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Kirby Corporation (NYSE:KEX)

Bank of America Global Transportation Conference Call

May 15, 2013 08:00 am ET

Executives

Joseph H. Pyne – Chairman, President and Chief Executive Officer

David W. Grzebinski – Executive Vice President and Chief Financial Officer

Analysts

Ken Hoexter – Bank of America Merrill Lynch

Ken Hoexter – Bank of America Merrill Lynch

Welcome to our 20th Annual Global Transport Conference. My name is Ken Hoexter. For those who don’t know me, I’m BofA Merrill Lynch’s Airfreight and Surface Transportation Analyst and we thank you for taking the time to join us today. We put together what we believe to be a great schedule of companies set that we have 40 companies’ industry representatives, all presenting over the next few days. So we think, we have a great show for you.

With us let me just get started right away. With us today we’ve got Kirby Corporation, Joe Pyne, Chairman and CEO; and Dave Grzebinski, EVP, President and CFO; and future CEO as Joe prepares for the Executive Chairman role next year. The company provides inland barging for industrial chemicals petroleum products and agriculture chemicals on both the inland waterway trade and coastal trade. This has been one of our favorites lately given the improvement of the offshore utilization. And with the growth of crew, there is certainly a lot of interest in growing, growing that rapidly interest within the story.

So with that let me turn it over to Joe. Thanks Joe.

Joseph H. Pyne

Thank you. Thank you, Ken. Good morning. Kirby Corporation is in two businesses. We’re in marine transportation and diesel engine services. With respect to the marine transportation segment, we’re both an inland tank barge operator as well as a coastal tank barge operator. We have a market cap of a little less than $4.4 billion enterprise value of close to $5.5 and about 4600 employees.

Just some facts about Kirby. Kirby, as I indicated is in the two sectors of the tank barge business both inland and coastal and we’re the largest in both sectors. We have on the inland side of the business 26%, 27% of the market and on the coastal side of the business, a little more, close to 30% of this market. We manage the business conservatively. On the inland side, 75% of our business is going to be under contract a year longer. On the coastal side, about 70% is a year or longer, but truthfully as that business improves we’ll look to move the contract mix up to a higher level.

In diesel engine business, we’re both a national provider of service to both medium and high speed engines and we’re in the land based drilling business, principally building and maintaining high pressure pumps used to frac shale deposits for oil and gas recovery. Kirby has been a consolidator. We’re the aggregation of 49 acquisitions that makeup our company. This looks at the marine acquisitions, we’ve made over the last 30 years and the diesel engine acquisitions.

With respect to the marine acquisitions, we’ve also brought a number of shipper fleets, shippers have started the outsourcing of their fleets in late 80s, early 90s, the ones that you would recognize would be Dow Chemical, Union Carbide and ExxonMobil’s fleets. We have good revenue growth over the last 25 years, over 16% the year, earnings growth a little less than 15% per year.

Drilling down into the marine transportation sector, we operate on the inland waterways system, for the inland part of our business, that’s a very extensive system 12,000 miles of navigable waterways that really opening the heartland of the country to itself and global markets. On the coastal part of the business, we’re on all three coasts: Atlantic, Gulf and Pacific, and we also have operations in Alaska and Hawaii. So we have a large geographic footprint in this business.

Just some facts about the business, this is a very important part of the U.S. transportation system. [Powerway] and the inland liquid business have about 3300 barges in this sector. There is a much larger dry cargo sector on the inland side of the business, over 18,000 dry cargo barges, we’re not in that area.

On the coastal business, as you define the market 200,000 barrels or less indicate, we have about 30% of that business that’s a much thinner marketers about 270 barges in that business. We do have a small offshore dry cargo business, seven of our offshore barges are dry cargo barges, but we’re principally a liquid mover. We’re protected by the Jones Act, a very little obsolescence in this business. You can move barges around to service the market and it’s an environmentally friendly mode of transportation.

This looks at the drivers, this is for the Transportation Group. A little less than 50% of what we do is chemicals followed by black oil refine products and then agriculture chemicals. With respect to chemicals that’s driven by consumer durable and non-durable goods. This is really the new part of the business, creating new demand. It’s the dislocation and poor infrastructure that moves liquids discovered in these shale formations to market and there is really three ways to do it: pipeline, rail and barge.

With respect to barging, we move quite a lot of cargo from South Texas to Houston and New Orleans. We move crude oil out of Albany for the New York Harbor into Delaware Bay. And there is a new movement rail to Anacortes, Washington and then barge to the California refining system.

Of course ship safety matters in our business because of what we carry and who we work for. Looking at the inland business, I mentioned there were 3300 barges in this business. Utilization rates are currently high in the mid 90% area. We are adding some equipment, but that equipment is being absorbed and the age profile of the fleet still argues for a lot of replacement that needs to occur.

Size does matter in this business, we enjoyed some economies or scale that smaller operators don’t have, more cargos that we can control, the more backhauls we can put together, more power we have in the system, more flexibility we have and picking up barges and dropping them and also managing the power more efficiently than smaller operators can. This is who is in the business. We’re the largest, drops down pretty quickly, the shipper fleets are indicated in red. We think that this is a business that we’ll continue to consolidate and we think we’re in a great position to continue to be a consolidator.

Moving out to the coastal business. As I indicated, we’re the largest operator in this business, 6.3 million barrels of capacity. We have a large geographic footprint, made several acquisitions here, and really began our entry point into this business in July of 2011 and after four acquisitions in about 18 months that have the market position that we have. As Ken indicated, this is a business that’s moving the balance, so we’re very pleased with the direction this business is going. The last acquisitions we made were late last year. We brought a company called Penn Maritime and a company called Allied Transportation.

This looks at the age profile of the fleet again another I think good fundamental for this business, it’s a fleet that has some age well this actually is, yeah, the age profile. And as you could see, there are about 50 barges, there are 850 barges, 30 years or older, again a need to replace, which tends to help keep balance in the fleet. This added to some new volumes that we’re saying should make this a very attractive acquisition for several years going forward. This looks at again who is in the business, we’re the largest. We think this business is also going to continue to consolidate and then we have the capacity again to be a consolidator.

Moving on to the diesel engine business. Really in three sectors, two of these sectors, we talk about together and that’s marine and power generation. Let’s see the legacy diesel engine business that we’ve been in for a number of years, a newer part is the land based diesel engine service business. This is where we manufacture and overhaul and repair equipment used in the land based oil service business, principally in the fracking of these shale deposits.

This business has been under some stress. We think that on the land based side, it’s really on the bottom and we’re beginning to see some activity that we think we’ll payoff late this year or early next year. With respect to what we work on both medium-speed, high-speed engines, it’s kind of who is who, who manufactures these engines and we also work on the transmissions and reduction gears that really connect the engine to what its intended for.

With respect to the land based business, we’re one of the largest companies in this area. We really think that that this is an area of great opportunity, as it applies to maintaining equipment in this business. The amount of horsepower that’s been added in this area is really significant and we think that the cycle time for overhauls are about (inaudible) what we’ve done in the last year is really focused on preparing ourselves to be a significant company in this area.

Let’s look at where the shale plays are, I think most of you has seen this map makes, it’s important both to the engine business as well as the barge business. And this is just a simple schematic of how we’re fracturing works, you can see that it happens generally a mile below the water table, if you have a problem for the water table, it’s with the vertical side it’s not really with the horizontal side, really a game changer in the energy or for the energy picture in the U.S.

With respect to the outlook, we’re forecasting $1 to $1.10 for the second quarter. We moved the guidance up from $4 to $4.20 to $4.10 to $4.30 for the year, and this just really assumes that the marine side of the business is going to continue to do well and that the engine business, the heritage business, which is the marine power generation business going to be stable and the land based business bumping along the bottom with some improvement, end of the year, first of next year. Now, I’m going to turn it over to David for the financial review.

David W. Grzebinski

Thank you, Joe. Thank you, Ken, for having us. I’m going to just run through a few financial items quickly here. These are the historical financials; I won’t spend any time on them. We’ve included them for completeness, but I will go to the operating margins because I think that’s where you can see the real story over the long-term. The yellow line is the operating margins of the marine segment and where the red line is the operating margins for the diesel engine services segment. A couple points on the yellow line for our marine business. Point to take away here is that the recent drop of ‘09 kind of ‘10 time period, that drop is higher than the last drop, which was sustained back in 2002-2003 timeframe.

The other point to make on the yellow line is the addition of the coastwise business, which began mid-2011, actually kept margins down a little bit, because the coastwise business when we acquired it was in the mid-70s, maybe high 70% utilization, so, the operating margins of that business were pretty low. So, without the addition to coastwise, you would see the yellow line be up into the coast of the mid-20s, maybe 25% range, but that is changing the coastwise business operating margins have improved and recently we’re in the mid-teens range for that coastwise business.

On the diesel engine services business, I guess that one comment to make here is 2006 to 2008 timeframe, the Gulf of Mexico, oil service market was very, very strong and our margins did very well. We do believe we can get this business to mid-teens margins and as we improved our service offering on the land based side and if the Gulf of Mexico oil service market helps again.

Moving forward to EBITDA growth and this gives you a feel for the cash flow generation capability of the company. I think a better, better metric maybe this slide or better way to show at is this slide, the green bars are cash from operations and the yellow bars are capital expenditures. Basically, this shows you the free cash flow generation capability of the company, the point being that the green bars are always above our CapEx spending. In the last couple years, we’ve had pretty heavy CapEx spending as we’ve done a replacement program for our inland fleet. We’ve taken the average age of our inland fleet down from about 24 years old in the last five years ago to call it about 16 years, 17 years old now. So we’ve done a good job in bringing down the fleet age.

CapEx for 2013 should in around the $200 million range, so our free cash flow generation should be pretty robust for 2013. Absent to any potential building of new equipment in the offshore side of the business, our capital expenditure should be probably below $200 million in 2014, so we should have fairly strong free cash flow growth.

This shows our debt to total cap. You could see it’s around 38%, each of the kind of blips up on the line represent acquisitions we’ve done over time, and absent to any acquisition, we’ll probably use our free cash flow to delever for a while and prepare for future acquisitions. This gives you a feel for our balance sheet. We’re A minus rated with Standard & Poor’s, Baa3 with Moody’s, BBB flat with Fitch, further strong credit rating. That’s important to us because Kirby uses a strong return on invested capital discipline. We used free cash flow to model acquisitions and capital expenditures. So that tends to mean that we’re going to invest counter cyclically. We’ll be in the shipyards when almost nobody is and the economy is weak or we’ll be looking for acquisitions when the business environments not so robust. So we believe it’s important to have a strong balance sheet.

With that I’m going to turn it back to Joe, you can summaries. Thank you.

Joseph H. Pyne

Thank you, David. Just some points we’ll leave you with. Long-term record of success in this business very experienced management team, managed business conservatively, a 75% of the business under term contract a year longer on the inland side of the business and almost 60% of that under time charter and in the coastal business 90% of that business is under time charter. Time charter really gives most of the risk to your customer and we’re moving the contract exposure up in the coastal business.

In the chemical area, which is 50% of what we do 70% of the chemicals moved are for consumer non-durable goods, goods that are much more recession resistant than the durable side of the business. Large national footprint in the diesel engine service side of the business, David talks a little bit about our financial discipline, strong cash flow and we think we’re in a great position to continue to consolidate this business having made some important acquisitions last year and in a good position to continue to make them. Thank you.

Question-and-Answer Session

Ken Hoexter – Bank of America Merrill Lynch

So what we’re going to do is ask a couple of questions and then we’ll open the audience. Maybe you can talk about, looking at that chart, you’ve moved from a huge talent at the greater than 40 years of age vessels over the last maybe decade to a much younger fleet industry-wide. Looking at your build and the recent build on that chart, do you feel we get to a point where the industry itself starts to overbuilding some of the great strong utilization on the inland barge side first begins to diminish for is there something structural growth whether it’s with crude oil or something else on the inland side that choose up that that capacity and you now see a longer-term growth base but…

Joseph H. Pyne

Yeah, we see a longer-term growth rate in the fleet it we built and added about 200 barges last year the business sort them easily there is still a business that goes uncovered on an everyday basis. This is driven by principally these liquids coming out of shale deposits, but going into the future, you have really two other drivers. The first driver is just the continued recovery of the economy and the fact that that you’re going to see more demand or liquid transportation driven by that. The second factor is $100 billion of investment that has been announced adding chemical capacity to the U.S., really driven by low natural gas prices.

We’re globally competitive in U.S., a position that we haven’t been in, in about 30 years. Most of that occurs in 2015 through 2017, and that’s also going to create some demand. But having said that, this is a supply and demand business, we watch fleet growth very carefully with stable volumes; stable to increasing volumes, intuitively, we think just given the pain that the industry went through during the last recession that there will be some pullback if utilization begins to deteriorate. So, we’re, I would say we’re mindful of it, but not terribly concerned about it.

Ken Hoexter – Bank of America Merrill Lynch

And when you look at the $100 billion of investments that have been announced, what kind of just to put in perspective for investors, what kind of growth rate does that provides for the industry over the next call it four years?

Joseph H. Pyne

Yeah, I wish I have the perfect answer for that. I’m not sure we have a computer model that’s big enough to forecast it, but yeah it certainly has moved the business from what was about a GDP growth business to a GDP plus something business, but I am hesitant to say it’s 4.5% to 3% or whatever, but I think we’ll just have to wait and see and how it all shapes out.

Ken Hoexter – Bank of America Merrill Lynch

Now, on the offshore side, you’ve gone from 75% utilization to over 90% which is a tremendous move, and in the inland side if you go back to the mid part of the last decade, when the same thing happened on the inland side, your pricing took off almost exponentially, and for a couple of years in a row you had mid-teens pricing. Do you anticipate a similar stress on the offshore marine side and as you pass that 90% utilization?

Joseph H. Pyne

Yeah, let me answer in this way. We certainly anticipate stronger pricing offshore than on the inland side of the business. And what typically happens as you come out of the recession is that volumes increased driving utilization, and then utilization drives pricing and as you become fully utilized then we need to add capacity. And pricing has to go a step further and then it needs to be to the extent that it can justify the capital investment. So to give you maybe a better sense for how big of a reach that is, David, do you want to talk about kind of what we have per barrel in our current fleet, and what replacement would be?

David W. Grzebinski

Sure, yeah, just to give you some benchmarks, not talk specifically about pricing, but when we purchased the K-Sea fleets, the seaboat fleets, Penn and Allied, our rough cost per barrel of capacity was anywhere from a $150 to just shy of $200 a barrel of capacity. If you were to build a brand new 185,000 barrel tank barge with a tug that unit would cost you roughly $80 million, which equates to well over $400 a barrel in terms of price per capacity.

So coming off of the bottom of this cycle, prices have had a ways to go. We did get pretty good price increases in the fourth quarter, high single-digits, in some cases double-digits, same in the first quarter. So prices are increasing, but in order to build, you need not only do you need a rate to justify it, but you need some type of term from the customers. I mean, these are big expensive units, and they’re very sophisticated buyers of this service. I mean, you are talking of some of the major oil companies in the world, and they would encourage buildings and offer many, many short-term kind of contracts just to flood the market with capacity. So, you have to be smart about how you build and I think the industry is demonstrating that and prices aren’t there yet.

Ken Hoexter – Bank of America Merrill Lynch

Just to clarify on that that cost of buy, the $150 to $200, does that include the investments that you had to make when you brought them in house and did the fixing up?

David W. Grzebinski

No, it doesn’t. Also there is also an older fleet, right, it’s not brand new. So your average life of a coastwise unit is maybe 25 years, and most of this equipment we bought was about half of its useful life remaining, so, maybe a little less. So…

Ken Hoexter – Bank of America Merrill Lynch

Okay.

David W. Grzebinski

There is a time value there, that’s included in that.

Ken Hoexter – Bank of America Merrill Lynch

All right, let me stick with you Dave on obviously the hot topic in terms of eating up utilization has been the growth of crude demand, Joe talked about it in the overview. On the offshore side, maybe, can you talk a little bit about, are there major oil terminal projects in the works or is it something that’s going to really chew up capacity even beyond what you thought and be a new area for growth?

David W. Grzebinski

Yeah, we are seeing it. I mean, that’s part of what’s tied-up increase the utilization, as on the map that Joe showed you, so the Bakken, you can see rail moving into the East Coast to Albany and then it will go from barge down from Albany or rail to the West Coast, Anacortes, Washington and then go by barge there or conversely it can go either to the river where we’ll take it on inland barges or down to the coast, where it may end up in a coastwise barge as well. Also Corpus Christi has barge moves that both inland on the intercostal waterway and then cross Gulf from Corpus to say Houston or New Orleans area, Port Arthur area. So that has absorbed some of the capacity. I think for Kirby of our 80 or so coastwise barges we have about six in that crude and condensate business. So, it has helped that. Do we see it growing, sure, it appears like and when you see some announcements in terms of West Coast and other terminals, so it looks promising.

Joseph H. Pyne

In that regard, there is investment on the West Coast and Anacortes and in Vancouver, Washington. There is investment on the East Coast. This is in marine-based terminals in Albany and there is a lot of investment in Corpus Christi area again in Marine terminals. So they are putting in the infrastructure. And I think, yeah, yesterday in fact, Kinder Morgan announced a new terminal in the Houston area.

Ken Hoexter – Bank of America Merrill Lynch

So, my last question before I open up to the audience is just why delever your 38%, you went from the inland barge to the coastwise, is it dividend likely in the future in terms of handing out their cash or do you see more investments and especially $200 million CapEx, it seems like you’re now coming off of a big build. What’s your thought on cash flow?

Joseph H. Pyne

Well, historically we’ve been able to use all the cash, so, we’ve resisted a dividend. Ken, you could argue that and you can probably do both now, you can continue to grow the business and dividend, that certainly a subject that gets a lot of attention at the board level. I don’t want to make prediction, but as we go forward it looks like, we’ll have a strong excess cash flow generally going forward, which could be used for investment, it could be used for share repurchases, and it could be used for dividends.

Ken Hoexter – Bank of America Merrill Lynch

With that, are there any questions from the audience? Yes.

Unidentified Analyst

(Question Inaudible)

Ken Hoexter – Bank of America Merrill Lynch

Given the environmental regulations around the remissions for diesel engines for the inland barges that are coming out?

Joseph H. Pyne

Yeah, the regulations for loading vapor is already in place and most of the fleet is equipped with vapor control equipment where you can gather the vapors and then flare them at shore. With respect to engines and it depends on where you are California has some pretty strict regulations. And they’re over and above what you see in other places in the country, but most of your fleets already grandfathered, if you build a new piece of equipment then you have to comply – with the exception of California that you have to comply, regardless of whether you have an existing tug or a new tug.

Ken Hoexter – Bank of America Merrill Lynch

Any other questions? Okay it seems that I’ll jump back in on the, maybe you can walk us back on a path to profitability on the diesel engine services side. Is there, obviously your margins, Dave you showed margins back down to 9%, obviously, all the drilling went way down and some manufacturing went to zero, but so how do you look at in the transition of services and the growth in improving the margins?

David W. Grzebinski

That’s a fair question. Back at its peak, those margins were in the mid-to-high teens depending on what quarter you’re looking at, but let’s say mid-teens. And now we think that that is a mid-teen margin business. The heritage business, the marine business came under pressure with Macondo and puts more time on drilling and what it is to the customer base of the services. Now that’s beginning to come back, so what we think, next couple of years you’ll see some margin recovery in that business.

On the land-based side, the margins were pretty strong for manufacturing business 2011, kind of first quarter of 2012 and then demand collapsed and with it margins. When we bought that business in early 2011, we said from the start that it was attractive to us, not so much for manufacturing, but as a platform to take a very strong marine service model and apply it to land-based equipment. And we’re well underway in doing that. We think that as you service that land-based equipment, you should see margins above the manufacturing margins. So what we’re saying is that we think that should be again a kind of a mid-teen margin business, when it’s fully recovered.

Ken Hoexter – Bank of America Merrill Lynch

Wonderful Joe, Dave I appreciate the time you spent this morning and thank you for the (inaudible).

Joseph H. Pyne

We appreciate it.

David W. Grzebinski

Thank you for having us Ken.

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