Wednesday, March 28, 2012

Valuation Thoughts About 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, and other offshore support vessels.

At $15/share, the current market capitalization is $92 million and the enterprise value is $57 million (assuming $35 million in excess working capital). For 2011, EBITDA was $33.6 million. That gives an EBITDA/EV yield of about 60%! Net income for the TTM was $19.2 million, which gives a P/E (ex-cash) of 3x! Net current assets are ~$9.27 per share and book value is $15.50 per share.

Here is a share price valuation matrix for a set of EBITDA assumptions (left column) and EV/EBITDA multiples (top row). Again, this assumes that there is $35 million in excess working capital.

2.0 2.5 3.0 3.5 4.0 4.5
20,000 $11.65 $13.20 $14.75 $16.31 $17.86 $19.41
22,500 $12.42 $14.17 $15.92 $17.67 $19.41 $21.16
25,000 $13.20 $15.14 $17.08 $19.02 $20.97 $22.91
27,500 $13.98 $16.11 $18.25 $20.38 $22.52 $24.65
30,000 $14.75 $17.08 $19.41 $21.74 $24.07 $26.40
32,500 $15.53 $18.05 $20.58 $23.10 $25.62 $28.15

Annual EBITDAs in 2011, 2010, 2009, 2008, and 2007 were $34, $20, $23, $40, and $33.4 million, respectively. Using the five-year average EBITDA of $30 million and a 4x multiple, give you a share price of $24, which is 60% higher than the current price. 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.

Jones Act
Be sure to read our post from a while back about the Jones Act. This is a federal law which essentially guarantees the continued existence of a U.S. shipbuilding industry by requiring 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 wholly by U.S. citizens.

Agricultural interests and industries that depend on shipping oppose it because is obviously raises the cost of shipping their goods. Given that it essentially pits populous coastal states against sparsely-populated farming states, the smart money would continue to bet on the Jones Act. People criticize the Jones Act for its protectionism, but the truth is, there is something wrong with economic theories about trade if the result of free trade is having your country hollowed out. Also, if petroleum becomes more expensive, the transport system will be shift to more efficient forms of transportation: from truck to trains and from trains to barges.

Everyone asks what is the catalyst for the Conrad long, as though a company whose stock is up almost 100% over the past two years (but still cheap!) is suffering for lack of a catalyst. Having said that, the ongoing catalyst is that the company is buying back shares. They bought back a total of $3.6 million in stock in 2011, which is equal to 3.9% of the end of year market capitalization. During the fourth quarter of 2011, they purchased 157,444 shares at an average price of $15 per share. A company that trades for less than 2x EBITDA and is buying back stock will quickly take itself private. Since the family and management own more than half of the company already, I could see them taking it private.

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.

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