Gulf Island Fabrication: The Turnaround Continues
Summary
- Gulf Island Fabrication has sold the majority of its shipyard division.
- The company is booking the transaction at a loss, but is getting rid of the unprofitable backlog.
- Gulf Island will have about $60 million in cash after settling working capital requirements.
- The remaining Fabrication division has higher margins and active bids for major project work.
- Gulf Island still has problems to solve, but management is making the right moves and showing they are serious about turning the company around.
Gulf Island Fabrication (NASDAQ:GIFI) is a company in transition. When I last wrote about them they had hired a new CEO, consolidated divisions, and adjusted their go-forward strategy. GIFI took another step forward this week by announcing the sale of the majority of their shipyard assets and contract backlog. On the surface this might not look like great news; the company is booking over $20 million in asset impairment losses, lowering revenue estimates, and only breaking even from a cash perspective. On the other hand, the sale gets them out from under a shipyard backlog that was unprofitable, frees up resources to focus on their fabrication division, and will dramatically improve the company's profitability metrics. GIFI still has problems to solve, but this asset sale makes me much more bullish on the company's future.
The Sale Fixes GIFI's Largest Problem
Prior to 2016, GIFI's primary business had been fabricating offshore drilling and production platforms and other specialized structures. At the end of 2015, the offshore oil and gas industry was in rough shape. Oil prices dropped more than 60% from June 2014 to Jan 2016, aided in part by the growth in US domestic onshore oil production. GIFI had some experience repairing marine vessels for customers operating in the Gulf of Mexico, so in early 2016 management decided to acquire the assets of LEEVAC Shipyards to diversify their business away from the offshore oil and gas market. This move was a disaster; over the last five years GIFI has struggled to maintain their shipyard workforce, made costly engineering errors, and built up a substantial backlog of work billed below cost. The company has lost tens of millions of dollars in assets write-downs and impairment charges; in 2020 alone the shipyard division posted a $24 million operating loss against $150 million in revenue.
In recent years GIFI has sold or closed the majority of their shipyards and fabrication facilities, consolidated their service and fabrication divisions, adjusted their operating strategy, and hired a new CEO in an attempt to turn things around. There were some green shoots in 2020; the fabrication division managed to eek out $1.9 million in adjusted EBITDA in Q4 of 2020. Despite improvements in the fabrication division, the shipyard backlog was an overwhelming drag on the company's performance.
GIFI took a large step forward on April 19th by selling the majority of their shipyard assets and contract backlog to Bollinger Shipyards for ~$28.6M. Management has committed to winding down the remainder of their shipyard backlog by mid-2022. The terms of the deal aren't particularly exciting; the company is booking over $20 million in write-down losses and is only breaking even from a cash perspective once working-capital liabilities are taken into account. The full details can be found here. Despite the impairment loss, the transaction is a step in the right direction towards transforming the business and will improve operating performance in both the short and long term. Looking at the company's pro-forma financial statements, GIFI would have reduced operating losses by over $10 million had this sale happened at the start of 2020:
(Source: Company 8-K)
What remains of the company's shipyard division is still losing money and won't be gone until at least 2022, but taking a $20 million non-cash loss to save $10 million a year in operating losses looks like a great return on investment to me. We won't know GIFI's exact Q1 cash balance until we get Q1 results in a few weeks, but working through the acquisition announcement I estimate GIFI will have around $60 million in cash and short-term investments against total liabilities of $55 million. I expect GIFI to report operating losses into 2022, and the $20 million impairment loss on the shipyard sale is going to make Q2 numbers look even more awful than usual. The balance sheet remains rock solid and the company has the potential to return to profitability within a couple of years.
GIFI is an Appealing Investment Without the Shipyard Division
The investment thesis for GIFI is twofold. From a balance sheet perspective, GIFI is cheap. After accounting for the sale of the shipyard assets, the company is trading at about half of book value, which includes $60 million in cash on the balance sheet and the Lake Charles and Jennings shipyards that they retained in the deal. Even if GIFI is unable to win any additional significant fabrication work and the post-shipyard company operates at break-even EBITDA, I think it is reasonable to assume that the gap will close between the company's market cap and its book value. If GIFI is able to take advantage of increased oil and gas activity and win some major contracts in 2021 and 2022, there is room for significant revenue growth and a return to profitability. Management has stated that they need about $150 million in fabrication revenue to reach positive net income; a few major deals should be able to clear that hurdle and make GIFI attractive from an earnings and cash flow point of view. Management has mentioned multiple active bids that have the potential to close in the back half of 2021. GIFI has a much longer history in the fabrication than they did in shipbuilding, so I expect them to make profitable bids and be able to deliver projects on time with a high degree of quality.
For GIFI to be an appealing investment, the company needs to improve its operating business enough to merit a re-rating of their multiples. Pro-forma, GIFI would have burned about $11 million in normalized cash flow in 2020. If we extrapolate that loss out over 2021 and the first half of 2022, which is when the shipyard division should be completely wound down, I estimate about a $17 million drop in book value. Very roughly, then their 2022 book value would be $83 million. If GIFI can close the gap between their market cap and their book value, the share price would rise 25% from current levels. That is an improvement, but 25% over two years isn't a good enough outcome to get me excited about an investment. I would treat this gap more as a 25% margin of safety and look to the company to win some major fabrication contracts. If they do, and if the company can return to the 5% net margins, they were posting in the late 2000s, I could see GIFI becoming an appealing earnings play. As an optimistic but still reasonable scenario, consider GIFI reaching $200 million in 2023 fabrication revenue at a net margin of 5%, giving them $10 million in net income. A PE of 20 might be too much to assume, but even a PE of 15 results in a market cap of $150 million and a compound annual return of 32% a year for today's investors. A positive outcome like this isn't a sure thing, but with strong downside protection from GIFI's balance sheet, the investment becomes "a heads I win big, tails I don't lose much" scenario that I am comfortable investing in.
Conclusion
At a high level, GIFI's sale of shipyard assets makes it a better business with better prospects. The company is trading 50% above its 52-week low, but the recent runup underestimates the value of the asset sale. GIFI isn't a great business, but it is trading too cheaply given its upside potential and downside protection. I am happy to own GIFI at today's price and expect the market to re-evaluate and re-rate the company in my favor over the next 2-3 years.
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Analyst’s Disclosure: I am/we are long GIFI. 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.
This article should not be taken as financial advice, it is only an expression of my own opinions as an individual investor
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5/19: 10,000 shares purchased at $4.51All purchases appear to be direct purchases made by the President and CEO.
