Geospace Stock: Adjacent Market Concerns (NASDAQ:GEOS)

While the general demand environment remains solid, Geospace’s (NASDAQ:GEOS) first quarter results were soft outside of a large one-time equipment sale. I previously wrote about Geospace, suggesting that it offered an attractive investment opportunity as its Adjacent Market business was undervalued. From a long-term perspective, I don’t believe the situation has dramatically changed but the poor first quarter performance of the smart water business was a surprise. Industrial sensing & IoT and smart water technologies are growth markets and are becoming an increasingly important part of the Geospace story. Any struggles in this area are therefore likely to have an outsized impact on the company’s valuation. While Geospace has attributed lower Adjacent Market revenue to customer destocking rather than something more serious, the company will likely need to demonstrate a return to growth before the stock bounces back.

The company could be in for a rough second quarter as management commentary seems to point towards muted seismic rental activity until later in the year. Lower revenue on the back of smart water meter customer destocking and less geophone rental activity will likely see profits evaporate, driving the stock lower.

Market Conditions

Geospace’s business is still largely dependent on oil and gas exploration CapEx, but the growth of its Adjacent Market segment is increasing the importance of smart water meter demand. Geospace’s smart water meter business has been performing well, as these types of solutions are becoming the norm and infrastructure spending is generally elevated. While Badger Meter (BMI) has suggested that demand remains robust, its growth is expected to moderate significantly in 2024.

Geospace Market Commentary

Geospace believes that energy companies will continue to invest in conventional seismic exploration and increasingly, 4D time-lapse monitoring. Geospace has reported an increase in quoting activity and expects healthy utilization of its ocean bottom node rental fleet during the second half of the fiscal year. The company doesn’t expect much from onshore customers, but aging equipment could help drive sales at some point.

CGG Market Commentary

CGG is a leading geoscience technology services company. It has been noted that market conditions have been fairly stable, with clients trying to balance production increases against long-term risk. CGG expects increased exploration activity concentrated in shorter time-to-market locations. Offshore and the Middle East are expected to be growth drivers. Activity in Southeast Asia has also picked up, which includes growing interest in carbon capture and storage projects. CGG believes that carbon sequestration could be a growth driver going forward, as projects are now targeting the monitoring phase, which is a larger regulatory concern.

The company expects the demand for quality data to increase as it can reduce exploration risk. Better processing techniques work particularly well with Ocean Bottom Node data, driving demand for OBN versus streamer acquisition, despite the significantly higher cost. Ocean bottom node demand is expected to increasingly come from deepwater projects.

There is also an opportunity created by the fact that most streamer assets are relatively old. For example, CGG has stated that its streamer base is around 11 years old. A replacement cycle is therefore likely to occur at some stage, but so far clients are choosing to incrementally replace streamers.

TGS Market Commentary

TGS is a data provider to the energy sector, with a large multi-client data library. PGS is a geophysical company focused on offshore exploration. TGS plans on acquiring PGS, which would create further concentration in the geophysical survey market. The combined company will have a fleet of seven 3D data acquisition vessels.

PGS continues to see improving contract rates and an increasing order book. The company recently completed its first offshore wind project and reports that there is considerable client interest in further offshore wind projects. PGS was recently awarded a large wind farm site characterization project in the US. It expects to procure a second ultra-high resolution 3D streamer set to support this.

TGS’ market commentary is more negative, with the company stating that a lack of year-end spending by supermajors had impacted its sales. TGS believes that spending in more discretionary categories is being hurt by price inflation elsewhere in the E&P value chain. Some of the company’s key customers are also currently focused on ongoing M&A processes.

While demand for seismic exploration from oil and gas customers appears to be fairly solid, it is important to note that the market has changed enormously over the past decade. Onshore data acquisition activity remains muted, and the supply of seismic vessels is a fraction of what it once was.

Geospace Q1 FY2024 Summary

Mariner ocean bottom node sales drove Geospace’s revenue in the first quarter, which was one of the few bright spots. A 20 million USD rental contract converted to a 30 million USD sale in late December. This brought revenue forward and will be a drag over the rest of the year. Given general expectations of increased demand for seismic data, recent technology improvements and the age of current equipment, it seems likely that Geospace’s Oil and Gas revenue will continue to trend up in the near term, even if it is lumpy.

Geospace attributed the significant decline in Industrial revenue to customers working their way through excess inventory. The company remains optimistic about the prospects of this business though, expecting continued strong growth for the foreseeable future. While there may have been some seasonality and customer destocking, Industrial revenue was at its lowest since early 2022 and this has likely spooked investors.

Emerging market revenue came from Geospace’s contract with the US federal government. Geospace still believes there is a solid opportunity with the Customers and Border Protection Agency, but any decision on contracts is not expected until later in the year. Geospace has also stated that inquiries related to carbon capture monitoring are increasing. These types of projects could become a meaningful revenue driver for Geospace, but I have little expectation in the near term.

Financial Analysis

Geospace’s first quarter revenue was approximately 50 million USD, up roughly 60% YoY. Growth was largely driven by a 30 million USD sale of ocean bottom nodes that were previously being rented, meaning the revenue is non-recurring and will create a drag from lower rental revenue in future quarters.

Absent the ocean bottom node sale, Geospace’s revenue would likely have continued its slide from the fourth quarter, as OBX rental fleet utilization fell. Revenue also appears to be set to fall further in the second quarter, before rebounding later in the year as rental demand picks up.

While the quarter looked ok from an oil and gas perspective, Industrial revenue was disappointing. Geospace attributed this to lower demand for its smart water meter connectors and cables.

Geospace’s profitability has continued to improve as revenue has increased. As a result, the company generated 12.7 million USD in net income in the first quarter. Geospace’s profit is likely to fall substantially in the second quarter on the back of lower revenue, but the company should see a large cash inflow from the ocean bottom node sale. The company’s accounts receivable currently sit at around 42 million USD.

Conclusion

Despite the increase in share price over the past year, Geospace’s revenue multiple remains near trough levels. After the post-earnings drop, Geospace’s market capitalization is only approximately 158 million USD. This is low considering that Geospace generated roughly 23 million USD in profit over the past year and currently has no debt and 34 million USD of cash and short-term investments on its balance sheet.

Without the benefit of a large equipment sale, and with headwinds from lower rental revenue, Geospace’s profitability will likely drop significantly in the second quarter. The market clearly places limited value on oil and gas revenue though, meaning forward returns will likely be dependent on whether Industrial revenue bounces back. This seems likely given that demand for these types of solutions is generally increasing but this could take several quarters if customer inventory levels are a genuine issue.

There are a number of potential positive catalysts on the horizon, like border monitoring, reservoir monitoring and carbon capture and storage. These aren’t well defined in terms of size or timing though, meaning Geospace will likely need to demonstrate progress in these areas before investors begin to price upside into the stock.