Kirby Looking At A Rising Tide Of Volume

| About: Kirby Corporation (KEX)
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Unless you live near a major river or coastal waterway, you may not give much thought to barges as a means of bulk transport, but it's a significant carriage option for agricultural and petrochemical products. With roughly 30% of the inland tank barge market and more than 20% of the coastal market, Kirby (NYSE:KEX) not only has uncommonly high share, but is in a good position to benefit from the ongoing growth in U.S. oil and gas production, as well as the billions of dollars of new petrochemical capacity coming online. While these shares are seldom cheap, waiting for a significant pullback can be a frustrating exercise.

A Sheltered Industry With Growing Demand

Kirby sits in a pretty sweet spot. As efficient and cost-effective as rail carriage can be, barge transport is even more efficient (about 40% relative to rails), and it is a significant option for a variety of raw and refined oil and petrochemical products. Through operational success and a series of acquisitions, Kirby has built itself into the leading provider of tank barge services, with roughly 30% share in the inland barge market (against around 10% for American Commercial Lines) and more than 20% share in the coastal market, ahead of Vane Brothers in the high teens.

Not only would it take upwards of $7 billion simply to replace the tank barge capacity that Kirby operates, the government helps shelter this industry from competition. For point-to-point transport between U.S. ports in U.S. waters, the Jones Act requires that the vessels by made in the U.S., registered under the U.S. flag, manned by predominately U.S. crews, and owned 75% or more by U.S. citizens. That not only short-circuits foreign competition, but it also keeps the costs of entering the business higher, as U.S. shipyards are expensive relative to most overseas options.

While the Jones Act adds to the cost of moving cargo, it fits into that bucket of "it is what it is", as there doesn't appear to be much momentum to overturn or significantly modify the law (and there is a waiver/exemption process). To that end, companies like Valero (NYSE:VLO), Exxon Mobil (NYSE:XOM), and Dow (DOW) have little choice but to turn to companies like Kirby to move chemicals and refinery products. In an example recently cited by Valero management, high tariff costs for a Shell (RDS) pipeline in Houston make it relatively economical to ship by barge from Houston to St. James, Louisiana and the production growth of oil and gas continues to outpace pipeline capacity growth - leading to a bottleneck that is profitable for companies like Kirby.

The one thing that Kirby cannot control, though, is hydrology. A year ago, the talk was of severe droughts leading to low water levels along the Mississippi, threatening a significant part of the company's inland barge business (70% of the company's marine revenue). Earlier this year, though, the opposite problem occurred - water levels were so high that some locks had to be closed. These problems come and go and it's just part of doing business for Kirby, though the faster growth in the coastal business does offset it to a slight extent.

Will Fracking Rebound In 2014?

Barge transport has long been the primary source of revenue for Kirby, and almost certainly will continue to be so, but Kirby's diesel engine business is a significant factor in the overall operations. This business is focused around the servicing/overhaul and manufacturing of medium and high-speed diesel engines.

While this business serves customers in the marine, industrial, railroad, and power gen markets, fracking has become a significant part of the business. Fracking rigs are most often powered by diesel engines, and Kirby has seen demand for its overhaul services rise and fall with fracking activity. To that end, revenue was down almost 18% in the second quarter (with operating earnings down more than 40%) on weaker fracking activity, though service companies like Baker Hughes (BHI) and Halliburton (NYSE:HAL) have been sounding incrementally more positive on fracking market conditions in 2014.

More Capacity, More Demand … More Earnings For Kirby?

A lot has changed in the U.S. energy and petrochemical industries just in the past decade or so. The exploitation of unconventional reservoirs has led to a significant increase in oil production, and the prospects for natural gas production have risen to a point where there is active discussion as to whether the U.S. can/should export surplus gas. With that, petrochemical companies have stepped up their plans in a big way, with billions of dollars in new plant capacity expecting to come online over the next few years.

Shipping of petrochemical products has also changed. Although pipelines have historically been the preferred option, the development of the Bakken region has led to a surge in rail transport of crude.

All of this works in Kirby's favor. While rail transport is a new competitive option for Kirby's clients, barges are still meaningfully cheaper. At the bottom line, then, more oil and gas production and more petrochemical/refined product production is a net gain to demand for Kirby's services. At the same time, the barge fleet is aging (close to 10% of the inland barge fleet is 40+ years old) and Kirby is one of the relatively few operators with the financial resources and scale to stay in the game for the long term.

Certainly there are risks. If the economy declines again, so too will demand for petrochemical products and Kirby's services. What's more, the U.S. waterway infrastructure is aging, and there seems to be little enthusiasm for a significant program of renovation. Last and not least, while it would take a lot of cash to replicate Kirby's fleet, barge transport is basically a commodity service and a sustained period of high rates will lead to capacity expansion/investment and a higher probably of downward pressure on rates.

The Bottom Line

Kirby is enjoying both good capacity utilization and strength in both coastal and inland rates. Add in the high pipeline tariffs and increasing supply of petrochemical outputs that need shipment, and it is not hard to be bullish on Kirby's prospects.

The only real catch is valuation. Kirby is already above its five-year mean EV/EBITDA of 7x, and even with the improving growth prospects it is challenging to argue that Kirby deserves a double-digit forward premium (though the forward EV/EBITDA ratio has gone as high as 12x in the recent past). On the other hand, the recent sale of Hornbeck's (NYSE:HOS) tank barge business at $260/bbl would suggest $4.5 billion in value just for Kirby's tank barge capacity (excluding the diesel business, the tugs, and any value assigned to the company's know-how/management skill).

With that, I'd be in no hurry to sell these shares today. Buying today requires a little more price insensitivity than I typically prefer, but investors aren't going to get very many chances to buy Kirby on a pullback, so waiting for a substantially cheaper price may be a long wait.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.