In an attempt to find a value play that is taking part of the North American energy boom, I stumbled upon SEACOR Holdings Inc. (CKH). Given the operational capabilities, superior industry tailwinds, overcapitalized balance sheet and cheap valuation, this stock appears to be ripe for either a large move higher or significant premium takeover.
This is an under-the-radar name with a strong management team that has little sell-side coverage. You can almost say that this is a mini-Berkshire Hathaway, Leukadia or Loews Corp. with a culture of growing value by acquisitions and execution. This is a CEO-driven company very much like Berkshire, with a focus on capital allocation, the mixing and matching of assets and knowing when to buy and sell.
Business Overview
SEACOR was founded in 1989 through the purchase of a small shipping outfit called Nicor and operates a fleet of marine vessels, air fleet, offshore support to supply and service offshore oil rigs. Recent tragedies including hurricanes and the Deepwater Horizon drilling rig explosion in 2010 have depressed demand for their services. The company currently and historically has offered a diversified suite of services including offshore marine, aviation, inland river, marine transportation, crisis and emergency management preparedness and response solutions, commodity trading, and logistics and offshore and harbor towing.
The company conducts its business operations in five primary segments:
Offshore Marine Services: operates a diversified fleet of offshore support vessels primarily in service of offshore oil and gas exploration and production facilities worldwide.
Aviation Services: operates and contract-leases helicopters that provide transportation services supporting offshore oil and gas activities. On January 1, 2013, SEACOR completed the spin-off of this segment called the Era Group, which now trades under the ticker symbol "ERA."
Inland River Services: Primarily engages in dry and liquid cargo transportation on the US Inland Waterways and the Gulf Intercoastal Waterways for a range of agricultural and industrial products.
Shipping Services: operates, invests in, and leases a diversified fleet of US-flag and foreign-flag marine transportation related assets including deep-sea cargo vessels and harbor tugs primarily for the oil and gas industry.
Alcohol Manufacturing: operates an alcohol manufacturing, storage, and distribution facility in Illinois. Through its subsidiary, Illinois Corn Processing, the segment produces and stores a variety of high-quality alcohol used in food, beverage, industrial, hand-sanitizer, fuel grade ethanol and petro-chemical end markets.
Discontinued Operations: Over the last few years, the company has purchased and sold a number of different assets including Environmental Services, O'Brien's Response Management, National Response Corporation, J.F. Lehman & Company, a private equity firm, SEACOR Energy, their commodity trading business, and SEACOR Response.
CEO Charles Fabrikant
The CEO and founder of the company is a man named Charles Fabrikant. He is a value guy in the traditional sense of the term and according to Barron's even chose the new name of his firm "primarily because it was less costly to paint over two letters than the entire name." (Nicor to Seacor).
He is another of these "Great Allocators" that seemingly can compound returns over long histories. Think: Buffett, Klarman, Leukadia, Redwood Trust, Markel, and Loews. From the 2009 letter to shareholders, all of which are must reads in the mold of Buffett's:
"Our asset base is diverse, and our horizon is broader than simply owning and operating equipment. We are a custodian of capital, and our mission is to use our expertise and knowledge to make money."
Fabrikant owns roughly 5% of the outstanding shares and serves as executive chairman having resigned from the CEO spot in 2010. However, he remains active in the company's business as they rely on his talent of buying and selling assets and companies. Fabrikant will go wherever he sees opportunity, in the fashion of Buffett. He deals only in tangible assets and thinks in terms of replacement costs. His track record speaks for itself compounding capital at nearly 15% since 1992 compared to the 6% for the S&P 500.
Performance
SEACOR has rivaled Berkshire in book value per share growth since 1992. Recent performance in ROE and BVPS growth has slowed due to the Horizon Deepwater rig disaster in the gulf. That should rebound this year and next as the rig count increases and demand bounces back.
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Core Business
Offshore Marine Services accounted for roughly a third of consolidated operating revenues over the last three years. In the third quarter of 2013, this segment was 44% of total revenues. The segment operates several disparate types of vessels through direct ownership, joint ventures, pooled or managed, or leased-in.
For a glossary of these types of vessels, see here, page 5.
The demand for this business is highly correlated to the number of offshore rigs and the level of exploration and drilling activities, which in turn is influenced by a number of other variables including oil and gas prices, demand for oil and gas, regulatory concerns, customer assessments of costs, geological opportunity and political stability in host countries.
As of September 30, 2013, the company had no vessels cold-stacked (out of the water) in the US Gulf of Mexico. Utilization was 75.9%, down a bit from the preceding quarter but average day rates were $19,060, up from $15,267, more than offsetting that lower utilization rate.
The business has significant international exposure with 56% of 2012 revenues coming from outside the United States. In the third quarter, Offshore Marine Services saw operating income of $45.8 million, more than double the year ago results due to the gains on the sale of six offshore support vessels and other equipment for net proceeds of $42.2 million and gains of $15.3 million.
The general strength in the business is dependent on utilization and the average day rates. Clearly a vessel not in use will not generate revenue for the company. Nor would an average day rate that doesn't cover the cost of capital at any conceivable utilization rate. With rig count rising as memories of the Horizon Deepwater rig disaster (Macondo) fade and restrictions lifted, SEACOR will benefit.
Below is the Baker Hughes Rig Count for the Gulf of Mexico where the company has large exposure. You can see the steady increase in the number of rigs operating in the region since the disaster:
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The main part of the core business are the Anchor Handling Towing Supply (AHTS) vessels that are used to tow, position, moor rigs and other equipment. In the 2012 annual report, the company stated that average day rates were $26,000, much higher than the rest of their fleet's day rates. Rates are a function of the size and age of the vessel as smaller and older boats lack the modern functionality to service a newer modern rig.
SEACOR's fleet caries an average age of 12 years. While not the youngest amongst the competition, it is a fairly young and modern fleet.
One of the risks to the business is the lack of moat, or competitor advantage. Pricing power and switching costs are very low and, generally speaking, there are minimal barriers to entry outside of the actual construction of the vessels. The main advantage is the business being able to contain costs and improve profitability to grow into a larger player in the space.
Contracts are used to secure business and providers like SEACOR have to balance duration and price within them. For example, contracts range from mere days to covering several years. A company can go out years in a contract but risks being very wrong on pricing and taking a hit on profitability. If they offer a contract that is merely a few days, it minimizes the risk of being wrong on pricing but doesn't have the protection of a long-dated contract increasing switching risks.
Overbuilding has been a problem for the industry in recent years as the boom in drilling following parabolic oil prices in 2007-2008 has brought an oversupply of offshore supply vessels. This, coupled with the post-Horizon Deepwater disaster lull had depreciated demand in the region hurting SEACOR's results. Given that there typically is a 2-3 year lag between the time when a new boat is ordered and when it is delivered, we are likely past the peak of new supply coming online.
In the chart above, you can clearly see how the day rates have declined over the last several years, along with utilization due to the factors mentioned above.
In the third quarter 2013, liftboats continued to rebound due to seasonality and increased rig count in the Gulf with pricing up 15% and utilization up 13%. Liftboat pricing is up a strong 35% year-to-date with AHTS's also seeing a sequential revenue increase of $7 million with dayrates up 23% sequentially. The segment also benefited from less drydocking days in the quarter, which boosted Marine Transport income up $5 million quarter over quarter.
Ancillary Businesses
Inland River Services are assets that are used primarily for moving agricultural and industrial commodities, and chemical and petrochemical products, on the US Inland River Waterways, primarily the Mississippi River, Illinois River, Tennessee River, and Ohio River along with the Gulf of Mexico's intracoastal waterways. A small piece of the business operates in South America. The segment contributed roughly 14% of consolidated revenues in 2012.
The assets include Inland River Dry Cargo Barges, Liquid Tank Barges, Deck Barges, River Towboats, and Dry-Cargo Vessels. In all, the company owns, leases, pools, or through joint ventures, 1,536 boats. Dry-cargo barges are the overwhelming majority of those vessels at 1,409 total boats.
In 2012, the business had $226.6 million in revenues, up from $187.7 million in 2011. Operating income in 2012 was curtailed as costs soared primarily due to the drought in the Midwest while 2011 results were hurt by a late season flood that boosted costs.
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In the latest quarter, operating income was $4.8 million on operating revenues of $52.7 million compared to $5.5 million and $47.4 million in the preceding quarter, respectively. Overall, revenue results were up 11% qoq and down 1% yoy. The company stated that the strong quarter was due to less downtime due to repairs along with the start of the harvest season for regional agriculture.
Overall, the profitability of the business has suffered a bit due to a combination of factors including poor weather, lower grain and corn production, lower export volume, and freight costs.
The business is fairly simple to understand. It is driven mainly by their dry bulk segment, which carries grain and corn from the mid-to-upper Mississippi river and exports them to other countries and geographies in the US. The better the growing season in Illinois, Iowa, Missouri, Kansas, and Nebraska, the more the company will export and earn. On the expense side, costs are a function of barge logistics costs, which account for more than 65% of total operating expenses in the business. These costs are driven by the conditions on the river, which are largely a function of the weather, which drives the water level.
Operating margins in the segment declined to 21% in 2012 from 30% the year before with revenue only up slightly. Given the last two years were poor years due to weather and the prior two were poor due to the recession, it's been some time since they've had a 'normalized' year. 2012 was really the worst year from a cost perspective so we have to assume it won't get any worse from here in terms of operating margin contraction.
Shipping Services is the last significant business and is effectively a conglomeration of different marine services. They invest in, operate and lease a diversified fleet of marine transportation related assets including deep-sea cargo vessels and harbor tugs. Their primary end-market is the servicing of the US petroleum industry and ships docking in the Gulf of Mexico and East Coast ports. Some supplementary services include liner and short-sea transportation to and from ports in Florida, Puerto Rico, the Bahamas, and Western Caribbean. The business relies on a strong energy trade for most of its profitability. Overall, the segment contributes roughly 11% of consolidated operating revenues in 2012.
Below is the quantity and types of equipment that comprise Shipping Services:
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The company, in addition to the above, took possession of four US-flag harbor tugs, all of which were new builds and delivered in the second and third quarters of 2013.
Petroleum transportation is the transport by vessel of fuel and other petroleum products primarily from production areas, refineries, and storage facilities along the coast of the US Gulf of Mexico to utilities, waterfront industrial facilities, and distribution facilities along the entirety of the US coastline. The number of vessels eligible to participate in the US domestic trade and capable of transporting these products have declined in recent years due to new regulatory requirements under the Oil and Pollution Act of 1990 which required the retirement of older vessels. In addition, US flag new-builds have been fairly slow to replace those retired over the last two decades creating a small opportunity in the 1990s for vessels that complied with the 1990 law and increasing existing compliant asset prices.
Harbor towing is the second largest piece of the shipping business and operates tugs alongside oceangoing vessels during their docking and un-docking procedures. At the end of last year, they had 29 operating tugs in ports in Florida, Texas, Louisiana, Alabama, and St. Eustatius.
Other operations include liner and short-sea transportation, also called RORO or Roll on/Roll off vessels and barges. The ships provide transportation services to and from ports in Florida, Puerto Rico, the Bahamas and the Western Caribbean and typically carry containers, vehicles, or project cargoes.
The financials of the business are a bit opaque due to some accounting treatments but generally, the segment can generate around $50 million in operating income. For an example on the accounting complexity in the segment, petroleum transport operating income was approximately $15 million after backing out the sale-leaseback of a couple of tankers and some depreciation accounting related to former vessels.
Liner operations appear underappreciated due to subpar performance before they were purchased in 2011. Over time, they expect to get much more value out of this business than the prior managers who had revenues of $22.5 million and operating income of just under $4 million. This is a segment where they can add significant book value if they can get the business close to the traditional SEACOR efficiency standards. If so, expect to see them double operating income over the next few years.
Lastly, harbor operations generate a fairly stable approximately $20 million in operating income simply based on some algebra of what's remaining after analyzing the first two pieces of the operations. This is a fairly competitive business so I can't imagine they A) will be investing very heavily into it or B) growing it extensively from here.
Future Growth
Fabrikant stated in his letter earlier this year that the immediate outlook appears promising for increased offshore activity, "even when viewed by a skeptic." He noted that a sharp drop in oil prices could alter the outlook but unless we see a massive slowdown/contraction in economic growth, the chances of that occurring are low.
I do think there is a secular play here in that the current onshore, domestic oil boom (Bakken, Marcellus Shale, Barnett) is not a long-term event rather a 'boomlet.' Eventually, these shale plays will start to whither, and experts disagree on when that will occur with some stating that it could start as early as next year. The future of both oil exploration and technology will be offshore and in deepwater.
Brazil has been a focus for the company and Fabrikant considers it the most important market for offshore rigs and vessels. He saw the present slowdown in Brazil as transient and Petrobras recently appears more open to working with partners through joint ventures to develop the new fields. Earlier this year, Petrobras and IBV Brasil recently discovered a new block of high-quality light crude oil and natural gas that may hold more than 3 billion barrels of oil.
At the end of 2012, the company had 10 vessels operating in Brazil, including five owned and five managed. I think the company will be moving heavily into the geographic area over the next few years.
Risks
With a slimmed down company, the offshore marine services business is now even more central to the company's growth. As I noted, the business is dependent on the offshore oil and exploration business, which is indeed rebounding. However, it is also dependent on the supply of support vessels all competing to service these E&P companies pumping out the oil.
As Fabrikant wrote, "unfortunately, the roster of boats on order is very substantial. I hate to raid a party, but in our business it is supply that kills the goose."
He also believes that the supply of boats appears as if it will keep up with, or outpace, new rig capacity. One of the reasons for all the new supply has been the lower prices at ship builders. Large PSVs can now be ordered for less than $30 million. The new Chinese shipbuilders are a large reason for the lower prices as they attempt to break into this market.
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Certainly, oversupply can cause lower prices and reduced profitability for SEACOR over the next few years.
High Level Themes
As I mentioned above, the SEACOR letters are must reads along the lines of Berkshire Hathaway, Leukadia, and Third Avenue. The letters talk a lot about SEACOR's "culture." Here is a snippet from the 2011 letter to shareholders:
One of the ways SEACOR differs from Berkshire is that SEACOR will typically sell assets where they have seen marked appreciation and use the capital to invest either in existing businesses, into a new line of business, or return it to shareholders. In 2012, the company sold its National Response corporation and certain affiliates, SEACOR Energy, Witt-O'Brien, and spun-off the aviation segment, now Era Group and trading under the ticket "ERA." At the end of January this year, they paid out a special $5 per share dividend along with issuing $350 million in convertible notes.
Fabrikant has a flair for buying assets, whether vessels or whole companies, at low prices and selling high. Most of his sales have been at large premiums to book value and he rarely loses money on any asset sales.
The attitude and investing axiom is summed up nicely in a recent letter:
And lastly, in response to the lower prices for PSVs:
That last snippet I believe sums up Fabrikant's value manager mantra. The management team is solely focused on building long-term value by focusing on cash returns and not empire building.
Valuation
I am always suspicious of companies that create their own non-GAAP measures of performance. Clearly, companies will design these measures in a way that makes them look best. However, in SEACOR's case, it may be justified.
Fabrikant uses a term called 'OIBDA', which is operating income before depreciation and amortization. He also believes this is free cash flowing to SEACOR. The company makes a distinction between capex used to purchase new assets and capex used to simply maintain their existing asset base.
In recent interaction with investors it is apparent some think of "CAPEX" as expenditures for "special" maintenance. In SEACOR's accounts all outlays for keeping equipment operational, whether for a routine repair, or special overhaul [planned or unplanned], is charged to operations as an expense. We do not capitalize the cost of special surveys. In our vocabulary "CAPEX" [or capital expenditures], means dollars spent to acquire additional assets, or upgrade existing equipment. Our operating income before depreciation and amortization equates to our "free cash flow," about which investors usually ask, dollars that can be used to pay dividend, retire shares, or banked for future investment.
This is an area that SEACOR is overly conservative and where investors may not be appreciating the full value of the company's assets. By expensing some of the maintenance of their assets they are purposely depressing their results in order to be cautious.
OIBDA over the last several years has been depressed because of the Macondo- Horizon Deepwater accident. However, as rig count has rebounded, OIBDA should rebound back to pre-Macondo levels as the demand for offshore marine services increases. While rig count has eclipsed pre-Macondo levels, I still am using lower OIBDA (and EBITDA) levels given the increased supply of PSVs hitting the market.
At an estimated $345 million OIBDA in 2014, SEACOR is trading at just 5.5x ignoring the small amount of net debt. The question is why is the market skeptical of the rebound in operating income or are they not realizing the thesis?
Clearly, there is some skepticism embedded into the stock on whether or not they can rebound to prior levels. However, another reason could be the elevated level of P/B. Typically, the company trades at 1.0-1.25x book value. Today, if one checks Yahoo! Finance, they would see a 1.40x ratio. But, one has to back out the Era Group spin-off earlier this year, which accounted for roughly 0.40x of book value per share. Additionally, you have to back out the $15 special dividend paid two years ago to get an apples to apples comparison.
Generally, these two items account for roughly 0.50x of P/B per share. While I typically dislike valuing companies based solely on relative valuation ratios, I do think it is helpful to study how other investors value companies and also how they could be valuing companies incorrectly.
Sum of the Parts
Below is my sum of the parts analysis of the underlying businesses based on EBITDA:
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I like these types of valuation analysis since they are more granular than a DCF model and don't rely on input assumptions that drive the intrinsic value like the discount rate or terminal growth rate. My analysis uses 2014 forecasted EBITDA figures, which I think are fairly conservative.
The model returned an intrinsic value 25% above the current trading price. Additionally, one could apply a higher multiple value to the offshore marine business as that is a growing, secular, core business segment.
The offshore marine business drives the underlying valuation and will make or break my analysis over the next few years. It is also the most volatile in the consolidated group with the correlation of performance in the segment tied to many outside factors. Again, I do think the market is discounting the lower EBITDA due to an anomalous event and that it is not appreciating the upside from higher rig counts and a restoring of prior business activity in the offshore drilling space.
Even if the company wasn't trading at such a discount to what I feel is its intrinsic value, I think it would still be a compelling buy given the long-term track record of creating shareholder value and growing book value.
Catalysts
- Rebound in Gulf drilling underappreciated
- Expansion into Brazil and other international markets
- Acceleration of book value per share
- Shipping services unrealized
- Conservative accounting depressing results
Conclusion
The main concern over the next few years is a more focused company after the sale and spin-off of several segments in the last year. This exposes them to more risks within the marine segments to oversupply of PSVs and a slowdown in rig activity should either prices for oil fall or another deepwater disaster occur.
Still, this is a company with a host of strengths including best-in-class management, underappreciated assets, conservative accounting, and expansion into new markets. Given the company's proven ability to create value, industry tailwinds favoring the company's core business, and catalysts above, look for the company to report much higher EBITDA levels in the near future making the shares a compelling value at this level.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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