Orion Marine Group, Inc. (ORN) is a provider of marine construction services on, over and under the water along the Gulf Coast, the Atlantic Seaboard, the West Coast of the United States as well as Canada and the Caribbean Basin. The company currently trades for about $212 million relative to book value of $238 million ($205 million tangible), average operating income for the past two years of $32.3 million. It has zero debt and $35 million in cash and equivalents. Moreover, it has generated average ROE and ROIC of 15% over the last six years while growing revenues at 18% CAGR from 2004 to the end of fiscal 2010.
Growing revenues and respectable returns over a business cycle that encompasses a peak and (hopefully) a trough would normally indicate a business that should be trading at a P/B of at least 1. Perhaps the following chart provides an explanation:
As we see here, revenues have declined quite dramatically since 3Q 2010. However, only the two most recent quarters showed YoY declines (of a whopping 18.6% and 45.4%, respectively). As revenue declined, margins took a deep cut as well, with the company ending in the red for the last two quarters. What gives?
According to the company, revenues have been in a freefall because its biggest customer (28% of revenues), the Army Corps of Engineers, has been limited in extending new contracts due to the US federal budget shenanigans of 2011. In their Q2 2011 press release, the company stated the following (emphasis added):
We came into 2011 fully expecting continued pricing pressure in marine construction as a result of the economic uncertainty. However, we did not foresee the gross inaction of Congress, which has made it impossible for agencies like the Army Corps of Engineers to effectively carry out their mandate of maintaining our nation’s waterways. This inaction has resulted in a gap in Army Corps of Engineers lettings, which has extended longer than we anticipated and significantly pressured margins and revenue during the quarter. We expected to start seeing federal bid opportunities for projects involving dredging services begin to be let in June. However, while Congress approved a 2011 Army Corps of Engineers budget in April, continued debt ceiling deliberations in Congress further exacerbated the gap in Corps lettings. The unprecedented dysfunction of the US Government has affected funding of long-term infrastructure projects that are greatly needed.
These pressures continued in Q3 2011 (emphasis added):
Funding inaction by the federal government has continued through the end of the third quarter. As a result, the Army Corps of Engineers, US Department of Transportation, and all other federal government entities are operating under a short-term continuing resolution until mid November. This type of inaction led to a slow pace of project lettings by the Corps for the majority of 2011, which resulted in underutilized equipment, reaching the lowest levels of the year during the third quarter.
In January, the company updated its investors with mixed news (emphasis added):
On the federal side, the Company was pleased to see a full year budget for the Army Corps of Engineers passed late in the fourth quarter after operating on several continuing resolutions since the beginning of the federal fiscal year on October 1st. The 2012 Army Corps of Engineers budget totaled $5.0 billion, representing a 3.0% increase from 2011. The Army Corps of Engineers also received an additional $1.7 billion in emergency funding to repair levee damage caused by last spring’s flooding along the Mississippi River. Although the 2012 funding bill has passed, the Company has not yet seen any increased letting activity to date by the Army Corps of Engineers. The Company believes that it will benefit from the expanded Corps budget beginning in the latter half of 2012 as lettings and awards are expected to return to their historic norms.
And therein lies the rub. The company has an extremely high level of exposure to government contracts and unlike for many companies where customer concentration is a theoretical risk, we see real effects here, with revenues plummeting through no fault of the company. So even though management seems to be quite competent and the company has a solid balance sheet, an investment in ORN is really a bet that the various levels of government will both have the financial capacity (in the case of its State and local government contracts) and the political will to continue funding projects which ORN can successfully bid on.
Perhaps the darkest period has now passed, since the Army Corps of Engineers now has a full year budget. This should help the company return to profitability and a recovery of its share price, but the key here is that an investor must ask himself whether he wants to be invested in a company with this kind of exposure. I do not. Even though the company seems cheap, if we expect revenues to recover to a more normal level, the ongoing risk of its exposure is too great, especially when considering the fixed nature of the company’s cost structure (note the lock step decline in the company’s margins as revenues collapsed).
One more thing to note. Despite the severe deterioration in performance, in January the company decided to award its President and CEO a grant of 248,000 options “supplemental to his equity award” of 166,667 restricted shares in August. I am not a fan of this, even though the deterioration was somewhat out of his hands. It is bad manners to award an extra $1 million of compensation (which will be worth significantly more in the future as the share price recovers as revenues normalize) when the shares are down by more than a third in six months.
What do you think of ORN?