Joel Wine - Chief Financial Officer
Matson, Inc. (MATX) Bank of America Merrill Lynch Transportation Conference Call May 15, 2013 3:15 PM ET
My name is (Robert Gill). I’m the industrial and transportation specialist on the sales team at BofA Merrill Lynch. We are very happy to close out our day today with the team from Matson. We have Joel Wine, the CFO and his colleague (indiscernible). As some of you probably know Matson is a container shipping servicer between Hawaii, Guam and the Mainland, United States. And without any further ado, I’ll let him take the rest.
Joel Wine - Chief Financial Officer
Thank you, (indiscernible). I’m Joel Wine. Let me kick this off. When you think about Matson, we wanted to start with just a couple of the attributes that we think differentiate us. First is the brand. We have been around 130 years. We are the company delivering freight to Hawaii unlike anyone else. We have got a leading share in Hawaii and now Guam, which is a core part of our business and it allows us to send about half our fleet on to China and we have got a premium service in China unmatched with by the competition allows us to get a premium in that market, which is very unique in the international business.
Underlining all that we have got high quality assets that have flexibility and a team that has been doing this for many decades by virtue of our history so those are really the core ingredients of the company I’ll talk through them as we go through the presentation and underlining all that is a financial model that boasts of a tremendous amount of free cash flow that allows us to continue to reinvest in our business and maintain our strong market share position. And as part of that free cash flow and the investment thesis is to deliver and return some of that back to shareholders through an attractive dividend.
So, let me talk about each. I mentioned 130 years. Matson has been enlist with - really the infrastructure of Hawaii. We carry two-thirds of the freight from the West Coast to Hawaii and we are really embedded in the infrastructure and the economy of Hawaii and but because Hawaii is a remote location and highly depending upon their ocean carrier reliability built into our company’s kind of DNA and resources the high level of customer service, reliability that’s well beyond the norm of the industry and our service standards are really unsurpassed the ocean transportation business because of that because they are so dependent in Hawaii on Matson and also have high level of financial stability.
We have got an investment grade metric balance sheet. We financed ourselves on the senior and secured basis, which is pretty rare in the shipping industry and all that is really the ingredients in the company that deliver value to the Hawaiian economy, which we have done for many, many decades. So, let me spend a second on our core deployment. We discovered ourselves of having a core deployment of nine ships, five ships through this blue line you see on this page, which go from Long Beach to Honolulu onto Guam then onto China and then back from Shanghai to Long Beach. And then we have four ships that do this triangulation services between Seattle, Oakland, Long Beach and Hawaii so that adds together our core nine ship deployment and I‘ll talk about each of those markets as we go through the presentation.
In addition, over the Christmas holidays, we made a small acquisition $10 million in the South Pacific. Matson has been in South Pacific many, many decades ago but this business it was the former assets of a company called Reef Shipping brings freight that of Auckland, New Zealand into Fiji, the Samoa and other parts of the South Pacific. It is adjacent to feeder service that we have in Micronesia that comes off Guam. So, this was a very interesting part of the world for us. It’s adjacent to where we already were and it’s a bunch of island economies that are similar to Hawaii in a sense that they are relying upon a carrier and ocean carriers being reliable on high service orientation, which I think that we think they were good at Matson. So, this was a small acquisition but its one that puts us in a new market, where we potentially can grow over time.
So, let me breakdown each of the markets I described before. The Hawaii market, we have been the market leader for many, many decades. Currently the Hawaiian economy actually did better through the downturn than the Mainland economy but volumes had declined in 2008 and 2009 but then flat lined in 2010, 2011 and 2012 are relatively flat. This last quarter, first quarter of 2013, we actually saw 5.5% volume growth about 1% of that was market growth and about 4.5% of it was share gains and some subcategories, where Matson has greater strength.
So, if you look at most of the statistics in Hawaiian and clearly part of the Matson investment thesis is always going to be centered around, how is Hawaii is doing, what’s the outlook for Hawaii and the long and short of is that Hawaii looks very poised for growth. The tourism data in terms of number of visitors and visitor spend reached all-time highs in 2012 it look like they will be even surpassing 2013. If you look at the airlines and the number of tourist and flights coming in to Honolulu and the Neighbor Islands had set very high levels. So, the economy looks like it’s poised to do well through U.S. Canadian, Australian, visitor arrival as well as lot of demand are coming form various markets in Asia.
For our business though, the core, we think the core volumes related to the GDP of Hawaii is more and less flat line for Matson so food stuffs, retail products, all the general things that you would - that you would need in the economy we think it flat line and maybe will start growing in a small rate, which really going to allow our growth to be greater than that and greater than 1% or 2% of the time return of investment spend in construction and new projects in Hawaii and that really has not happened for about four years. There hasn’t really been new project development since 2008.
So, we track very closely building permits and importantly construction jobs that we showed here. You can see the decline in actual people in the field working on construction projects. It was a positive number in 2013. It’s projected to be a significant positive number in 2013and beyond. So, the construction investments what really drives Matson volumes in a big way going forward we think in the Hawaii market.
The next market is Guam. Guam has historically been a two carrier market. It was ourselves and our primary Horizon that’s our primary competitor in Hawaii. Horizon pulled out of the Guam market in November of 2011 so since that point and time, Matson has been the sole carrier of U.S. freight too long. So, our volumes move from 14, 15,000 containers a year to Guam to last year 25,500 so we expect this market to be relatively flat. There is only about a 160,000 inhabitant in Guam. There is not a lot of growth in that market but it’s a very profitable market for us as we carry all that volume on ships that are going by on the way to China. It’s a very profitable good market for us as part of our China strength.
With respect to the China business, we have premium service in that market. If you define the market as Shanghai to Long Beach Matson is about 3% of the market. If you define the market as all of china to the West Coast Matson is less than 1% so we are very, very small player and we do this with Jones Act Vessels that are high cost but we got a premium expedited service. We are able to move freight from Shanghai to Long Beach in three to six days faster than anyone else and because of that we are able to charge a premium of on a low end several hundred dollars to and some example $600, $700, $800 per container over the underlying spot rates of all the other commodity carriers and that’s because of reliability and speed that I mentioned before.
So, when we ruled this, we didn’t start this business until 2006 but effectively since 2006 our ships have been full the whole time it’s a question of how much premium can we charge across all the containers on the ship itself. So, for us as you think about our company its lesser play on what do our volumes coming out of China because our vessels are full, what changes quarter in, quarter out, year in, year out are the actual rates that we are able to charge.
Our business this year or the last 12 months of 2012 did about 59,000 containers Shanghai to Long Beach about half of those are annual contract rates and half are with freight-forwards in the spot market. So, we are affected by the spot market rates. These are not rates that we show in this page we do get a premium over them but watching the channel rates does impact - does impact our quarterly and annual performance on that portion of our business.
The other business that we are in that’s embedded in our ocean transportation operations and segment is a joint venture called SSAT Terminals with the company called SSA Marine, which is a high quality world-class terminal operator. This dates back to 1999 by virtue of Matson’s longstanding history on the West Coast. We own and operated our own terminals. But as others got into the business of terminal operations and had more leverage in buying power for cranes and terminal equipment as well as a larger negotiations with the union the Longshoremen unions we decided in 1999 to contribute our assets, our terminal assets with SSA Marine is a bigger global operator in exchange for a 35% partnership position in that joint venture and it allowed us to turn capital intensive operational intensive business into a financial asset and we’ll ask somebody else to operate the terminal. So, right now the joint venture own six of the 26 terminals on the West Coast, which represents about 20% to 25% of the overall less capacity coming into the West Coast port.
Now as part of that it was very important for Matson to negotiate into that contract, that joint venture agreement all the servicing and high operating performance standards that we need in our terminals to get our ships in and out quickly and maintain that high degree of reliability and service that I mentioned to Hawaii. So, this is a - this is not only a financial asset it’s a very important operating asset for us that we embedded into the contract with SSA Marine the high level of service in the dedicated terminals.
The other business that Matson is in is the other segment, which is Matson Logistics. This is about a $400 million annual business. We were a top 10 third-party logistics broker. There is really three pieces to this business. There is a truck brokerage piece. There is an intermodal brokerage piece, which brokers both international and domestic intermodal freight and by the way we do that both on the UP and the BNSF.
If you look at other like J.B. Hunt or Pacer or others they tend to be skewed towards UP or BN. We do both which is an interesting differentiation point for us in the marketplace that’s the second business. The third business is the warehouse business. We have got warehouse locations in Savannah, Long Beach and in Northern California and Oakland, which is that business is really contract logistics business. This business was homegrown.
It’s started within Matson, when we originally had the ocean transportation containers are going to back from Hawaii. They might go inland to Kansas City or Chicago or Denver and wherever and we had to procure a freight to get them back and not have (that had) coming back. So, from that business in the 1980s it became its own standalone unit maybe seven and over the last 25, 30 years it’s grown primarily organically. We did do some brokerage acquisitions primarily on the truck brokerage side in the 2000.
But we, it’s a highly, it’s a low capital intensive high ROIC business. It’s been a good one for us. It’s been a good one to leverage off the Matson brand as well given the brand attributes I mentioned before even though we are not a big carrier in the grand scheme of the overall ocean carrier business for those companies that might be large like a Target or Wal-Mart or Costco and however they do business in Hawaii. They know Matson. They know our high service, reliability and that helps our logistics business from a calling card brand perspective as well.
I’m going to fast forward a little bit to our financial results. If you look at our results, last year, our 2012 EBITDA was $169 million fast forward for the first quarter of this year our LTM EBITDA was $180 million. Our EPS from continuing operations is $1.22 last year and the analyst estimate this year around the $1.45, $1.48 or so. Our ROIC was just a hair under 10% last year.
If you look at our balance sheet (indiscernible) income statement, I mentioned LTM EBITDA of $180 million and to put that in perspective from an EBITDA this chart shows on the left hand side a 10 year history of EBITDA. The average EBITDA for that 10 years was $170 million. However we weren’t in the China business until 2006 and we didn’t expand in Guam as the one competitor Horizon moved out of Guam in 2011 and we started carrying 100% of the freight in Guam at the very end of 2011. So, with regard to the 10 year average, there is some new businesses that we have today that really weren’t there. And so, if you just look at the $180 million of LTM EBITDA it’s not a bad number to use. It’s just kind of a forecasting average of EBITDA. And then on the right hand side of this page, you see CapEx our average maintenance CapEx excluding new vessel builds is $40 million over the last 10 years.
So, if you look at the free cash flow power of our company $180 million of LTM EBITDA about $40 million of cut on average CapEx. Our cash taxes and interest expense would reduce those numbers to around $100 million. We payout about a $26 million dividend right now that’s very steady and we would like to judiciously grow that over time with our cash flow. You are still looking (indiscernible) its going to have $70 million, $80 million, $90 million of free cash flow to be deployed in this business over time on a market cap today that’s about $1 billion equity market cap. So, it just gives you a sense of the cash flow, the free cash flow generation power of our business.
Turning to the balance sheet now, we thought, we have a very strong investment grade metric balance sheet. Our total debt was right around $300 million at the end of last quarter, which leaves our debt to EBITDA ratio around 1.6 times. And in Matson used to be holding on by Alexander & Baldwin and spun off last year starting in July. So, if you look at the three quarters since we have been a publicly traded independent company, we have already paid down debt by $72 million again just speaking to the free cash flow strength of the company and the business model.
And so what do we do with that cash. I think this is a depiction of the last quarter. It was a blend. We had paid down debt $18 million in the first quarter of this year. We bought the South Pacific asset that I mentioned for $10 million so an M&A transaction in the first quarter. We had maintenance CapEx was $6.3 million and the dividend was $6.5 million. So here is the blend and I think what you’ll see within Matson is a blend of these uses of cash over the next three to five years. There is basically five things you can do with cash you can invest in maintenance CapEx you can invest in M&A or you can return the capital through share buyback dividend or paying down debt and so we did four of those five things since last quarter and I think you’ll see us do all five things in a blended fashion over the next three to five years in terms of capital deployment use of cash.
Last slide here and then I’ll open up for questions about our business but in terms of our outlook what we see in 2013 we talked about our ocean transportation business being moderately higher than 2012, we have some businesses that are performing better than last year some little bit off versus last year’s from a net basis we think it will be moderately higher this year. And then our Logistics business expected to be – it’s been coping along around $4 million or $5 million of operating income last couple of years we expected to stay in that range in 2013 as well.
So, with that, what am I open up to questions.
Great. I’ll start if I can. On the – as you went through some of the Hawaii macro that was helpful, as we look at some of the trends we’ve seen on the airline side with the weakness in the Japanese Yen has impacted travel into Hawaii. Are you – do you see something like that or is it too small in the realm of compared to when you’re talking about construction and kind of that.
We – it would be too small to see in a short-term for us, I think the longer term as you did see a declining towards from the Yen effect. Over a longer period of time let’s call it 12 months or 18 months you start seeing issues with hotel occupancy RevPAR and the profitability of the hospitality industry would start coming down that could affect our volumes in a longer term and also could affect the dollars that maybe that the hospitality providers would be spending on refurbishment hotel refurbishment or new product which would affect the construction investment spend that I talked about before.
But I would say it’s the Golden Week which happened two weeks ago which is the big week where lot of Japanese tourist come down well the numbers we’re off of what expectations we’re in two or three months ago they still look very, very strong. So if you look at the overall amount the number of tourist coming into Hawaii from Japan is about 20% it’s about one-fifth. So there’s a little bit of headwind because of the Yen effect on that PC saw a very, very strong tourism demand from all the other 80% especially Australia, Western Canada, U.S. is doing just fine in all the Asian – all the other Asian economies in a very, very strong incremental demand for tourism into Hawaii so if you talk to the economist and folks in Hawaii these are very bullish outlook for the next 5, 10, 15 years with respect to tourism.
That’s helpful, thanks. I’m thinking about Guam with Horizon leaving in kind of having monopolistic sort of opportunity there, how much of a barrier potentially is there for someone else if you guys would talk little bit.
There is a substantial barrier to entry the first of which is, is physical location at Guam, you can’t see it on the flat maps but Guam is really very, very far away from anything else it’s not like it’s nearby and Hawaii is not nearby either and you can only see that if you look really the globe and look at the great circle type of routes. So you really need to see an opportunity of growth there for to probably attract the competitor in that market the other barrier to entry is the piece of the Jones Act is applicable to Guam the full Jones Act stay suggestive moving new freight between to U.S. port it’s got to be a U.S. built vessel U.S. owned vessel and a U.S. crude vessel so that’s for the Hawaii trade.
The Guam trade the only requirement is the U.S. crude vessel so you don’t have you can use a foreign body vessel it could be foreign owned so for instance in the Pacific APL and Maersk both have the U.S. crude operations distributors of the U.S. military because U.S. military won’t allow you to move goods without it’s being a U.S. crew. So but you’ve seen APL reduce its U.S. crude fleet in the Pacific because the military demand for movement into Afghanistan and Iraq is it going down obviously with the military exiting those areas so there hasn’t been as much business they’re reducing their U.S. fleets in the Pacific.
So those are the only two that would really be that well positioned to move freight from the west coast to Guam because they have U.S. flag operations and they’re just not that much volume is enticing on that now. So it looks like we maybe there the only carrier there for quite sometime but we’ve been very careful to say look we don’t know there’s traditionally been a two carrier market at some point and other carrier probably come into that market and we won’t carry all of the freight for ever but it doesn’t appear like there is much of a catalyst in the short to intermediate term to track someone in.
Any question from the audience?
Can you give what’s the breakdown of revenues by each market that you serve Hawaii, Guam and China?
We don’t disclose volumes excuse me revenue for each of the segments but on a volume basis I can help you size it, if you look at this route map last year fiscal calendar 2012 we brought a – we had a 137,000 containers in Hawaii trade, the Guam trade was 25,500 and the China trade was 59,000 containers. Now they all had very different rate structures so the freight to Guam is most expensive than Hawaii and then the transpacific Shanghai to Long Beach is actually the cheapest per container. And I mentioned Horizon as the other competitor, they do about a third of the market so the overall market to Hawaii is around 200,000 containers 205,000 so our 137,000 was about two-thirds of that market.
For your I guess the expedited service to China who are your primary customers and why they are preferring to use your service over I guess traditional streamline service from the likes of Maersk?
The customers that we go after are the ones that are most time sensitive that really want to deliver the goods as quickly as possible and reliably as possible. So for instance the Guam is high value to us is fashion goods where the Inland retailer might turn over inventory 14 or 15 times a year and a fashionable dress will be on the racks for four five weeks tops and then they want to get it out. So the distributor that distributes that product to the Inland retailer has very important centers to get it there on time and if they miss it by four five days they have a penalty, if they miss it by 10 days they don’t even get paid. And the goods in the container might be $100,000 of dresses. So that’s a great example of a market that’s willing to pay an up-charge of $300, $400, $500 $600 on a $2200 box because they’ve got a 100,000 inventory at risk in penalties at risk with their Inland customer.
So if you look at garments out of Shanghai to Long Beach we think we’re about 35% of that market even though I said before we’re 3% of the overall market. Consumer electronic is another good example so we can go talk to Samsung or someone and say look you air freight almost everything over right now and so the air freight is available of about three but really more like four days. We can - our freight can be available in a 11 days so if you just take a small portion of our supply chain and extend the supply chain on one portion of it by seven days our costs are less than 10% of the cost of air freights you can save a lot of money by just extending a little bit of your supply chain on a good that doesn’t 100% have to air fright developer.
So it’s a great niche for us we’re trying to penetrate new markets and get more and more premium customers willing to pay for it. And the good thing about it is the big carriers that are ordering to 15,000 18,000 to your ship they don’t care about this at all I mean they’re focused on lowering cost per unit and having the lowest cost vessels coming across the ocean so you ask them what about Matson’s premium service they wouldn’t even pay attention to us they don’t – we don’t really create a blip in their radar screen.
And it’s also interesting that we’ve got – we have a high cost Jones Act operator. So it’s kind of a paradox that our high cost operations have the lowest breakeven cost of anybody in the industry because we have a dual head all with all those freight paying revenues to Hawaii and Guam that nobody else has. So our vessel show up in China the whole wage is already paid for even though we’re high cost Jones Act U.S. operators. So it’s a really this blue screen here is really a remarkable business that Matson has just done a great job to find them so it’s getting into that it’s really very difficult in a short - almost impossible in the short-term to replicate that you need five Jones Act shifts to replicate that.
Thinking about the logistics business in terms of growth, can you talk through sort of organic opportunities versus potential M&A in that room?
Yeah. We’re primarily focused on organic opportunities now I mean the business produced $20 million, $21 million, $22 million of operating income for several years in a row 2005, 2006, 2007 now it’s pretty seem like I said 2005. So we think there is lot of opportunity within our own business to get back some of the margins reverse some of the margin compression that occurred both in the truck brokerage and the motor brokerage side. So the organic growth there comes from acquiring new talent, new agents on the truck brokerage side. Some of those might be small and then they deal for you, buy an agency in you know Minneapolis or Denver somewhere that comes along with four, five, six different agents it’s a very small some of that just really getting people in the door. But we’re, so we’ll look at M&A and what’s going on in the marketplace both in the sectors we’re in other logistics segments so those will be less focus for us versus getting our business back to $10 million plus operating income contribution which we think it can get there in the next three, 4 years.
And then can you take us through conceptually M&A opportunities outside of that?
Yeah. That’s a good question. So because we get that a lot that what about the free cash flow what you’re going to with that. We do have to do continue reinvest in our fleet and these vessels are expensive that U.S. built so they are quite expensive. But beyond that we’ll focus on what our competitor advantages are what we’re think we’re good at. And I mentioned that before, we think we’re going to vessel operations, high service, high reliability to remote locations that are highly dependent upon those attributes that help fuel and their economies. So that’s why the South Pacific was such a good example, very remote island, very far part, very line upon somebody is going to come in and be very reliable. And they want to pay a little bit of extra for that so there is an example one of these islands the island of Nauru the one of the entities in that market I'm going to say it was, got off schedule and they’re completing this their every two weeks but they completely missed both of their December deliveries and the whole island got no Christmas products, I mean there is like no literally no toys, nope and it is really bad.
And so those people will remember that for a long, long time that I want a reliable carrier that’s going to be here and not have our island and missed Christmas I mean that’s a really I mean so we’re good at that, the massive brand I mean people in the South Pacific know the Hawaii history and they know that we’ve been a really reliable carrier over time. So long winter wait there we’ll look for niche ocean opportunity with other junkers certainly niche Jones Act opportunities ocean carrier freight opportunities but there is also once in the international markets we don’t want to go in the big markets that can be with the big global players we see ourselves having no competitive advantage three at all probably competitive disadvantage. So it’s going to be niche ocean freight opportunities that will be our primary focus for us.
And in terms of comparing yourself to the big guys, are you at target or is there regulatory issue there?
Yeah well the Jones Act itself stipulates that we have to be at least 75% on by U.S. citizens. So that we, we’re not a foreign care we’re not the oil purchaser company.
But first another Jones Act yeah kind of company.
Yeah there is no, there is no we’re the biggest Jones Act player by a wide margin in terms of EBITDA in ocean carriers. That was really Jones Act players that are large Kirby is a great (indiscernible) they’re a great company they’re not in, they’re not in ocean container. Horizon is large on a revenue perspective because they’re in the Hawaii trade but they’re also in the Alaska trade in the Puerto Rico trade. So the revenues are quite large and as large as ours but their EBITDA is less than half of ours or around half of ours.
Any other questions in the queue?
Joel Wine - Chief Financial Officer
Thanks very much for your interest. Thank you.
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