If you have not yet, please read my previous post about the macro case for ISH. I am diving straight into the analysis in this post.
Let’s start by adding some more color to the operations of ISH and its various business segments. The revenue contribution % is based on the Proforma 2013 estimates and includes the numbers for UOS which the company acquired in Q4, 2012. 2012 numbers are relatively similar once you adjust for various changes and acquisitions/dispositions the company made in 2012. The US Flag segment operates under the Jones Act.
|US Flag||Intl Flag||COA||Rail Ferry||UOS (will merged with US Flag)|
1 multi-purpose vehicle
1 bulk carrier
2 container vessels
3 multi-purpose vehicles
7 bulk carriers
3 container vessels
2 small tankers
|1 Sulphur Carrier||2 roll-on/roll-off vessels||2 Handysize bulk carriers
4 Tug-barge units
1 Harbor tug
|Key Customers||Virginia Power
Various US Govt Agencies
|PT Freeport Indonesia||Gulf Sulphur Services||Almidones Mexicanos
Grupo Papelero Scribe
|Tampa Electric Company
|2012 9 mth Segment EBT margin||17.52%||18.86%||-0.01%||0.03%||-|
Additionally, the company owns 25% stake in 10 mini-bulk carriers and 50% stake in rail terminal in Mexico
Legend: PCTCs are Pure Car/Truck Carriers. Cars and Trucks roll on and off for loading and unloading. Similarly, Rail Ferry serves the same purpose but instead of cars/trucks it loads railcars.
Prior to acquisition of United Ocean Services (UOS), the ISH’s US Flag segment made up for a little over 50% of its revenues. Post acquisition, ISH now has the largest Jones Act dry bulk capacity in the industry and it will contribute 65% to the revenue.
I remarked earlier that there is not much of a glut in the Handysize ships that ISH uses and this has helped keep the asset values firm. Between 2007 and 2012, the smaller Handysize fleet grew at about 1/3 rate of growth for Capesize fleet. Between now and 2016, the orderbook for new Handysize ships (to be built) is 16% of the current fleet, while about 30% of the current fleet ships is older than 25 years of age (and likely to be scrapped).
In addition to looking at the demand/supply dynamics of the ships, it may be even more important to look at the actual prices these ships have fetched in the market. Fortunately, 2012 saw ISH make many sale transactions that I am listing below.
- On Feb 22, 2012, they sold and leased back a 2007 built PCTC. They received $59 million for the sale and booked a gain of $14.9 million
- In Mar 2012, they sold 2 of their international flag PCTCs for $73.9 million and booked a gain of $3.8 million
These 2 data points show that the valuation of the assets that they have on the books are fair or even below the market.
The company has also done transactions to take advantage of arbitrage potential between US Flag and International Flag vessels. For example,
In Oct, 2012, they sold one of their 1994 built US Flag PCTC and in exchange received a 1999 built International Flag PCTC and $3.5 million in cash. With this deal, they pocketed the valuation differential between US Flag vessels and International Flag vessels (cheaper) in cash and upgraded their PCTC ship to a 5 year younger vessel. They promptly reflagged this ship to US Flag.
With this as the background, we have enough insight to start valuing the balance sheet. As usual, we will lean towards realistic conservatism.
Q3 2012 Balance Sheet Analysis
For this analysis, we will use the price as of close of the market on Jan 7, 2013. The idea is to imagine yourself buying this company and all its assets and we are evaluating how much we want to pay for the assets first.
Price=$17.61/share, Shares Out Standing= 7.2 million, Market Value=$126.79 million
Summarized Balance Sheet
|Balance Sheet (Q3 2012)||Adj Factor||Adjusted Value||Notes|
|Current Assets||$64.80||100%||$64.80||Since Current Assets are either cash or short term inventory, I do not mind paying the full price for them. In this case, nearly $30 million is in cash, there is minor inventory (they own maintenance yards) and about $24 m is receivable. The receivable is from either the Federal government or highly rated businesses (see attached presentation)|
|Net Fixed Assets (net of depreciation)||$415.10||90%||$373.59||We saw that the company has been able to realize better asset value in the market than what is on their books (net of depreciation). Still, I am cheap and I will only pay 90% of the book value. What if some ships become unproductive and I have to scrap it (their vessel utilization is close to capacity right now though, except for normal in between contracts ships)|
|Intangibles||$1.80||0%||$-||It is their word against mine and I will not give them any credit for what may be a worthless asset anyway|
|Other Non Current Assets||$88.42||69%||$61.11||I had to dig a little deeper into this so I attached a table below.|
|Total Assets||$570.10||$499.50||This is a number that a reasonable and well informed buyer of assets might settle at.|
|Total Liabilities||$316.70||100%||$316.70||I still have to pay the bills and debt in full|
|Equity (Book Value)||$253.60||$182.80|
What is in the Other Non Current Assets Line?
The company has been doing quite a few sale/leaseback transactions. As the asset is capitalized on the balance sheet, the company starts incurring lease expenses over the period of the lease term. A Deferred charge asset is created on the books and it is amortized over time as the lease payments are made. The Other Non Current Assets line includes this Deferred Charge asset. It also includes other long term assets, mainly financial instruments related to its equity investments in other assets. I have listed them below
|Other Non Current Assets Breakdown||in thousands||Adjustment||Adj. Val|
|Deferred Charges, Net of Amortization||18278||30%||5483|
|Due from Related Parties||1735||70%||1215|
|Investment in Unconsolidated Entities||13524||90%||12172|
|Net Investment in Direct Financing Leases||14391||90%||12952|
I have kept the adjustment factor for Investment in Unconsolidated Entities (ships and yards they have 50% or lesser ownership stake) and Direct Financing Leases at 90% as it very likely has similar asset quality as owned assets. I have discounted Notes Receivable by 15% assuming some impairment and aggressively discounted the Deferred Charges asset due to its long term nature and the uncertainty that it introduces (the underlying asset value may change over time triggering write downs). As a result, the $88.4 m line item may be closer to $61 m if the company were to try and sell these assets in the market today.
With all these adjustments, my estimation of a fair and tangible book value for the company assets is $182.80 million.
Require a 30% margin of safety from this value to account for errors, omissions and a lack of crystal ball, and we are looking at $127.96 million as an amount that I would be willing to pay for the company today. With 7.2 million shares out standing, this translates to $17.77/share.
The stock today closed at $17.61/share.
What About Earnings, Profits and Things Like That?
The company is well run, is a leader in its niche market and is amply protected from competition in its largest segment: US Flag Jones Act Carriers. With the UOS acquisition, this segment is growing larger and with it the market share will be larger as well. Since 2003, the company has been profitable every single year as you can see below:
|Cost of Sales||168.9||195.6||208.1||205.2||221.9||134.6||176.4||294.9||233.8||191.1||187.2|
|Net Profit Margin||-0.04%||2.13%||4.86%||2.67%||6.18%||8.83%||16.39%||11.11%||5.28%||11.97%||4.91%|
The current quarter will not have the benefit of the contribution from the 3 vessels that were contracted to US Military Sealift Command as this contract was ended and not renewed in February 2012 (the government paid termination costs until Q3 but they are not clearly spelled out and I think are minimal). However, the contribution from UOS will kick in from the next quarter and will be accretive. The company is able to stay profitable, meet its obligations and pay dividends.
The reason I am not too concerned with the Income Statement is this. The current P/E ratio of 10.36 gives it an earnings yield of 9.65%, of which it pays out 5.70% in dividends. If you buy the stock today, you are buying marketable assets at more than 30% discount (conservative estimate), which essentially gives you a potential of at least 30% gain. And while you wait for this gain to materialize, you will be paid 9.65% on each share in terms of earnings, of which 5.7% comes direct to you in cash every year as dividends.
But there is a kicker (or two)
Let’s not forget the International Flag segment. The company generated 43% of its revenues on the spot market (2013 will be less in % terms after UOS acquisition), mostly in the International Flag segment. Eventually the spot rates are going to go up as the rest of the industry exits the current slump. How high and when can’t be predicted with too much accuracy so I will just leave it as gravy.
Finally, if you recall, the new Handysize ships on order between now and 2016 (it takes 2 years on average to build a ship) is about 16% of the current fleet whereas 30% of the current fleet is more than 25 years old. At some point soon, more ships will be scrapped than built, which will make the existing ships more valuable. Again, there is no need to speculate. It suffices to note this and keep our eyes and ears open going forward.
There is always the possibility of PE multiples expanding when the industry recovers and investors become more enthusiastic.
- Buy International Shipholding below $17.77. Lower the better
- Initial sell target is at 1 times adjusted book value which is $25.38/share. This may change over time if the business grows its intrinsic value significantly
- Holding period= 2 years or less
- Portfolio allocation= up to 6%