Kirby's (KEX) CEO David Grzebinski on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: Kirby Corporation (KEX)

Kirby Corporation (NYSE:KEX)

Q2 2014 Results Earnings Conference Call

July 31, 2014 11:00 a.m. ET

Executives

Sterling Adlakha – Investor Relations

Joe Pyne – Chairman

David Grzebinski – President and Chief Executive Officer

Andy Smith – Executive Vice President and Chief Financial Officer

Analysts

Michael Webber – Wells Fargo Securities

Jack Atkins – Stephens

Jon Chappell – Evercore Partners

Gregory Lewis – Credit Suisse

John Mims - FBR Capital Markets

William Horner – BB&T Capital Markets

Ken Hoexter - Bank of America Merrill Lynch

John Barnes - RBC Capital Markets

David Beard – Iberia Capital Partners

Nicholas Bender - Wunderlich Securities

Operator

Welcome to the Kirby Corporation 2014 Second Quarter Earnings Conference Call. My name is John and I'll be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Mr. Sterling Adlakha. Mr. Adlakha, you may begin.

Sterling Adlakha

Thanks, John and thank you all for joining us this morning. With me today are Joe Pyne, Kirby's Chairman; David Grzebinski, Kirby's President and Chief Executive Officer; and Andy Smith, Kirby's Executive Vice President and Chief Financial Officer.

During this conference call, we may refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is available on our Web site at kirbycorp.com in the Investor Relations section under non-GAAP financial data.

Statements contained in this conference call with respect to future are forward-looking statements. These statements reflect management's reasonable judgment with respect to future events. Forward-looking statements involve risk and uncertainties. Our actual results could differ materially from those anticipated as a result of various factors. A list of these risk factors can be found in Kirby's Form 10-K for the year ended December 31, 2013, filed with Securities and Exchange Commission.

I will now turn the call over to Joe.

Joe Pyne

Thank you, Sterling, and good morning. Yesterday afternoon we announced record second quarter earnings of $1.31 per share. That compares to $1.11 per share reported for the 2013 second quarter, a quarter that also included a $0.07 per share benefit from the production of the earnout liability associated with the acquisition of United Holdings.

During the second quarter our inland and coastal tank barge fleets continued to experience healthy levels of demand across all our markets, high equipment utilization levels and continued favorable pricing trends. With operating conditions in both of these markets, which we would say were seasonably normal. Overall, our marine markets continue to benefit from the growth of the domestic petrochemical, crude oil and condensate production, all of which we expect to continue to remain strong.

In our marine and power generation diesel engine business, we had also performed well and benefitted from healthy levels of demand in most of the markets. Our land based continued to show improvements, particularly as it related to orders for new pressure pumping equipment. The reman business also improved and we continued refine our business process which we believe will result in better long-term performance.

I will now turn the call over to David.

David Grzebinski

All right. Thank you, Joe. Good morning, everyone. Starting with our marine transportation segment, during this second quarter our inland marine business continued its overall strong performance with equipment utilization in the 90% to 95% range and modest improvements in term and spot contract pricing. As Joe mentioned, operating conditions were relatively normal for the second quarter.

Long-term inland marine contracts, those contracts that are one year or longer, were 80% of revenue for the quarter with 56% from time charters and 44% from affreightment contracts. Due to strong demand from term customers and limited available capacity, we now expect contract revenue to remain around 80% level for the remainder of the year. Pricing on the inland marine transportation term contracts that renewed during the second quarter increase in the low to mid-single digit level compared with the 2013 year ago quarter.

Spot contract rates which include the price of fuel, increased modestly compared with the first quarter and remained above term contract rates consistent with what we experienced in the first quarter of 2014 and throughout 2013. On the coastal side, it also continued to perform well with equipment utilization in the 90% to 95% range which is in line with our first quarter, but above the 90% range we saw throughout 2013. During the second quarter, approximately 85% of coastal revenues were under term contract compared with 75% from the year ago quarter.

Demand for coastal marine transportation in refined products, black oil including crude oil and condensate as well as petrochemicals remained at healthy levels. As we announced, it was intention last quarter, to meet increasing customer demand we have signed agreements for the construction of 255,000 barrel coastal ATBs and tug units. We currently expect the first of these vessels to deliver on mid to late 2016 and the second in early to mid-2017.

Estimated 2014 progress payments for these additional units are included in our updated capital expenditure and Andy will go into that in more detail later. With respect to coastal marine transportation pricing, term contracts that renewed during the second quarter increased in the mid to high single digit range when compared to the year ago quarter. Spot contract rates which include the price of fuel continued to improve sequentially during the second quarter and remained above term contract rates.

In our diesel engine services segment, the second quarter reflected positive results across most of our markets. In our marine diesel and power generation markets, demand was generally stable. The land-based diesel engine services market benefited from an increase in the demand from the manufacturer of oil field equipment as well as the sale of engines, transmissions, parts and services. Orders for new pressure pumping units increased in the quarter and demand for remanufacturing remained relatively consistent with what we experienced in the first quarter.

With that I will turn the call over to Andy, who will give you some detailed financial information and then I will return to discuss the outlook.

Andy Smith

Thank you, David, and good morning. In the 2014 second quarter, marine transportation segment revenue grew 8% and operating income grew 19% as compared with the 2013 second quarter. The inland sector contributed approximately 70% of marine transportation revenue in the second quarter with the coastal sector contributing approximately 30%.

Our inland sector generated a second quarter operating margin the mid to high 20% range and the coastal sector generated an operating margin of approximately 20%, benefitting from improved year-over-year pricing and the seasonal uplift in the Alaskan market. Overall, the marine transportation segment's second quarter operating margin was 25.4% compared with 23% in the 2013 second quarter.

Let me also comment about the seasonal effects of navigation conditions on margins and revenue per ton mile which can be misleading. Historically, our third quarter is our best operating margin quarter due to favorable navigation conditions, while the fourth and first quarters generally experience lower margin due to the seasonal weather patterns affecting navigation conditions in both our inland and offshore markets. Conversely, revenue per ton mile is historically lower during periods of favorable navigation conditions and higher in the fourth and first quarter when navigation conditions are negatively affected by seasonal weather.

During the 2014 first half, we took delivery of 39 new tank barges with a total capacity of approximately 450,000 barrels. We retired 21 tank barges and returned five leased barges, moving approximately 420,00 barrels of capacity. The net result was an addition of 13 tank barges to our fleet and approximately 30,000 barrels of additional capacity. Of the 39 tank barges delivered, 37 were 10,000 barrel barges and two were 30,000 barrel barges.

For the second half of 2014, we expect to take delivery of 27,000-30,000 barrel inland tank barges with a total capacity of approximately 760,000, most of which we expect to deliver late in the fourth quarter. Combining these additions with our current planned retirements for the second half of the year of six barges with 60,000 barrels of capacity, will result in an approximate capacity at year-end of 18 million barrels, 700,000 barrels above our current 17.3 million barrel capacity level.

Our current inland tank barge building plan for 2015 calls for the construction of 30, 10,000 barrel tank barges which we expect to be delivered throughout the first half of the year. In the coastwise sector, the construction of our two 185,000 barrel articulated tank barge and tugboat units at a cost of approximately $75 million each is proceeding as planned. With delivery of the first unit expected in mid to late 2015 and the second in the first half of 2016.

As David mentioned, earlier this month we signed agreements to construct two 155,000 barrel coastal articulated tank barge and 6,000 horsepower tugboat units at a total combined cost of approximately $125 million to $130 million. One of the units is scheduled for delivery in the second half of 2016 and one in the first half of 2017.

Moving on to our diesel engine services business. Revenue for the 2014 second quarter increased 22% while operating income was down 4% compared with the 2013 second quarter. However, operating income increased 62% when excluding from the 2013 second quarter, the $6.1 million benefit to operating income resulting from the reduction of the United earnout liability.

The segment's operating margin came in at 8.4% compared with 10.7% for the 2013 second quarter or 6.3% excluding the earnout benefit. Our land based operations contributed approximately 65% of the diesel engine services segments revenue at a mid-single operating margin. As David mentioned, we continue to see signs of improvement in this business with strengthening demand for the sale of engines and transmissions, parts and service, as well as orders for new pressure pumping units and the remanufacture of existing units.

The marine and power generation operations contributed approximately 35% of the diesel engine services revenue, with an operating margin in the low double-digit range. On the corporate side of things, we reduced debt by $58.7 million during the 2014 second quarter, thanks to continued strong cash flow, and added to our marine equipment construction plans. As of today, debt stands at $642 million. Our 2014 capital spending guidance is currently in the $370 million to $380 million range, including approximately $140 million for the construction of 66 inland tank barges and one land towboat expected to be delivered in 2014. And approximately $105 million in progress payments on the construction of new ATBs.

The balance of $125 million to $135 million is primarily for capital upgrades and improvements to existing inland and coastal marine equipment and facilities, as well as diesel engine services facilities and final cost for the construction of two offshore dry barge and tugboat units delivered during 2013. Total debt as of June 30 was $649 million, $100 million reduction from our total debt of $749 million as of December 31, 2013. Our debt to cap ratio fell to 23% as of June 30, compared with 27% as of December 31, 2013.

I will now turn the call back over to David.

David Grzebinski

Well, thank you, Andy. In our press release, we announced our 2014 third quarter guidance of $1.30 to $1.40 per share. This compares with $1.21 per share earned in 2013 third quarter, a quarter that included an $0.08 per share benefit due to the reduction of the United contingent earnout liability. For the 2014 year, we raised our guidance to $4.90 to $5.10 per share compared with $4.44 for 2013. Remember also that 2013 earnings included a cumulative $0.20 per share benefit due to the elimination of the United earnout contingent liability.

Our third quarter guidance assumes normal, seasonal, operating conditions in our marine transportation markets. It also assumes a continued strong coastal market with higher term and spot contract pricing. With inland marine rates currently strong, we expect pricing increases to remain in the 3% to 5% range. Going forward, we expect earnings increases to be driven by these price increases as well as from capacity growth as new tank barges continue to be absorbed by the market.

For our diesel engine services group, we expect to see continued improvement in our land-based market. Our third quarter guidance assumes our diesel engine services, marine and power generation markets will remain stable. The primary difference between the low end and high end of both our third quarter and full year guidance range is the level of improvement in our land-based diesel engine services business and operating conditions in our margin transportation segment.

In summary, the first half of 2014 has gone well and the outlook for our markets continues to be positive. We continue to invest our strong cash flow in building new inland and coastal equipment and we also continue to pay down debt and strengthen an already strong balance sheet which will allow us to pursue any potential acquisitions that may emerge.

So with that operator, we will like to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Webber from Wells Fargo Securities. Please go ahead.

Michael Webber – Wells Fargo Securities

David, you talked a bit about the new ATB orders and I know in last quarter when you guys were still in the process of placing those final two order or looking at that, you were talking to an after-tax return of around 12%. I am just curious, how those numbers actually came in when you placed the order and then how those kind of trended relative to the previous 180 orders you guys placed.

David Grzebinski

Yes. No, remember we -- Mike, we look at, when we look for our 12% return, we look through the life of the asset. You know it's a discounted cash flow through the life of the asset. But rates are sufficient when you get the new equipment delivered to give us that 12% return. But rates currently aren't there, so they have to continue to grow. But the forward price that we are getting on the contract for the one new 185,000 barrel barge is sufficient to get our 12% return.

Michael Webber – Wells Fargo Securities

Got you. That’s helpful. And as my follow-up just along those lines. Can you maybe talk to how much demand you are seeing out there from your customers for additional coastal ATBs and maybe just on a relative basis to the work you guys have already done in terms of ordering these four. How big of an opportunity is out there relative to what you have already done?

David Grzebinski

No, we continue to see increased demand, a lot of crude and condensate demand. Refined product demand is increasing. So the demand is increasing but also, and I think this is important, when we look at the market of ATBs and barges there are 200,000 barrels and less, there are 47 that are over 30 years old. And that’s out of base of about 268 barges. So that’s a lot of capacity that’s going to have to come out in the next five years or so.

So you have got this increasing demand. You have got a supply base that’s some part of it is pretty old and needs to come out. So it's a pretty good supply demand dynamic. And we are very comfortable with our position in that and with the four new ATB's that we are building.

Operator

Our next question comes from Jack Atkins from Stephens. Please go ahead.

Jack Atkins – Stephens

So I guess jus to start off with, going back to diesel, excuse me, going to the coastal side of the business for a moment. You know I noticed in the press release, you commented about modest pricing gains but everything we have been hearing from you over the course of the last year and a half, two years in terms of, contract renewals indicate mid to probably high single-digit contract growth, pricing growth. So just sort of curious, are you guys seeing maybe that market plateau in terms of the pricing gains year-over-year or do you still think there is some room to go in terms of getting price there.

David Grzebinski

No, I mean in the coastwise market we are seeing mid to high single-digit price increases. So that’s still pretty good. And then as we put some, maybe some spot equipment on to contract, you know the price increases there are quite good at times. So, no, I think pricing is remaining pretty strong in the coastal market. I think in the inland market as you saw, we said, we think the price increases will remain in that kind of mid to low single-digits, 3% to 5% is what we said. So it's still a pretty good market. And we take a very long term approach on this and as we have said before, we don’t want to be overly aggressive on pushing price.

Jack Atkins – Stephens

Sure. That makes sense. And then as a follow-up, on the diesel engine services side of the business. You know it sounds like that incremental demand is coming from new equivalent orders. Do you think this cycle will be dominated by new equipment orders versus remanufacturing? And at what point would you maybe think about adding some capacity to your existing facilities, just given the demand that I think everyone sees out there for refurbished or new frac equivalent over the next couple of years.

David Grzebinski

Yes. It was a good question, Jack. Well, as you look at the public comments from our pressure pumping customers, their business is improving. They are running 24/7 and in many cases really putting the equipment to work. We are starting to get a little bit of pricing increase which makes them more willing to spend both new capital dollars and maintenance dollars. We continue to see reman grow where we are servicing more customers, different customers. But right now we are seeing an influx of new equipment orders. I think there has been some pent up demand over the last year or so. So that’s starting to play out.

In terms of us increasing our capacity, I guess I would just say this. We are adding a second shift, a partial second shift, so we are buys right now. And things continue to look like they are going to improve on the land base side.

Operator

Our next question comes from Jon Chappell from Evercore. Please go ahead.

Jon Chappell – Evercore Partners

David, I could understand the ATB orders seemed to be geared towards customer requests. But you also announced 30 more 10,000 barrel tank barges. Is that commentary at all about the returns that you can get from newbuild assets relative to the acquisition environment today? And if that is the case, are you concerned that others may follow suit and the overbuilding that tends to happen in cyclical industries may happen sooner than you would have thought otherwise.

David Grzebinski

Good question, Jon. We are seeing increased demand from our customers, both coastal and inland. Some new plants are coming online. We need the equipment to meet that demand. What you are seeing is with, you know in the last couple of years we have had bonus depreciation and that has rolled off. So with that coming down, when we look at the 2015 build plans out there and look at the shipyards, the number of newbuilds is actually down a little bit and we think that maybe driven by the lack of bonus depreciation. But we are still seeing the need for new equipment as new plants and restarting of some plants comes online.

And, yes, we are able to get our return on that new equipment above our hurdle rate. But pricing for acquisition, you know acquisitions are just so hard to predict and there are so many different things that drive a seller. But given the market, you would expect that price expectations are up a little bit. But we are happy to build the equipment for the needed demand and we will be patient on acquisitions.

Jon Chappell – Evercore Partners

All right. And then as my follow-up, kind of on same lines as with the balance sheet. I mean if you continue to pay down debt at the pace of last couple of quarters, you are going to be down to just the senior notes, probably by early next year. So arguably maybe a little underlevered and I know you kind of like to be that way for flexibility. But how do think about financing CapEx, to really have to have the cash to do it but debt being cheap as it is today, would you maybe take on a little bit more of that as well?

Andy Smith

Yes, Jon, this is Andy. We have always been very consistent in how we think about our allocation of capital. And we certainly will continue to look at any M&A opportunities that come along. But to the extent that we think we can still build and attain our 12% after-tax return on capital, we will invest in our fleet. After that our next priority would be to pay down that additional remaining debt and then look at other alternatives with our cash beyond that.

Jon Chappell – Evercore Partners

But you probably keep the senior notes outstanding until the come due. Is that correct? Would you chip away at those

Andy Smith

I don’t foresee us chipping away at them right now. We have got, just in this current year we have got about $210 million to $220 million more dollars than we are going to have to spent on our capital expenditure program. And with relatively decent sizes capital expenditure program next year with the progress payments that we will have to make on the ATBs as well as our inland fleet addition. So I don’t foresee that happening anytime soon. But we will sort of cross that bridge when we come to it.

David Grzebinski

And Jon, as you know,. We have returned capital to shareholders with repurchases in the past and of course if we won't get too under-levered, we may look at a dividend. We have talked about this before that we have discussed -- that Joe and I have discussed it with the board. But right now it's just premature to declare anything like that.

Operator

Our next question comes from Gregory Lewis from Credit Suisse. Please go ahead.

Gregory Lewis – Credit Suisse

David, when we think about the DES business, I mean clearly it looks like customers are opting to manufacture new equipment as opposed to remaning equipment. Is there anything Kirby can do in communicating with these customers? I mean clearly these units are -- the engines themselves initial, originally built to be remaned. Is there any sort of value proposition that you guys are actively looking at to sort of get some of these customers to shift over to the remaning favor and remaning over new equipment or is it just sort of, we are just going to wait and see how the cycle plays out.

David Grzebinski

No, it's a good question, Greg. We are value selling the reman. If you think about, you can essentially reman a frac unit for about half the capital cost of a new unit, sometimes less than that. And there is a, as the pressure pumpers look into return on capital, that’s important. We continue to value sell that. And as I said in my prepared remarks, we are seeing actually more customers. We keep adding customers. And I think this as a, the market is slowly developing and getting confidence in reman. I think it's a relatively new phenomena. Some people have done reman and if you look at the majors like Halliburton and Schlumberger, they have internally remanufactured all along. So it's some of the other players that are -- and we want to be their outsourced remanufacturing that are coming along.

So it's an evolving market. I think as more and more customers get comfortable that a remanufactured frac spread is essentially good as new, that market will continue to grow.

Gregory Lewis – Credit Suisse

Okay. Great. And then just shifting gears over to the coastal business. We have seen some news about condensate exports out of the Eagle Ford. I mean when we think about that, I guess two things. One, has that impacted customers willingness or should I say have you noticed the slowdown in customers appetite for coastal barges following those announcements. And I guess the follow up to that is, can you sort of have a gauge on what percentage of coastal fleet is moving condensate out of the Eagle Ford. If you could just provide any sort of color around that, that would be pretty helpful.

David Grzebinski

Sure. No, we are not seeing any change in the customer mindset around crude and condensate. I think as you think about crude and condensate. They have to run it through a splitter or a topping unit or something like that. And actually those are generally leased to some other volumes that we may get a chance to move. There is some derivatives streams there. So we are not really seeing anything. But it's still early days and we will see how it plays out. I would say in terms of the general market, in terms of coastal business, I know what we do about 50% of what we move is refined products. 25%, well maybe a little more, maybe 35% is what we call black oil. And that within black oil is crude and condensate. For us that’s probably around 10% range but you could see that that maybe higher for some other players.

Operator

Our next question comes from John Mims from FBR Capital Markets. Please go ahead.

John Mims - FBR Capital Markets

So let me ask you on the net additions and some of the capital plans you just laid out. It would seem that you are adding most of the net additions this year will be the 30,000 barrel barges on the inland side and you are retiring, what I would assume would be 6,000 to 10,000 barrel barges, for the next year adding significantly to the 10,000 barrel barge fleet. Can you talk about the dynamics between the two and the inland in terms of absolute demand versus replacement demand, if there is any noticeable different in average age there? And kind of where the inland market is going from here, if you are going to see kind of noticeable shift towards the 10,000 versus what we have seen is more growth in the 30s over the last couple of years.

David Grzebinski

Yes. A lot of that are fleet specific and what we are looking at forward in terms of both customer demand, for example like [small] (ph) light chemicals and the (indiscernible). You would move those in 10,000 barrels barges. But also, if you look at our age profile, we also think years ahead at the age of our fleet. And it's also about what's available to be built. We haven't declared yet on 30,000 barrel barges for next year. We are building ten so far, that’s what we have announced. So it's a customer mix and it's fleet driven for us.

John Mims - FBR Capital Markets

Okay. Is there a noticeable difference in average age between the two in your fleet?

David Grzebinski

Yeah. Our 10s are older. I don’t have the exact number here but our 10s are a few year on average older than our 30s.

John Mims - FBR Capital Markets

Okay. Then as a follow up, kind of on the same lines. There has been a few new methanol plants announced that are being built and one of the numbers, I think it was five down the lower Mississippi, and one of the numbers I saw thrown out is, each will be producing about 5,000 metric tons of methanol per day an all of that is going to by barge or by ship. Can you help sort of frame that, if it is 5,000 metric tons per say, what that would potentially mean in terms of barrel capacity, I guess barrel demand? And I would assume those would go in 10,000s right, not 30s.

David Grzebinski

We know of one of our customers who is starting up a plant here at the end of the year and we will be moving methanol for the customer. It's not appropriate for me to talk about who the customer is. But we anticipate getting those volumes. And I am not sure whether they are being moved in 10s or 30s. Yes, probably a little bit of both.

John Mims - FBR Capital Markets

Okay. But then is there a simple, kind of rule of thumb as far as metric tons versus barrels?

David Grzebinski

I am sure there is but I don’t know it off the top of my head.

Joe Pyne

This is Joe. The kind of standard 10,000 barrel barge moves about 15,000 short tons. You can convert to metrics. But you know it's not as easy as that because it's based on where it's going. This is ton-mile business. If it's going up river it takes more barges, if it's just going across cross channel, it takes less. So it's not an easy calculation. You need to understand kind of the dynamics of the market and what customers are servicing and where they are located.

John Mims - FBR Capital Markets

Right. Right. No, I understand that. I mean I know there is a lot of moving parts but we are seeing kind of 2-5 million metric tons of production coming online which seem to be kind of big numbers. So just wanted to try to back into something. But, fair enough. Appreciate the time.

Operator

Our next question comes from Kevin Sterling from BB&T Capital Markets. Please go ahead.

William Horner – BB&T Capital Markets

It's actually William Horner on for Kevin. David, going back to Greg's question on the diesel side for a second, let me ask in a different way. Is the service and reman business, is it accelerating a little slower than you might have thought or are you finding the traction and confidence you are gaining with your customers sort of along the lines you would expect at this point in the cycle.

David Grzebinski

Yes. Well, I guess it never moves as fast as you want it to, right. But if you go back to the last cycle in 2011, there was not much reman at all. I think in 2011 we didn’t do any remanufacturing. It was all new. So I think this is an evolving market and the customers are really starting to get used to reman. Could the pace be better? Yes, I guess it could. But I think the progress we have made from working with just a couple of customers to, I think we are up over 13 different customers now that we are doing reman for. So it is evolving. Perhaps not the pace that you would hope for but it looks like it's headed in the right direction. Right now our volume is picking up more on the new equipment side but we are still new orders every day for reman.

William Horner – BB&T Capital Markets

Okay. That’s helpful, thanks. And then maybe going back to the inland side for a minute. You noted in your last quarter, you thought that your contract coverage might track back down to the 75% range. But it sounds like 80% range is where it's going to stay for the rest of the year. And I know we are too early to talk about 2015 but given your capacity adds and the appetite for the market to absorb this capacity, would you kind of think 80% might be in the more normalized way to look at your contract coverage.

David Grzebinski

Yes, you know it's an interesting dynamic. What happens is you have these term contracts and within their term contract they call for a certain number of barges. But then when they need extra barges, we will take our spot equipment, that would normally work in the spot equipment and put it work for term contract customers. So that’s part of the dynamic you see. You never want to let a good customer go to somebody else for an additional move. As a long way of saying that it could -- as we take deliveries of the 30s, that could come back down a bit but there is a general tendency for it to be closer to 80 right now.

Operator

Our next question comes from Ken Hoexter from Merrill Lynch. Please go ahead.

Ken Hoexter - Bank of America Merrill Lynch

Dave, can you talk a little bit about your thoughts on the inland capacity? I know you are growing to 18 million barrels, up from the 17.3. How is the industry absorption of the fleet, given retirements are seeming to slow as that fleet is clearly younger than what you have to do on the coastwise side.

David Grzebinski

No, we are -- there is a lot of equipment that has been coming in, but it's largely being absorbed or still running 90% to 95% utilization. But as we were talking earlier, you have got methanol plants and other plants that are coming along that are absorbing it, and that’s just starting. So we are quite positive about the growth in demand and being able to absorb the equipment. Also what you are seeing -- we have pulled the shipyards as there is only about 125 units being built in the shipyards next year which is down from closer to 250 to 300 this last year.

So, again, we think that’s about bonus depreciation rolling off. So we still demand increasing. Little less building because the incentives are a little lower for some of our competitors. So I think again the dynamic is, supply-demand dynamic is still pretty positive.

Ken Hoexter - Bank of America Merrill Lynch

So, I guess two parts. Are you still see then that 3% to 5% rate, kind of as you look forward and then to that same point, you haven't placed your 30,000 barrel order yet or maybe haven't publicized it. Could that be that the same thing is going on with your competitors that they haven't either announced it or is that what the yards have smarted our already (indiscernible) they just haven't ordered them yet?

David Grzebinski

It's hard to speak for them, who knows. But we still continue to think 3% to 5% the right price increase range going forward.

Ken Hoexter - Bank of America Merrill Lynch

Okay. Helpful. On the coastwise side, you talked about the absorption of capacity and industry deliveries and you said you are at low 20s in terms of margins but not yet at 12% returns. What level do you need pricing to get your margins to before you are at those reinvestible rates and where does this business settle in? Does it get above the inland margin side?

David Grzebinski

Yes, it has the potential to get there. Yet, it takes a while for that new coastal capacity to get in. I mean you heard our new announced capacity here, some of it doesn’t get into the market until 2017. So if price increases continue in that high single-digit, we certainly could see margins in the coastal business actually get up into the high 20% range. But we will see. We are as you mentioned, around 20% margins now. Pricing is probably, to get to that newbuild pricing is probably 15% to 25% below where it used to be but it's increasing.

Operator

Our next question comes from John Barnes from RBC Capital Markets. Please go ahead.

John Barnes - RBC Capital Markets

Two things. Number one. Dave, your comment about the 47 kind of sub-200,000 barrel coastal barges that are out there that are 30 years old and older. Can you comment maybe to the owners of those barges and how many of those owners do you view as having the financial wherewithal to replace them or is that where your opportunity lies?

David Grzebinski

Well, first, we never underestimate the willingness of banks to lend. So some of them have the wherewithal to build and we are seeing some building. I don’t know, you can see the shipyard contracts that have been let, besides our barges there is approximately ten other newbuilds being announced. So there is some building that’s coming on but just remember, it takes several years for it to get into the market and we still have that aged fleet there. So I am not sure I am answering your question. I think the banks will continue to lend and there will continue to be new equipment built. It is needed and that’s the primary driver. So pricing will continue to improve, to drive that new building. But I think it's got -- given 47 units that need to come out in the next five or so years, it's got to happen.

Now just to comment on older capacity. Every shipyard will get a chance to make a decision whether to extend that life and in a weak market you wouldn’t extend the life and in a very strong market there sometimes you make decisions to extend it for one more shipyard and sink a little bit more money into it. So that’s a dynamic that plays out in every cycle.

John Barnes - RBC Capital Markets

Okay. All right. That makes sense. I have worked for a couple of banks by the way that don’t lend money. So I could certainly point your competitors to the right ones. The other question I had is, along the same lines, with these vessels that you have ordered and the ones that maybe potentially have to get replaced, what do you think is the percentage of the coastal equipment that will be build under some already negotiated contract like what you have been able to put in place. And are you at all exploring the op of putting coastal vessels in place without those type of agreements so whether right now you are focused entirely on new equipment, having an agreement in place that gives you some visibility.

David Grzebinski

No, when our equipment comes out, it will be under contract. So I guess to rephrase your question, how much of the newbuilds that I just described are on spec or don’t have a contract yet. I am not sure of the exact number but I would think the market is strong enough that it will all be termed up and contracted out by the time it comes out of the shipyards.

John Barnes - RBC Capital Markets

Okay. And then on the inland side. Are you starting to see any of that, is there any increasing of inland capacity coming out with already negotiated contracts as well or is that still a little bit more under the old way where it just kind of shows up in some (indiscernible) contract and some goes into the spot market?

David Grzebinski

Yes, it's more the latter, John, just because it's a sheer number. As we think about it, we don’t, because we have 860 or so barges, the fleet is kind of fungible and you don’t need a contract for your next 30 coming out of the shipyard. You are going to melt them into your fleet and you treat the fleet as a whole and of course we don’t view that there is much risk at all to not putting that equipment to work and in fact we need that equipment. We still routinely turn away customers that are asking of equipment.

Operator

Our next question comes from David Beard from Iberia. Please go ahead.

David Beard – Iberia Capital Partners

Just a little bit of a follow-up on the capacity additions. Looking at your deliveries this year and high 60s and 30s scheduled next year. In the average age you are getting down to the point where your fleet seems to be at a pretty comfortable average age. Would you expect to reach that point next year or should we think that’s a 2016 event?

David Grzebinski

No, we are always -- your fleet has a variety of ages, we think in terms of an average age because it's easy to quote a number, right. But there are a range, we have a group of barges that is zero to five years old. Some that are five to ten and it goes all the way up incremental five. We have got buckets of them. So there is always some fleet replacement that needs to happen or fleet retirement that needs to happen in any given year. So it's not just, do we get to one number. We tend to build for the retirements that we anticipate coming in. Right now, we are building more than our retirements need. So we are expanding capacity. So that’s a little different. In expanding your capacity, your average is going to come down because you are just going to have more new barges.

David Beard – Iberia Capital Partners

Right. And then just to switch over to the coastal market. Can you talk a little bit about where peak margins maybe and could we or should we use the (indiscernible) numbers relative to peak margins or do you think you have changed the equipment and the operations such that they may be different in this cycle.

David Grzebinski

You know KC's peak margins, we have already passed. Under the Kirby model we are able to leverage our cost a little better, we have got our admin cost on our shore side, our share between our inland and our coastwise business. So that helps margins. But also, we are -- KC worked kind of the lower end of the market sometimes and we are working for the major customers where there is -- you get paid for your custody of their product and we work hard to meet their service needs. So we are getting an improvement above where KC got it, in just in the normal cycle. I think where could peak margins go, that’s a hard thing for us to say. But clearly we see margins continuing to evolve and move upward over the next several years.

Operator

Our next question comes from Nicholas Bender from Wunderlich Securities. Please go ahead.

Nicholas Bender - Wunderlich Securities

Kind of following up on the coastal margin discussion. I think it goes back to a comment that Joe has said on one of these calls a couple of years back. Sort of thinking that coastal margin might have been more like a load of mid-20% type range. Is there anything that’s sort of fundamentally changed that has improved your outlook there or is it just, sort of as you run the business for a couple of years and with conditions improving in coastal that that’s changed that profile a little bit.

David Grzebinski

Well, yes. We have certainly consolidated into our general marine business which allows us to get more leverage. So that is -- our thinking has evolved there and the potential that that can provide has evolved. But I think given where cost to build a new ATB and tug unit, you know pricing has to be higher in order to justify the returns. So that implies that you are going to have to have higher margins. Now, is it substantially than last cycles, I am not sure. But clearly, we believe that margins should be able to get into those high 20s.

Joe Pyne

David, let me just add to that, this is Joe. When we talked about low 20% margins, those are sustainable margins. What happens in this business is that you price as an objective to new construction rates and as you do that, the prices rise for your existing fleet. So you can get periods on your existing fleet where margins actually are higher. But over the long run, what is the sustainable margin? And the sustainable margin theoretically is what the margin is for the return that you are looking for. I don’t if that helps.

Nicholas Bender - Wunderlich Securities

No, that's great, Joe. That’s very helpful. Just one quick one, sort of following up on all the capacity discussion that’s going on. Can you give us a little commentary on the coastal side what the order book looks there? Obviously, you have got some longer lead times, 18 to 24 month kind of timeframes. And if we think about your guys potentially adding more capacity, would you expect to do it in sort of the -- in the near term timeframe or if you announce some additional capacity would it be on the longer term, sort of time horizon like you have announced with some deliveries dates out in 2016-2017.

David Grzebinski

Let me talk a little bit about the order book. You know we have got our four barges that we are building, which are primary larger, right. 185 and 155s, two each. But we have tracked that, I think there is ten other orders out there and five of them are -- well, seven of the ten are 100,000 barrels or less. So there is some capacity being built but it's a little bit smaller than what we are building. Well, we will see if there is more there. And in terms of our plans to add additional capacity, we were evaluating that. We are not ready to clear anything at this time.

Nicholas Bender - Wunderlich Securities

Sure. That’s fair enough. That’s helpful, Dave. Talking about some (indiscernible) in the past, just between or around synergies rather, between inland and coastal customers and the ability to sort of drive some incremental value there. Where are you in that process? Is there anymore juice that’s ought to be wrung out of that at all?

David Grzebinski

We are very far along in that. Right now most of our major customers, we do both inland and coastwise moves, so I don’t want to say there is no juice left to squeeze there, that sound negative because those are the big customers. Those are the ones you want to work with. They are the ones that are going to have the incremental volumes as crude and condensate continues to play out, as refinery capacity grows, as chemical capacity grows. Those are the guys you want to be with. In terms of the synergy, maybe there is no juice there, but in terms of where you want to be in the juice that comes from the major customers, well, that’s still in front of us.

Nicholas Bender - Wunderlich Securities

Right. No, that makes sense. Switching over to DES real quick. Obviously, again not getting to caught up in sort of quarter-to-quarter variance in maybe the OEM sort of market. But is the long-term objective still is to have a business model that’s something along the lines of sort of two-thirds remanufacturing and maybe a third OEM. Is that right?

David Grzebinski

Yes. And in the remanufacturing, we put parts, other service and remanufacturing. You are exactly right. We would target and are targeting to get about two-thirds in that service, spare parts and remanufacturing area, which is a little less volatile, right. That’s why we are targeting it, plus it's higher margins.

Nicholas Bender - Wunderlich Securities

Yes, yes, absolutely. And then the last one. Again, we sort of covered the ground on M&A on the marine side, but any thoughts on M&A on the DES side and in the land-based market that seems to be improving a little bit or growth initiatives really of any type, I suppose.

David Grzebinski

You know we are always looking at it and you may see us do a small tuck-in regional add in our diesel business. But on the land side of the diesel business, acquisitions, I think we have got -- our platform is still getting right and growing, and we have gotten lot of opportunity there. So I am not sure an acquisition would make sense right there in that space. But you may see us do small tuck-in, regional type engine service acquisitions. But they are, as I say, small.

Operator

We have no further questions at this time

Sterling Adlakha

We appreciate your interest in Kirby Corporation and for participating in our call. If you have additional questions or comments, you can reach me directly at 713-435-1101. Thank you and have a nice day.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, you may now disconnect.

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