World Fuel Services (INT) strikes again, announcing more bolt-on deals to further expand its business. Given the anticipated accretion and the company's strong track record with regards to value-creating dealmaking, I think that investors should be pleased with the latest announcements.
After factoring in the anticipated synergies, World Fuel trades at merely 13-14 times earnings, despite the growing operations and its track record.
One explaining factor for the relative low multiple is the nature of the business, as World Fuel faces some potential tail risks. The financing business and extensive usage of derivatives could potentially result in credit losses or a rogue trader. It should be stressed that these potential concerns have never been real issues in the past.
These concerns and potential worries about long term demand for oil and related products, depress the valuation multiples attached to the business. Despite these concerns, I think that the valuation is very compelling given the underlying quality of the business and the growth. For that reason, I continue to like the company as an investment, even after the decent returns seen so far this year.
A Quick Intro To World Fuel Services
World Fuel Services is a service provider as the name suggests. The company essentially takes care of all the energy and oil handling procedures of its clients. This includes all the steps to make sure that the right fuel is available at the right location and the right time. Services provided include procurement, distribution, financing, and consulting, among other services.
The company operates in a unconsolidated but global market, with its activities subdivided in three segments: marine, land and aviation. The aviation segment is the largest business, responsible for $11.7 billion of the $30.4 billion in annual sales in 2015. Both the marine and land business posted sales of around $9.3 billion that year. While annual sales were down sharply compared to the $43.4 billion revenue number for 2014, this decline does not tell you a lot about the health of the business. The fall in revenues is entirely the result of lower oil prices, while volume growth has been very health in 2015.
Actual gross margins increased from $814 million in 2014 to $860 million in 2015. While this looks like a decent number, this amounts to just $0.05 per gallon being handled by World Fuel each year. Given the collapse in energy prices, gross margins did expand from just 1.9% of sales in 2014 to 2.7% last year. In actual dollar terms, the margins are remarkably stable.
The land segment is actually the most profitable business with margins of 3.3%, followed by 3.0% margins for the aviation segment. The marine segment saw a decline in margins to just 2.0% as that industry is facing some real challenges amidst the slower pace of global growth.
The full range of services provided to customers include financing as referred to before. Investors might be scared to see that the company provides a lot of credit to energy related players in such a volatile environment. The good news is that the accounts receivable portfolio stood at just $1.8 billion by the end of 2015. This just shows how many inventory turns World Fuel Services makes each year, indicating that these "loans" are very short term in terms of their nature. Thanks to diligent management, credit losses totaled just a few million dollars in recent years, including the volatile 2015.
A Great Growth Story
As referred to before, World Fuel's topline results can be very volatile. While this might be true, the company has delivered on real growth over the past decade. Sales totaled just $11 billion in 2016, at a time when oil prices were not particularly low.
Revenues peaked at $43 billion in 2014, and now come in closer to $25 billion a year, resulting from the plunge in oil prices. That is not necessarily a bad thing as the actual gross profits per gallon tend to be quite stable in actual dollar terms.
Growth has been driven by the company's role as a consolidator in this fragmented industry. The company made numerous deals in recent years but has been quite active in 2016 as well.
In February, World Fuel announced a $260 million deal to buy aviation fueling operations from Exxon Mobil. With the deal, the company obtained 86 aviation locations across the globe. Few financial details regarding the operations were revealed. Management did indicate that non-GAAP earnings should increase by $0.32 to $0.36 per share as a result of the deal. That is suggest an after-tax profit contribution of nearly $25 million, suggesting that the company bought the operations at an appealing multiple.
This deal was followed by the recent announcement to acquire US land distributors PAPCO and Associated Petroleum Products in a combined $230 million deal. These businesses report combined revenues of $1.6 billion and are expected to boost earnings by $0.22 to $0.26 per share going forwards.
The Pro-Forma Business
The company released its first quarter results in April of this year. Continued profitability and a reduction in working capital, following the decline in oil prices, has boosted cash flow generation.
This means that the company ended the quarter with $690 million in cash, while debt amounted to $805 million. The net debt load of $105 million was very modest following multiple deals being announced in recent years. Following the closure of the Exxon deal as well as the latest bolt-on acquisitions, net debt is seen around $600 million going forwards.
First quarter revenues fell to merely $5.2 billion amidst a further decline in oil prices, but that number does not tell a lot given that volumes were up by 6%. Operating profits fell to $63 million following an increase in operating expenses. Net earnings came in at $52 million as a result of a very low tax rate during the quarter, although World Fuel's effective tax rate is generally quite low.
Note that the company suffered from difficult operating conditions in the marine business, as well as the impact of a warm winter. Another headwind was the fact that energy prices were very low in the first quarter, resulting in the fact that some clients did no longer hedge their exposures. Given the recent rally in oil prices, hedging activity could pick up again.
If we simply multiply the first quarter numbers by four, operating profits come in at $250 million a year, with net earnings approaching $210 million. Buybacks have reduced the outstanding share base to 70 million shares, translating into earnings of $3 per share. With the combined non-GAAP accretion from the Exxon, as well as the PAPCO and APP deal seen at $0.58 per share, GAAP earnings could improve towards $3.50 per share.
With shares currently trading at $47, that results in a mere 13-14 times earnings multiple. The current operating profits of $250 million could likely increase towards $300 million following the recent dealmaking, as run-rate D&A charges could approach $100 million. That suggests that EBITDA could improve to $400 million a year, for a 1.5 times leverage ratio. Given the non-cash amortization charges impacting GAAP earnings, and the very modest dividend yield, World Fuel Services has the capacity to deleverage rather quickly.
A Great Business, Worth Owning, Recognize The Tail Risks
What is not to like about a business which has increased the size of its operations by a factor of 5 times over the past decade?
With dilution of the shareholder base amounting to just 20%, real growth has been achieved on a per share basis while the balance sheet has remained very healthy.
A 1.5 times leverage ratio is very manageable and a 13-14 times earnings multiple seems very interesting. The trouble is the risks which the company might face, although they have not manifested yet. Competitors have at times been plagued by credit losses or rogue traders, both issues with potential devastating effects. That said, the business has managed its credit in a very good way historically.
The other challenge is of course a potential shift away from fossil fuels to alternatives. While the company can easily play a role in bio-based fuels, it will see a real challenge if oil volumes will lose long term market share to non-fluid based alternatives. That said, the company is pro-active with regards to change. It recently hired experts in order to built a team to investigate the opportunities regarding LNG demand.
While the company certainly faces long term challenges, it has been able to overcome these issues. Organic growth and dealmaking has created a lot of value, overshadowing any potential doubts which investors might have in the long run. The very appealing valuation and track record outweigh the potential longer term concerns in my book, making me still upbeat on the prospects for the firm.
Disclosure: I am/we are long INT.
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.