May 24, 2011
Conrad Industries, Inc. (“CNRD” or “The Company”) is a micro cap., with a market cap. of ~$82mn and an enterprise value of $50.6mn, which provides new construction (66.5% of revenues) and repair services (33.5%) for tugboats, ferries, lifeboats, barges, offshore supply vessels and other specialty vessels for commercial and government markets at its four shipyards and its six drydocks located in S. Louisiana and Texas. J. Parker Conrad, Co-Chairman, founded the Company in 1948. All revenues occur in U.S. and Puerto Rico.
CNRD went public in June 1998, and on March 30, 2005, voluntarily delisted stock due to the high costs of public listing, a limited shareholder base, and other distractions associated with being a publicly listed company. It began trading on the Pink Sheets, and subsequently institutional coverage went away as did most liquidity for shares of the Company.
I originally identified CNRD while performing an EV/EBITDA multiple and other FCF yield screens for companies in December 2009 when I was seeking cheap stocks that had flown under the radar. Conrad’s market cap. was ~$40mn and shares traded at ~1.3x 2009 EV/EBITDA. Since then share price +83%, going from $7 per share to $12.80 per share. Earnings power, backlog and book value have continued to build. With each passing quarter has retained its huge discount to its intrinsic value.
Target Price & Valuation;
Asset Value Based Valuation: At $12.80, Conrad’s enterprise value is $50.6mn (market cap $82mn, cash $34.0mn, debt $2.6mn). Current assets less current liabilities is $56.9mn and a book value is $83.6mn. CNRD is trading at slight discount to its current account liquidation value and its enterprise value is priced well below its book value. In other words, this is a classic net-net.
As Conrad’s liquidation value is $12.51 per share and its current enterprise value is $7.90, or a huge discount to liquidation value the street is probably assessing some unwarranted discount due to illiquidity and family control. However, by any traditional investment valuation method Conrad is remarkably cheap and would truly be a Benjamin Graham sweetheart.
To find Conrad’s liquidation value use a 50% recovery on inventory and other current assets as goods have little value to non shipbuilders. Haircut land value and buildings, office value by 25% for transaction fees and taxes in the event of an asset sale. Net PPE after adjustments close to reproduction value as a competitor can reproduce this current infrastructure at a comparable reproduction cost. Off-balance sheet adjustments include 20% of Conrad’s profits ($3.9mn) based on recurring relationships and another $4.8mn, or a 5 year average of SG&A, to account for R&D, expertise and employee training.
Conrad Adjusted Asset Valuation (As of3/31/2011)
Cash & ST Investments: $34.0 mn
Receivables: $49.0 mn
Inventory: $1.1 mn (50.0%) $0.5 mn
Other Current Assets: $3.7 mn (50.0%) $1.8 mn
Total Current Assets: $87.7 mn Adjusted: $85.4 mn
Land: $5.2 mn (25.0%) $3.9 mn (shipyards, 97 acres)
Buildings: $34.2 mn (25.0%) $25.7 mn (230k Sq. Ft. Book value at $149/sq. foot)
Equipment: $20.1 mn (30 Overhead cranes, 7 rolling cranes)
Drydocks: $11.5 mn (5,050 ft.of steel bulk head,5 slips)
Barges & Boats: $1.7 mn
Gross PPE: $72.7 mn, Adjusted PPE $62.9 mn
Accum. Depreciation: ($35.5 mn)
Total Net PPE: $37.3 mn Adjusted: $27.4 mn
Customer Relationships: $3.9 mn
Cost to Create Workforce, Build Expertise $4.8 mn (1x5 year average SG&A)
Total Off Balance Sheet: $8.7 mn
Total Assets: $125.0 mn Adjusted: $121.4 mn
Total Debt: $2.6 mn
Other Liabilities: $38.8 m
Total Liabilities: $41.4 mn
Total Adjusted Net Asset Value (NAV): $80.1 mn, $12.51 Per Share
Earnings Power/Cash Flow Valuation: Built detailed propriety earnings model to find Conrad’s earnings power based on the Company’s historical operating margins and management guidance. I believe 7.0x 2011 P/E is justifiable given Conrad’s historical average P/E multiple of around 7.0x, the barriers to entry of U.S. Jones Act shipbuilding, and conservative estimates of internal U.S. trade demand growth. Accordingly, 5.0x forward EV/EBITDA justifiable given Conrad’s historical forward multiple of 5.0x EBITDA and strong backlog visibility. Below market average forward multiples makes sense to me as this is a competitive business with undifferentiated products. Despite these competitive dynamics, Conrad’s ROIC(1) over the past three year has been 14.3%.
By using 7.0x 2011 earnings of $19.4 million and 5.0x 2011 EBITDA of $33.4 million, Conrad’s earnings power offers a blended (50/50) earnings power target price of $26.75, or a >120% margin of safety. Furthermore, due to strong transparency and a large backlog this earnings power is highly predictable.
Footnotes: (1) ROIC = Tax Effected EBIT / Total Capital – Non-interest paying liabilities.
Comparables: No pure comparables as most U.S. Jones Act shipbuilder competitors, remain privately held, and/or are part of larger ship operators such as Kirby Corporation (KEX). Other publicly traded U.S. shipbuilders such as Gunderson, is part of The Greenbrier Companies and Trinity U.S. Inland Barge, is part of Trinity Industries, two larger publicly traded transportation conglomerates.
However, In January 2011, Todd Shipyards Corporation (TOD), a clean comparable acquired by Vigor Industrial for $98.1 million. Valued TOD at 3.8x LTM EV/EBITDA and 9.3x LTM EPS. Using average of multiples on 2011 results leads to $23.18 target price.
Building Backlog/Long Term Visibility: Backlog declined from $80.9mn in 2007 to $38.3mn in 2009. As of 3/31/11, backlog was $112.3mn. On 3/29/11, released 2010 annual report disclosing additional $75.2 million of NEW BUSINESS subsequent to 2010. Since reporting surprise robust Q1 2011 orders, CNRD’s market cap. has declined by $5mn. Using Conrad’s 5 year historical net income margin of 8.9%, the $75mn revenue surprise will lead to an additional $6.7mn of earnings, meaning “Mr. Market” is attributing less than 0x this new earnings surprise. At Conrad’s 2008 EBITDA margin, 2011 EBITDA would hit nearly $50mn.
Industry Wide Inflection Point: In February 2011 tonnage of all commodities moved on internal U.S. Waterways, was the highest in five years. However, tank barges that operate on the inland waterways of the U.S. declined from 4,200 in 1982 to 2,900 in 2002. Levels increased from 2002 to 3,100 by 2011. Risk of oversupply is mitigated by mature fleet with approx. 850 tank barges over 30 years old. Average age of a tank barge is 20 years old, with only 28% built in the last ten years. The economic collapse also helped consolidate excess supply with bankruptcies at Bender Shipbuilding and Trico Marine Services, Inc.
Diversified Strategy: Transitioned away from cyclical oil/gas industry into more diversified product and customer mix. Decline in new construction for Gulf of Mexico oil/gas, offset by securing work from other commercial customers and government sources. In terms of business mix in 2010, 75.5% of revenues came from commercial, 14.1% of revenues came from government, and only 10.4%
revenues came from energy. Strong support for long term viability with or without Gulf of Mexico oil drilling.
Expanding Margins: Main cost is steel and CNRD is building steel escalation clauses into contracts. Vessel construction gross margins hit peak in 2008 at 20.1%. Since 2008, experienced pricing pressure and gross margins declined to 11.6%. Expects margins to be similar to 2010 levels. Even if gross margins flat vs. 2010, Conrad will make significant gains from strong volumes booked. Conrad’s labor costs are 20-30% lower than unionized competition as most of its employees are hourly labor and non-unionized.
Owner Operator Mentality: J. Parker Conrad, age 95, founded Conrad Industries and served as Chairmen since inception in 1948. Since March, 1998, J. Parker has been Co-Chairmen of the Board with son John P. Conrad Jr., age 68, whom has been at the Conrad since 1962. Conrad’s own 49.1% of outstanding common stock. Shareholders are partnering with Conrad family and the Conrad’s continue to make prudent long term investment decisions in the best interests of its shareholder’s over the past seven decades.
Shareholder Friendly: In 2008, Conrad bought $9.4mn shares back. August 2010, approved $5mn share buyback, representing ~15% of CNRD’s total market cap. at the time. Conrad building earnings power which will be distributed over a diminishing share base.
Pristine Balance Sheet: Conrad’s debt totaled $2.6mn, with cash of $34.0mn on March 31, 2011. Untapped $10mn revolver with JPMorgan expires April 2012 at interest rate of ~2.2%.
Barriers to Entry: Jones Act (1920) requires all goods transported by water between U.S. ports be carried on ships constructed in the U.S., and owned and crewed by U.S. citizens. Barrier eliminates foreign competition whom can build ships at nearly ½ the price. Protectionist legislation in place ~100 years and not likely to change. The U.S. shipbuilding industry will probably not draw new entrants as the current industry enjoys measly margins, unexciting growth, and an ugly, boring business model.
Competitive Market Lacking a Moat: Shipbuilding and repair is extremely competitive on price.
Small size and limited liquidity: Avg. volume of 5,237 shares or ~$73,000 per day. Only 3 – 3.5mn shares freely tradable.
Shareholder Restrictions: Company bylaws limit outside influence and make a potential buy-out more challenging. The stockholder’s rights plan will expire on May 13, 2012, unless redeemed or exchanged at an earlier date.
Mississippi River Floods: Rising water levels may impair business this spring, took precautions to safeguard.
Exposed to Gulf of Mexico: The Department of Interior lifted a moratorium on deepwater drilling on October 12, 2010. Lifting the ban on drilling, however, really did not take away the long-term uncertainty.
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