Kirby Corporation (NYSE:KEX)
JPMorgan Aviation, Transportation & Defense Conference Call
March 15, 2012 11:10 am ET
Joseph H. Pyne – Chairman and Chief Executive Officer
David W. Grzebinski – Executive Vice President and Chief Financial Officer
Okay, we’re going to kick off the next presentation this morning. With us today, we’ve got Joe Pyne, who is the CEO, and also Chairman of Board of Kirby Corporation.
And with that, we’re going to hand it straight over to Joe.
Joseph H. Pyne
Okay, good morning. Kirby is in two operating businesses. We’re in the marine transportation business, and the diesel engine service business. About 65% of our business, marine transportation and 35% diesel engine services. I’m going to come back and drill down to both these businesses a little later in this presentation. Just some market facts about Kirby.
We have a market cap of a little over $3.8 billion, enterprise value a little better than $4.5 billion. We’re the largest, both inland and coastal tank barge operator. On the coastal size, we’re measuring that market at barges 185,000 barrels of capacity or less.
Size does matter in this business. We think that we enjoy some economies of scale that smaller operators don’t enjoy. But 75% of the inland transportation revenues are on contracts a year or longer. In the coastal side of the business, about 60% of that revenue is under contract. A time charter is where a customer takes a tow on a daily basis in the inland side of the business. But 55% of the business is time charters, and the coastal business traditionally has a much higher portion of their business under time charters.
In the diesel engine service side, a national footprint. We work on really all the engines that are used in the marine environment. With respect to the oil service side, we also manufacture oil service equipment. That’s in our Company, United Holdings, and again, I’ll come back and comment on United a little later.
Kirby is the aggregation of a number of acquisitions, 45 different acquisitions. I think we’re pretty good at that. This looks at the acquisitions that we’ve made in the marine transportation area. Many of these you’re not going to recognize because they’re independents. The shippers are in red, and the ones that stand out will be Dow Chemical, SeaRiver is Exxon Mobil, that kind of fleet.
And then on the diesel engine side, 16 acquisitions. The last was by far the largest, and that was United Holdings. And again I’ll come back to that. We’ve enjoyed strong revenue growth since 1988, over 16.5% a year. Earnings per share about 15% a year that does not include our 2012 projection, either.
On the marine transportation side, this is our operating area, the inland waterway system is in yellow and in red. And then the coastal areas are shaded in blue, but let me just focus on the inland business for a minute. 12,000 miles of navigable waterways in the inland system, really does open the center of the country to other markets, domestically and to global markets as well.
On the coastal side, this is a new area for us; we inherited this when we bought K-Sea Transportation mid last year. That service area is the three coasts, as well as Hawaii and Alaska.
Just some facts on the industry, again to calibrate everybody. Both in inland and coastal operator on the inland side, there is 3,100 tank barges in the business. A much larger dry cargo sector, we’re not in that sector for a host of reasons. We like the ability to add value in the liquid area. We have about 26%, 27% of this market.
On the coastal side, as we have defined the market, which is 185,000 barrels or less, about 275 barges in total in that market that we have a little better than 20% of that market. No foreign competition, the Jones Act protects this business, no real economic obsolescence. It’s not something that you lose sleep over, because somebody is going to come up with a new way of doing something. You can move this equipment as the market changes. Very important part of the U.S. domestic economy, and also an environmentally friendly way of moving cargo around.
Looking at the drivers, this looks at total marine transportation revenue. If you just were to look at inland revenue, about 70% of inland revenue is in the petrochemical area. The drivers in the petrochemical area of course consumer non-durables and durables. But because 70% is in the non-durable area, it really gets pulled around last by the economy, believe it or not, because so much of this goes into the things that we use everyday.
Durables are more tied to the economy, housing, automobiles, that kind of thing. We move black oil, and you can see the drivers there. Refined products is principally transportation, fuel, that’s the driver, and then agricultural chemicals moved by the farm economy.
Safety matters in this business because we’re a liquid operator and because who we work for. So we see this as an important part of our service, and we’re recognized as the leader in our business in this area.
Drill down to the inland tank barge business. This looks at the industry population of barges. I think it’s worthy to note that, our last peak pricing, peak utilization was kind of end of 2007, beginning of 2008, that was when we were producing about 1.5 million homes, had a car manufacturing run rate of over 16 million units, and unemployment substantially lower than it is today.
We added barges through the recession, because the order book mandated that, so we kind of went into 2010, 2011 with 3,100 barges. Yet today, we’re kind of back at peak pricing, peak utilization levels. And guess the point I’m going to make here is that, that there been other things that happened in our business, despite the weakness in housing and despite the higher unemployment, and the – the really the non-sustainable level of cars being produced that have propelled the tank barge business really to full utilization.
A lot of that has to do with energy, low natural gas prices as it applies to the U.S. petrochemical business. And liquids that come out of shale formations principally in South Texas.
This looks at the age profile of the fleet. We still have quite a lot of replacement to do. We’ve said in the last several months is that we’re not particularly worried about any over building occurring in this business, partly because of the volume growth, but also because of the age profile of the fleet.
Bigger is better, I mentioned that at the beginning of the presentation. The reason that size matters is that, the bigger you are, the more cargos you control, the more you can put back-haul opportunities together. The more power you have in the system, the more flexibility you have to move cargos around, the better positioned you are for cargos.
With respect to our tow boat fleet, we both are an owner and a charter of tow boats. About 30% of our tow boats are chartered, so we can size that power quotient, which is about 80% of the cost in this business-to-business levels. And we can maintain very high utilization rates on our power, which allows us to control costs a lot better than many of the others in the business.
This looks at who’s in the business. Kirby is the largest, then it drops down to number of medium-size companies. The shippers are in red. We think that consolidation is going to continue in this business, and we plan to play a role in that.
Looking at the coastal business, this is primarily a refined products driven market. Our fleet consists of about 3.8 million barrels of capacity. There are 59 barges, 56 are double-skin barges, and the fleet age is relatively young compared to other fleets.
The markets are really the coastal markets of the U.S. including Alaska and Hawaii. We think this business is improving, utilization continues to get better. We think as capacity is removed from the market, which is going to be mandated by just the single skin issue. All single skins have to be out of the market by the end of 2014. And as demand returns, this business will balance, and it’s going to do just fine.
What we’ve again said is that, this isn’t the next-quarter story. This is a several year story. But as we look at the dynamics in this business and the fundamentals that drive it, we’re still very comfortable that this is going to be a good business. This looks at who is in the business, again, a lot of kind of independent companies. There are some public companies, Hornbeck Offshore and OSG are the ones that come to immediate mind, but the rest are private family-owned entities.
Moving to the diesel engine business, this is our traditional -- well, no, this is the business in its entirety, 70% of it is land-based, which is principally focused on the oil service business, a little over 20% marine, and a little less than 10% power generation. With respect to the engines that we work on, they’re really the engines that are used in marine applications and oil service applications. And you’ll recognize most of them.
Looking at the land-based side of the business, this is driven most recently by the exploration of oil and gas in shale formations. The advent of hydraulic fracking technology, particularly as it’s used in horizontal wells has revolutionized the business. One of the components of United is assembling, manufacturing oilfield equipment for this business.
What appealed to us about United wasn’t so much the assembly portion of it, but it was the access to a number of engines that have been used in this application, a market that has really quadrupled last four or five years and not really had a very careful overhaul remand process for through for this population of engines. And we think that our legacy diesel engine business, which is in that business, they’re in the business of repairing engines and reduction gears and transmissions, but that model can be moved to the land-based engine business. And we’re in the process of doing that.
This looks at the shale plays in the United States. There are a number of them. Some are more liquid-rich, and some are dryer. What you’re seeing is a migration although given the price of natural gas, from gas plays to a more oil rich plays. And then for those of you that aren’t familiar with hydraulic fracking, this is just a wonderful diagram that kind of shows you how it works.
You’re drilling a horizontal well. You’re perforating it, and then you’re using these high pressure pumps to pump water, sand and some other things into the fractures to allow you to recover the gas and oil.
Going on to the outlook, our first quarter guidance is $0.86 to $0.93 that’s compared to $0.60 the year before. Marine transportation, the assumption is that we’re going to stay at utilization levels that were similar to where they were as we ended the year. And with respect to the diesel engine business, the assumption is that we’re going to have strong demand for oil service equipment and that we’ll see a modest recovery in our heritage diesel engine business. For the year, our guidance is $3.85 to $4.05 per share which it compares to a $3.33 per share number for 2011.
I do want to use this opportunity to comment on the frac business, and particularly our part in it. There’s been a lot of noise in the last, I would say, two to three months about this business, concern that margins in the field are going to decline, that customers are pulling back on their capital plans for 2012. And that the environment for this business is going to be more difficult. We are seeing some of this translate into United’s business in the area of customers wanting to kind of push out their orders into 2013.
Now, I don’t want to be either too negative or positive about this because I think some of this is to be expected, uncertainty, I think causes people to pull back and reflect. And certainly the uncertainty of the low natural gas prices has caused some concern in this area. What we’re seeing though is a transition from principally an industry that was focused on recovering gas to an industry that is looking for oil and there’s an enormous incentive to find oil at these price levels.
I think that we just need to give it some time to work its way out, we’re not particularly concerned about it. I think part of the markets concern is that they really view what’s happening through a historical prism where when the oil service business collapse, collapses, it collapses, because the energy businesses has collapsed. That’s not happening here, what’s happening is there isn’t the incentive to find natural gas, there isn’t incentive to find crude oil, and you’re just seeing a natural rotation from natural gas to crude oil.
Now with respect to Kirby’s guidance, our guidance actually did project some deterioration in our United business, but it didn’t project maybe some strengths in other parts of our business, our heritage diesel engine business is doing quite well, our inland tank barge business is doing well, K-Sea is performing about as expected.
So as we look at the year, what we expect to see in United is maybe some reduction in demand for new equipment. We think that there will be an increased demand for remand equipment and in fact we think that is pause is probably good for the remanufacturing side, which is the side that we, frankly bought the Company for, because it’s providing some breathing room to free up some of this equipment to bring in and repair.
As I look at this year guidance, this $3.85 to $4.05 guidance, I don’t see any reason to change our views on it. I think that the range is still pretty secure, so we’re kind of reconfirming that the $3.85 to $4.05 number is still a pretty good number for us.
I am now going to turn the presentation over to David for the financial side.
David W. Grzebinsk
Good morning. I’ll just spend a couple of minutes on some of the financial highlights. This is last year versus year before, 2011 versus 2010. I know it’s behind you and you’re more focused on forward-looking stuff, but I just want to point out a couple of numbers on this because it puts in context the transactions that we had last year.
If you look at marine transportation revenues we were up 31%, operating income was up 36%. The revenues were up because of the strength in the inland barge business, pricing and utilization were up. But we also have the – some impact from K-Sea. K-Sea rolled in June, excuse me July 1 of last year, so that helped 2011 marine transportation revenues.
On diesel engine services side, you’ll see it’s up 200 plus percent and that really reflects the United acquisition. I’ll spend a few minutes on margins, the yellow line are marine transportation segment margins, the red line is the diesel engine services margins. Just a couple of points on the yellow line.
You see the last economic downturn of substance troughed for Kirby in 2003, we were about 15% operating margins. This last economic cycle was pretty sharp, it was more of a V rather than a bathtub kind of form, and you’ll see that our margins troughed around 21%. We did have a quarter where we did below 20%.
Now moving into 2011, we have K-Sea therein, K-Sea is in a little different business cycle than the inland marine segment and their operating margins were kind of in the mid-single digits last year. So they depressed our overall margin here. Without K-Sea, the inland margins would have been in the mid-20% range. So the point of this is that higher lows and higher highs, all things being equal, with K-Sea in, it’s dampening the margin a little bit because of where they are in the cycle.
Now, with K-Sea, things seem to be improving. They were in – supply and demand was a little stressed. There was a little too much capacity built in advance of the single-skin phase-out in the coast-wise business. And then the refined products market demand is down, given the economic weakness and the unemployment situation. So – but we’re seeing some – that stabilize, and there are signs that things are moving in the right direction.
On the diesel engine services side, you’ll see fairly stable margins. You’ll see back in the ‘06, ‘07, ‘08 range, they were higher mid-teens, that was when the Gulf of Mexico was active. Of course, that’s – with Macondo, it’s been down a bit. We are seeing some signs of resurgence there, but it’s still early days. And the other thing that’s happening with the margins is, in 2011, you have United, which are just slightly lower than our traditional margins. So there’s a mix effect happening with the margins.
All things said – all things equal, we would hope to get and expect to get these margins for the diesel engine business in the mid-teens over time, particularly as we migrate the service and grow the service side of United.
This is just to give you a feel of the cash flow generation capability of the company. This is EBITDA per share. The next slide I think shows it a little better. The green bars on this slide are the cash from operations. The yellow bars are capital expenditures. The point of the slide is the green bars are always above the yellow bars.
The last two years, we’ve had – well, excuse me, 2011 and what we’re forecasting for 2012, pretty heavy capital spending cycle. We’ve been replacing our fleet and renewing it. The average age of the Kirby fleet in the last three to five years has gone from about 24 years down to just under 17 years in the inland space. That cycle, that replacement cycle, is about over now and you should see CapEx coming back down into a more normal range in 2013, which implies a pretty healthy free cash flow starting in 2013.
We’ve used our free cash to do acquisitions, and when we do acquisitions, we tend to use our balance sheet. And you can see, this is our debt to total cap, that there’s been some bumps up along the road, and those are reflective of acquisitions. You can see that we did five acquisitions last year that took up our debt to total cap.
In the absence of acquisitions, we’ll use our free cash flow to de-lever. But we are hopeful, and the acquisition environment is pretty now and we continue to look at acquisitions and look for consolidation opportunities in both the inland space and the coast-wise space.
This just gives you a feel for our balance sheet. We’re A-minus rating with Standard & Poors, BAAA-3 with Moody’s, pretty good capital structure.
And with that, I’m going to turn it back to Joe.
Joseph H. Pyne
Okay, thank you, David. Just some things to leave you with, and then I think we’ll have some time for questions. A long-term record of success with an experienced management team. The marine transportation business, 75% of it contracts a year or longer, 55% of that time charters. With the coastal business, as that recovers, you’ll see us put more of that business under contract.
Chemicals are the majority of what we move and are very, very stable really even through recessions. A typical recession, the volumes, which is what we concern ourselves with, are down 6% to 8%. Diesel engine business, great model, great service model, started in the marine business. We’ve extended to land-based engines. We think that this is a business that will grow.
Strong financial discipline as we invest our cash flow, and we’ve really made a number of acquisitions in 2011, and think the environment for acquisitions continues to be pretty strong.
So, we will end the presentation and be happy to field some questions.
Joseph H. Pyne
We start in the first row. Yes, sir? Because this is webcast, if you could just use the microphone that would be helpful.
I had a kind of a big-picture question. There’s been a lot of refinery shutdowns on pad one. Is there an opportunity or what are the economics of taking refined products out of Gulf Coast and taking them up the East Coast? Because everybody I speak to says that the refinery economics are fantastic, but we still end up importing from Europe. We’re basically keeping the European refineries afloat by doing that. And I was just wondering – I understand the Jones Act, you can’t park tankers there, but is there any opportunity for the industry or for you guys to do something on that front?
Joseph H. Pyne
Yes. And there have been Jones Act vessels that engaged in that trade for a long time, right now not many, but during other periods a number of them. As you look at that market, the first gallon that is used in the Northeast, Mid-Atlantic is the gallon that’s made there. And you’re right, the refineries are shutting down, so it has to come from someplace.
The second gallon traditionally that’s used comes up the pipeline. The principal pipeline is Colonial. The third gallon was an imported gallon from the Caribbean, from the Canadian Maritimes, and from Europe, but the Europe gallon was more [dump] than – I don’t think they make a lot of money at that, particularly with the bifurcation of Texas intermediate and Brent. It’s even further disadvantaged. And then finally, you had the Jones Act trade.
We think what’s going to happen is more cargos are going to come up the pipeline. There will be cargos that will be moved by marine vessels, Jones Act vessels, from the Gulf Coast to the East Coast, and the balance will be imported. I’m not particularly concerned that the East Coast is going to run out of gasoline. I don’t think that that’s the issue. There are plenty of ways to get it there.
How much we’re going to play in that arena is still unknown. Typically, it’s the larger size vessel that is best used to move cargos from the Gulf Coast to the East Coast. But as cargos get into the New York harbor, and as they come up the pipeline, and as you further close refineries up here, there’s still some that are slated to be closed – you create opportunities for marine vessels. So we think we’re going to see some of those opportunities at K-Sea. So net-net, we think it’s positive.
And if I could just follow up, I mean, a lot of the Caribbean refineries are also getting shutdown or been on the market. (Inaudible) I mean, there is a bunch of – so that doesn’t seem like – but that’s another area where more refining capacity that used to come from the East Coast might get shutdown. I guess my question is what are the economics of, like – [Pedavax] or whatever vessel and take the refined product from Europe and you refine it into the East Coast versus taking one of your vessels up the Coast? What are the cost per gallon, or the metric? I mean, is it very competitive, or somewhat competitive or?
Joseph H. Pyne
Yeah. I hesitate to respond to that because this is webcast again. The question is comparing the competitiveness of a Gulf Coast to East Coast move using a Jones Act tanker versus a foreign flag tanker from Europe. And the reason I hesitate is that the tanker – the foreign flag tanker industry is under great duress, so you’re seeing some very low rates. And I’m not sure I understand the economics of the higher cost of crude as it gets processed in European refineries. I can tell you that there’s less imports from Europe and more cargos that they’re being moved from the Gulf Coast principally by pipeline. I can tell you that.
Just a quick question. Of the coastal fleet, what percentage of it is single hull?
Joseph H. Pyne
It’s about 8% that’s single hull.
You described the transition going on in the diesel servicing business, but those low natural gas prices presumably are tremendous benefit to the petrochemical industry at the same time. And I realize you don’t have much excess capacity, but is it combination of a little more capacity, spot movements, pricing going to be a big plus for you?
Joseph H. Pyne
Well, we think it’s positive. And the fact that the U.S. petrochemical business is globally competitive and it appears based on where you think natural gas is going, that that’s sustainable. That’s, long-term, very positive. The other thing that’s happening that is energy related and a function of shale formations are the liquids that are coming out of these formations. And we are moving of some of that out of South Texas, and we’re beginning to talk to people about moving it out of the Bakken. The Bakken move is railed to a port city and then loaded on a barge, but it’s all positive.
Any other questions?
Just in regard to United, maybe if you could talk about the time to switch from natural gas production to moving it to an oil basin and getting back into production?
Joseph H. Pyne
Well, that – it doesn’t take a lot of time to do it. Those frac spreads will follow the drillers. And as they drill for oil, the only way you’re going to recover it is to frac it, and so the transition can be pretty quick. What United does is it services that equipment, but it also has a manufacturing component, which is principally driven by making these frac spreads. And what we have said really from the beginning is that the manufacturing side of that business isn’t really the side that we’re after.
What we want to do is capture the service part of it. We do that very well on the marine side of our diesel engine business, and we want to take those skill sets and apply them to land-based engines. We’re seeing more of that business, and we think that, over the year, it’s going to continue to grow. Did that answer your question? It did? Okay.
If I can ask a follow-up on the coastal trade, to what extent do you see West Coast through the canal up to the East Coast and Northeast, and is that another opportunity, or is it primarily Gulf Coast?
Joseph H. Pyne
Yeah. The cargos actually would move Gulf Coast out to the West Coast. That’s not a very efficient move, but you do see those cargos move from time to time. Chemicals and, to a lesser extent, some refined products will move out there.
And with gradual economic recovery, would you expect a lot of that supply to no longer be exported necessarily along the Coast, but to satisfy local demand, what is that?
Joseph H. Pyne
Well, I think that the U.S. going forward, it’s going to be not only a net exporter of chemicals, but very likely a net exporter of refined products. The economics of producing refined products are just very good on the Gulf Coast. And I think that only improves as you eliminate the bottleneck at Cushing, which is going to happen with the reversal of the Seaway pipeline. And when we finally do approve the Keystone Pipeline, because that’s more crude oil that can be processed in Gulf Coast refineries, I think it helps the export market. Think it also helps our business, because the more that you make down there, the more opportunity it is for us to touch it.
Okay. With that, we’re out of time. Thank you very much.
Joseph H. Pyne
Okay. Thank you.
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