Conrad Industries designs, builds and overhauls tugboats, ferries, liftboats, barges, offshore supply vessels and other steel and aluminum products for both the commercial and government markets. The company provides both repair and new construction services at its four shipyards located in southern Louisiana and Texas. It’s a cyclical business that has shown impressive growth and earnings the past five years, but despite this the company is currently trading at a ~5.3x P/E-ratio including cash and just a 3.2x P/E-ratio excluding cash. Some quick stats based on the numbers that the company reported last Thursday. These are different than reported by for example Yahoo Finance because they haven’t yet updated for the new results and share count:
Last price: 16.80
Shares outstanding: 6,088,287
Market cap: 102.3M
Cash and Equivalents (mrq): 43.7M
Enterprise Value: 58.6M
P/E (ttm): 5.3x
EV/EBITDA (ttm): 1.6x
P/B (mrq): 1.09x
With numbers like this you would expect that Conrad Industries is a business like some of my other holdings: one with a mediocre past and future. I don’t think this is the case at all, the company compounded book value per share at a 13.5% rate the past 10 years and at 21.0% the past 5 years. There is also reason to believe that the company is not operating at peak earnings at the moment since historically a large amount of business was related to oil drilling in the Golf of Mexico, and after the Deepwater Horizon accident this dried up. With the current high oil price drilling activities will probably pick up again, and that should be good news for the company. The best part of course is that at current prices you aren’t really paying anything for this potential.
Historical resultsI have created a spreadsheet that includes key statistics for the company for the past 10 years, and made some tweaks compared to the Solitron spreadsheet. The diluted shares outstanding used in the per share calculations are the amount of shares outstanding plus options at the end of the year. All companies report EPS numbers based on average weighted shares outstanding during the period, but I think that’s stupid and not reflecting economic reality. If you own 50% of a business and decide to buy the remaining 50% in the second quarter you would say that you own 100% of the business and profits at the end of the year, not a weighted 75%. I’d guess it would make some sense if earnings would be distributed to shareholders during the year.
The reason I ran into this issue was because Conrad Industries is buying back shares, and it bought this year a lot back in the last quarter. So the share count is down nicely, but the weighted average share count is not.
A last tweak I made is to base the average earnings and cash flow per share numbers on the reported shares outstanding in the most recent quarter. What matters is how big of a piece of the business you are buying right now, not how big it was in the past. If I would also make this adjustment for Solitron those numbers would be looking a bit worse since it has a slow but steadily rising share count. Anyway, enough about the accounting, the financial overview (click to enlarge):
The historical results show some positive and negative things. The company was facing troubles in the years leading up to 2005, and that was also the year when the company decided to delist from the Nasdaq to save costs, and since then Conrad Industries has been trading on the pink sheets. The company has not gone dark, and is still publishing quarterly and annual reports that provide an excellent amount of information. Besides audited financial statements the company breaks down revenues by segment and provides information about the order backlog, among other things. Small positive note: the CFO managed to reply within an hour when I emailed a question about the latest annual report.
If we would know nothing about Conrad industries a conservative valuation would probably be to assume that the average earnings for the past 10 years is a safe estimate for the normalized earning power of the company. Throw a conservative multiple on that, add back the cash and you can be fairly sure that you are not paying too much. Average EPS for the past 10 years has been 1.17, combine that with a 8.5 no-growth multiple and add back the $7.07/share in cash and you would end up with a $17/share price target: basically today’s price.
I would say that the 17$/share price target is ridiculously negative since the company has shown a good growth rate and healthy margins even when we include some of the worst years in it’s history, and the company managed to achieve this growth in book value while carrying a large non productive cash position. The company has also become more diversified. Historically most of it’s revenue was Golf of Mexico related, and that this has been successful is shown by the fact that the Deepwater Horizon accident is barely visible in the results. If you would take a more normal multiple for the business (let’s say 10~12.5x) and take the average of the past five years as a guess of normalized earnings power you would get a price target between $34 and 41$/share.
And I don’t think that’s overly optimistic since we are talking about a period that includes a recession and the Deepwater Horizon accident. It should be noted that the backlog is down this year, it was $47.1 million at December 31, 2011 compared to $89.5 million at December 31, 2010. The estimated backlog at March 31, 2012 is $68.7 million.
Another important thing to note is that the company has changed between now and 2002. The company expanded into the aluminum marine fabrication and repair business in 2003 and in 2005 the development of a new construction area was competed that enables Conrad to efficiently construct larger vessels than before. In the past years they also seem to have replaced a lot of rented equipment with company owned equipment, so the capex in the past years wasn’t just maintenance capex. This supports the notion that the financial results after 2005 should be weighted more heavily.
Capital AllocationThe company has shown some good capital allocation decisions in the past: it bought back ~11% of outstanding stock in 2008, and reducing the share count by another 6% since. The trading volume in the stock is limited, so this is a decent result, and the board of directors have approved a new share repurchase program for 2012. Can’t say the repurchase program was executed genially: they stopped it at the end of 2008 only to resume end 2010 because of concerns about the economy, and obviously that would have been the best time to buy with the lowest prices. But hindsight is of course 20/20.
A bigger development is a new capital expenditure program for 2012 for $20.8 million, a very significant increase compared to previous years (Conrad spend approximately $40 million on capex the past 10 years). It’s of course always a bit uncertain how this is going to work out, but in this case it could be a positive development. The company has been compounding book value at a nice rate the past years, and it’s only better if the company can reinvest a big part of the cash balance in the business:
Our Board of Directors has approved a $20.8 million capital expenditure program for 2012 which includes a contract we entered into July 2011 to purchase 50 acres of property adjoining our Conrad Deepwater facility for approximately $5.5 million which is subject to customary closing conditions.And another quote from the latest annual report (emphasis mine):
Other significant approved capital expenditures include bulkheading, upgrade to launch system and purchase of various cranes. The remaining capital expenditures are for the repair and upgrade of existing facilities and purchase of machinery and equipment that will allow us to improve production efficiencies. The board has indicated to management their desire to be prudent and if conditions are not favorable to postpone the less important expenditures.
InsidersInsiders own 51.2% of all outstanding shares so while they should have the incentive to operate the business in a prudent manner, other shareholders have a weaker position as minority shareholders. I’m not worried about this since management seems to have a solid track record, is not excessively paid, and there are no ugly related party transactions. The CEO, John P. Conrad, Jr., gets a base salary of $330,000 and a bonus that varied between $330,725 and $549,300 the past three years. The company stopped using an option based compensation plan after delisting from the Nasdaq (this is by the way driving the decreasing diluted share count from 2002 till 2007, basic outstanding shares has remained constant in that period).
The founder of the company J. Parker Conrad is 96 years old and owns 18.7% of the outstanding stock while his son, the current CEO, is 69 years old and owns 17.8%. His daughter owns 12.1%. John P. Conrad, Jr. assumed the role of CEO in 2004 and has been in charge turning the company around in 2005/6. Conrad was written up earlier this year on VIC and the author included a nice quote about the operational abilities of the management:
During the second quarter of 2011 we were affected by rising water levels along the Mississippi and Atchafalaya Rivers. The primary adverse impact was the temporary suspension of operations at our Morgan City shipyard which is located on the Atchafalaya River outside the protection of the levee system. In order to minimize the impact of the imminent flooding and decrease the amount of down time, we constructed our own levee system to protect our Morgan City shipyard. This resulted in no property and equipment damage and also allowed us to return to full operation with minimal clean-up, months sooner than otherwise. We relocated all of our production and support personnel and many of our projects to our other shipyards and continued operations at a minimally reduced level for approximately forty-five days. We resumed limited operations at our Morgan City shipyard during middle of June and were fully operational at this yard by July. All of our other yards remained fully operational. Due to the efforts of our people to plan for protection and move projects to other facilities, there was only a minimal impact on our profitability and no material adverse effect on our Company. Additionally, we were able to keep our people working and we were able to meet the delivery deadlines committed to customers.
Competitive advantageWhen buying a company because you think it’s potentially a good business you have to ask yourself what kind of advantage the company has that is protecting profits and margins, and I’d say that this is a bit of a weak point in the thesis. The company is protected from international competition by the Jones Act:
Section 27 of the Merchant Marine Act of 1920 (the “Jones Act”) requires that all vessels transporting products between U.S. ports must be constructed in U.S. shipyards, owned and crewed by U.S. citizens and registered under U.S. law, thereby eliminating competition from foreign shipbuilders with respect to vessels to be constructed for the U.S. coastwise trade. Many customers elect to have vessels constructed at U.S. shipyards, even if such vessels are intended for international use, in order to maintain flexibility to use such vessels in the U.S. coastwise trade in the future.While the Jones Act has been in existence for a long time I see it more as a risk than a competitive advantage, since protectionism is being reduced worldwide. The geographical location of the company, near the Golf of Mexico, is a bit of an advantage because it’s making the company attractive for the oil and gas industry in that part of the world, but I don’t think there is a real big competitive advantage at Conrad Industries compared too other shipyards. They are simply well managed and able to serve a diversified customer base thanks to the different facilities they operate.
ConclusionThe case for Conrad Industries is quite simple. If you are very pessimistic about the growth and future earnings of the company you are not paying too much at today’s prices. If the company manages to maintain the average performance of the past 5 years it’s already significantly undervalued, and if it can continue to grow at current rates the sky is the limit. I wouldn’t bet on a lot of growth though since I can’t find a compelling reason why the company has a big competitive advantage.
I have been on a buying spree the past month and Conrad Industries is the latest addition to my portfolio. It’s a bit of a different idea than most of my other idea’s that are asset based. I’am not saying that Conrad Industries doesn’t have a strong balance sheet (it does), but the great thing is that it’s a healthy business that should be growing intrinsic value yearly. With an asset based play you are more betting on someone unlocking the value contained in those assets, and the longer that’s taking, the lower your returns will be. With Conrad I’m actually hoping that time is going to be my friend.
On a scale from 1 to 10 I give the stock a 9: It’s a nicely growing company with a strong balance sheet that seems to be well managed, and most importantly: you’re not paying anything for the upside potential.