Ukraine and the reluctance of the European Central Bank to raise interest rates, unlike the Fed. Due to the geographic diversification of MRC Global, in 2015, we already saw how a strong dollar can cause impacts on sales. Therefore, I believe that it is worth considering that the growth of sales could be partially limited as a result of the strengthening of the dollar in the coming quarters.

Conclusion

I do not find any serious problem that endangers the future of MRC Global, nor a permanent weakening of its operations, but rather a series of headwinds that have exhausted the patience of investors over the years due to the weak position in which the company had to face them due to its high exposure to debt. Today, the debt has once again reached levels close to zero, the company has reduced the number of outstanding shares by 19%, and not least, it has demonstrated its ability to generate positive cash from operations year after year.

This means that debt interest expenses have been reduced by more than $100 million and that the company is once again prepared to use its cash to enter a new stage of growth, as well as to continue buying back its own shares to expand the positions of investors who hold their shares. For this reason, I believe that a ~66.5% decline in the share price since 2013 represents a good opportunity to acquire shares and hold onto them, at least until the stock price is bullish enough that the upside potential becomes too limited. Still, as I mentioned in the article, I recommend saving an extra bullet in case current expectations are unmet in the short to medium term.

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