Small Cap Value Idea: Conrad Industries (CNRD)

Executive Summary
Conrad Industries, Inc. (CNRD) is a small-cap shipbuilder engaged in the construction and repair of steel and aluminum marine vessels for commercial and governmental customers in the United States. These vessels include tugboats, ferries, liftboats, barges, aluminum crew/supply vessels and other offshore support vessels. Conrad was founded in 1948 and based in Morgan City, Louisiana.

At $10/share, the current market capitalization is $64 million and the enterprise value is $29 million. EBITDA for the trailing twelve months (TTM) was $18.4 million. That gives an EBITDA/EV yield of 64%! Net income for the TTM was $9.8 million, which gives a P/E (ex-cash) of 3x! Net current assets are ~$7 per share.

Description of Business
Conrad operates four shipyards: one in Morgan City, Louisiana, two in Amelia, Louisiana and one in Orange, Texas.

The company constructs various offshore barges, including tank, container, and deck barges for commercial customers, and yard barges for the U.S. Navy; inland barges, including deck and tank barges; lift boats to support construction and ongoing operation of offshore oil and gas production platforms; tug boats; offshore support vessels; ferries; aluminum crew/supply vessels to transport crews to offshore facilities; aluminum fire/patrol vessels for governments to fight fires and patrol rivers; and drydocks to lift marine vessels from the water. It also does conversion projects involving the lengthening of vessels and other modifications to increase the capacity or functionality of a vessel. The company’s marine repair activities include shot blasting, painting, electrical system and piping repairs, and propeller and shaft reconditioning.

For the nine months ended September 30, 2010 the new construction segment accounted for 63.4% of total revenue and the repair and conversion segment accounted for 36.6% of total revenue. They received approximately 11.7% of their total revenue from customers in the oil and gas industry, 10.9% from government customers and 77.4% from other commercial customers.

Valuation
At $10/share, the current market capitalization is $64 million and the enterprise value is $29 million. EBITDA for the trailing twelve months (TTM) was $18.4 million. That gives an EBITDA/EV yield of 64%! Net income for the TTM was $9.8 million, which gives a P/E (ex-cash) of 3x!

Here is a share price valuation matrix for a set of EBITDA assumptions (left column) and EV/EBITDA multiples (top row).

	1x	2x	3x	4x	5x	6x
10,000	$7.34	$8.90	$10.45	$12.00	$13.56	$15.11
15,000	$8.12	$10.45	$12.78	$15.11	$17.44	$19.77
20,000	$8.90	$12.00	$15.11	$18.22	$21.32	$24.43
25,000	$9.67	$13.56	$17.44	$21.32	$25.20	$29.09
30,000	$10.45	$15.11	$19.77	$24.43	$29.09	$33.74
35,000	$11.23	$16.66	$22.10	$27.53	$32.97	$38.40

Annual EBITDAs in 2009, 2008, and 2007 were $23, $40, and $33.4 million, respectively. For simplicity, I am going to take the average of the current TTM plus these three preceding years' EBITDA, which gives a four-year average EBITDA of $29 million.

Using the four-year average EBITDA of $29 million and a 4.5x multiple, you get a share price of $26, which is 2.6x the current price. The company's backlog has grown over 50% year-over-year, so it seems reasonable to use an EBITDA figure that is higher than the trailing twelve months.

However, you need both a seriously bombed-out EBITDA and multiple assumption to come up with a valuation downside to the current price. That indicates a very high margin of safety.

Discount to Tangible Book Value; Current Asset Coverage
The company trades at 80% of tangible book value. There is over $7/sh in net current assets, which provides a nice valuation backstop.

During the past nine years, the company has made $41.8 million of capital expenditures to add capacity and improve the efficiency of its shipyards. If you take that figure plus the net current assets, you get $13.86 per share.

Protection from Foreign Competition: The Jones Act
The Merchant Marine Act of 1920 regulates maritime commerce in U.S. waters and between U.S. ports. The MMA has a section known as the Jones Act that deals with cabotage (coastal shipping), which requires that all goods transported by water between U.S. ports be carried in U.S.-flag ships, constructed in the United States, owned by U.S. citizens, and crewed by U.S. citizens and U.S. permanent residents.

This is ridiculous, protectionist legislation, but it has been around a long time and it is not very likely to change. The U.S. would be without a shipbuilding industry without the Jones Act, which would be a national security and employment problem. 

Catalysts
Everyone asks what is the catalyst for the Conrad long, as though a company whose stock is up 50% in the past six months (but still cheap!) is suffering for lack of a catalyst. Having said that, there are several catalysts:

The company is buying back shares. In August 2010, the board authorized the company to repurchase up to $5 million of common stock, and they purchased 38,075 shares during Q3 2010 at an average price of $7. I will be interested to see the annual report, and find out how many shares were repurchased during Q4. The stock was under $9 for all of October, so they had the chance to make some attractive purchases. A company that trades for less than 1.5x EBITDA and is buying back stock will quickly take itself private.

The Conrad family (J. Parker Conrad, John P. Conrad, Jr. and Katherine Conrad Court) own or control 2,963,463 shares of common stock (46.0% of the outstanding shares), and members of their immediate families own approximately 297,654 additional shares, which together total more than 50.6% of the outstanding shares.

Since the family and management own more than half of the company already, I could see them taking it private. In fact, the company would make a great leveraged buyout target. If I had a few hundred million dollars, I would feel pretty comfortable doing a tender offer at $15. 

As of the most recent quarterly report, the backlog had gotten much larger: "Our backlog was $86.1 million at September 30, 2010, $38.3 million at December 31, 2009 and $56.1 million at September 30, 2009." This implies that there will be an increase in EBITDA, which could be a positive "surprise" and therefore a catalyst.

Disadvantages
The key disadvantages are the small size (<$100MM market capitalization), pink sheet status, and small public float due to the sizable percentage owned by the family and management.

There's always an "ick" factor in value investing. If these disadvantages are the only problems with Conrad, then I think there is more than enough compensation for the ick factor. If the company had a billion dollar market capitalization, it would not be this cheap.

I actually kind of like pink sheet investing. You have to pay attention to the order book, and buying is sort of like buying an actual piece of a business from a human instead of a robot.