Tenaris

We will discontinue analyst coverage of Tenaris on or about Oct. 14. We provide analyst research and ratings on over 1,600 companies globally and periodically adjust our coverage according to investor interest and staffing. We will discontinue analyst coverage of Tenaris on or about Oct. 14. We provide analyst research and ratings on over 1,600 companies globally and periodically adjust our coverage according to investor interest and staffing.

We lower our fair value estimate for Tenaris' ADRs to $37 from $39 due to softening oil prices resulting from OPEC+'s unwinding of production cuts and longer-term margin compression from tariffs.

In the longer term, Tenaris still has the opportunity to grow in non-US markets, as we expect international exploration and production firms' capital expenditures to outpace those of North American E&Ps. Competition nevertheless remains steep, and some key markets, such as China and Saudi Arabia, increasingly favor domestic producers. We expect modest margin improvements, mainly driven by higher fixed-cost absorption as pipe production increases and internal efficiency strategies take hold. Tenaris commands higher pricing for its premium products, ranging from 1.5 times-2.5 times that of nonpremium products. However, the premium market is becoming more competitive, and we expect Tenaris to face greater pricing pressure. We are skeptical that the firm can return to the margins per ton and returns on invested capital demonstrated before 2015.

We do not think Tenaris possesses an economic moat. We believe it’s unlikely the firm will generate material returns on invested capital greater than its cost of capital during the next decade.

Tenaris' intangible assets related to its premium connections and other higher-end OCTG products are a competitive advantage. This includes patents, brand reputation, and other technical capabilities. Increased competition (especially in the lower-end OCTG markets) and limited product differentiation (through efficiency gains and/or cost reduction) continue to exacerbate challenges associated with the ever-present industry overcapacity. During the US shale boom (2007-14), Tenaris and Vallourec lost about 10% of their combined share of the premium market, falling to about 60% by the end of the period. Nonpremium competitors like TMK and US Steel entered the market in pursuit of the then-high profit margins enjoyed by existing OCTG providers. The premium OCTG connection market historically represents a little under one third of global OCTG demand, so Tenaris is operating in a smaller end market than its nonpremium peers. Competition remains heightened and fragmented on a global scale, as specialty OCTG and generalist steel producers alike seek to address demand for tubing in the oil and gas industry. Advancements in production processes also present challenges, as end markets that previously relied on Tenaris’ premium products have since developed methods for achieving comparable efficiency with less complex, lower-cost products. This ultimately reduces Tenaris’ ability to benefit from its higher-priced premium products while exposing the firm to increased competition from nonpremium producers.

This is especially true in the US, where shale operators’ widespread adoption of semipremium OCTG products exacerbates competition in an already saturated market. Tenaris itself initially worked with shale producers to develop these semipremium solutions to achieve sufficient productivity at a reduced cost. Well operators continuously seek opportunities for cost reduction, so while this solution likely benefited Tenaris initially, competitors acted quickly.

Semipremium products, while still more complex than nonpremium products (such as API connections), don’t require as much expertise to produce, allowing less sophisticated competitors to service the US shale market. Now, semipremium and premium products each represent about one fourth of total US OCTG demand, with API connections constituting the remaining half. Opportunities for premium OCTG products remain in markets characterized by more specialized and complex drilling projects, namely offshore. These are also spaces where brand reputation and technological know-how are more applicable due to a higher cost of failure. Nearly 20% of Tenaris' tubes revenue comes from offshore contracts. The exposure to offshore also helps partially protect Tenaris from industrywide pressures like input cost volatility. The harsh nature of these environments requires corrosion-resistant alloy OCTG. Generally speaking, the cost of raw materials drives about one fourth of CRA OCTG costs, compared with over half for other OCTG grades. This means that changes in steel prices have a comparatively lower impact on CRA OCTG. Contracts with customers have a far greater impact, driving about half of CRA OCTG costs.

Although contracts vary, they usually allow for Tenaris’ prices to adjust in line with changes in input costs over time. Tenaris can therefore partially protect its margins when costs rise, as they did when iron ore prices increased approximately 40% during the first half of 2021. This is not unique to Tenaris, however, as competitors operating in similar end markets experience the same impacts, so we don’t consider it to be a competitive advantage. Profitability for all OCTG producers fell markedly in the 2010-14 oil and gas cycle versus 2005-08 owing to global OCTG overcapacity. In 2020, Tenaris and its peers posted negative operating profits as well production reached a near standstill. Heightened trade restrictions in Tenaris’ largest market, the US, could protect pricing in that market, but any volume diverted from the US only worsens the overcapacity in the rest of the world.

Tenaris’ Rig Direct program will streamline the cumbersome OCTG supply chain, adding value for the company and its customers.

The state-of-the-art Bay City mill will lift Tenaris’ US sales above prior peak levels while augmenting its supply chain optimization initiatives.

Growth in international offshore drilling markets will increase demand for Tenaris’ premium products for which it can command higher prices.

Tenaris’ sales of high-end products to deep-water offshore customers will likely never return to levels seen before the post-2014 downturn.

Rival Vallourec’s pivot to low-cost production in Brazil and China is likely to lead to weaker pricing and a more competitive market for Tenaris’ international operations.

US shale customers’ pivot from premium to semipremium OCTG has cut into Tenaris’ pricing power and market share in its most important end market.