Co-written by Patrick Kirts
Horizon Lines, Inc. (NYSE: HRZ), the nation's leading domestic ocean shipping and integrated logistics company, is an excellent example of a company with a strong economic 'moat'. Portfolio Asset Management has been looking for some protectionism plays as the stimulus plans take form, as I mentioned on CNBC during my February 2nd interview on Closing Bell.
HRZ is the primary beneficiary of Congress' 1920 Jones Act, which states that a vessel transporting cargo from one U.S. port to another, whether via wholly domestic or foreign ports, must be owned, built, and crewed by Americans. More than one billion tons of the two-and-a-half billion tons of annual maritime cargo in the U.S. falls under Jones Act control. Horizon's competition, therefore, has an expensive barrier to entry into the domestic maritime shipping market. When was the last time you saw a cargo ship being made in the U.S.?
Furthermore, it is the only Jones Act shipper serving all three non-contiguous U.S. markets, Alaska, Hawaii, and Puerto Rico, as well as Guam. Alaska has a tailwind while the Hawaii is a late cycle recovery play. Despite diversification and lack of international exposure, HRZ has suffered a price decline from more than $32 in 2007 to around $4 today, based on guilt by association with other dry bulk shippers. It currently trades less than the company's book value. Let's get into why it is cheap and if it will be around to recover.
Even with its favorable competitive position, the company had a disappointing fourth quarter, which should come to no surprise. Management claimed in their January 29 conference call that adjusted operating income was down 55% for the quarter and 29.5% for 2008, and net income declined 74% for the quarter and 33% for the year, and earnings per share saw a loss of $0.63 for the quarter, but a profit of $0.10 for the year. A recession in Puerto Rico and Hawaii (due to the fall in tourism, which will be one of the last things to recover in an economic cycle) has been indicated as the main culprit in these losses, which have been offset by continuing strong performance in Alaska and improved cost-cutting, particularly a 16% reduction in their non-union workforce.
Stay with us here as we go through the balance sheet. It will be painless! First off, it would be an understatement to describe the company as leveraged. Horizon's management claims that this past August's refinancing of their revolving credit facility leaves them with no recapitalization needs before 2012, but Horizon already has $564M in long term debt, and only $114M in stockholder equity, a ratio of 4.9 (the current ratio is a much healthier 1.2). This is not a new condition for the company, but it is troubling given the slowdown in growth. It pays $6.5M per month on that debt, but its payments on its revolving credit facility dwarf this amount: $80M in the fourth quarter, $37.5M in the third, and similarly large payments continuously in recent history. Such expenses do not spell doom, yet. For many companies it pays to be highly leveraged, and Horizon evidently has ample liquidity, as management emphasized in their conference call. However, recently we have seen a few go down into Davy Jones' Locker due to the inability to refinance that debt.
One barometer that might be used is Horizon's small but steady dividend, costing between $13M and $14M per quarter. Given the size, and the fluctuations, in the debt payments, this is probably a red herring. Cutting the dividend would not provide nearly enough cash to meet these obligations, so if that happens, it will probably be too little, too late, and will be an indication that the company's lenders have lost confidence in their ability to pay. Sudden, bad economic news out of Alaska (think oil or fish), or serious further disturbances in Hawaii and Puerto Rico may be better indicators of incipient underperformance.
Nevertheless, we retain, with Horizon's management, a 'guarded confidence' that Horizon is well positioned for 2009. It continues to ship at almost full capacity, and plays a role in the market that others are not available to fill. No labor contracts will come up for renegotiation until June 2010, and there are no planned mergers or acquisitions. Despite the unanticipated deepening of the financial crisis, they managed to salvage a modest profit in 2008, and their cargoes are mainly necessary items. If there is a shipper to bet on right now, go for protectionism with a barrier of entry. The bottom line is that if they can pay the debt and keep afloat, the company will come out of this stronger and ready to pounce. We think the dividend is the canary in the coalmine and will take action if it sings. Just make sure you have enough pepper in your portfolio to make some profits in 2009.
Disclosure: long HRZ