Sunday, June 21, 2015

Conrad Industries, And a Shipyard As a "Toll Booth"

I wrote a post on Conrad Industries almost three years ago called Decomposing Conrad's Return on Equity. The share price was about $12 (!) when I wrote the post, so I think both the pick and the analysis in the post were solid.

Looking back on it, I have some further thoughts on the Conrad business model and how they are able to earn money. One thing I wanted to add regarding the Conrad repair business, which has been very cyclical; not only revenue cycles but cyclicality of profit margin as well.

Any marine vessel needs constant repair over its lifetime. Saltwater and steel have a very uneasy peace. Actually, saltwater inevitably wins given enough time.

That means boats need regular maintenance. A key concept is the "survey" - ships are periodically examined, problems and corrosion are found, repairs are needed.

A shipyard is a "toll booth" on marine activity. Every second in saltwater and every turn of the screws accumulates damage to the vessel that the shipyard industry will need to fix if the beneficial uses of vessels are to continue.

There will be revenue, but will there be profit? And how much, and by whom will it be earned?

Now imagine you own a working vessel in the Gulf of Mexico. Maybe an offshore supply vessel. When you need repair, you look at the list of Gulf coast shipyards, of which there are a finite number. Only some of them will specialize in your type of vessel and work, only some of them will be available at the time you need service, etc.

The shipyards are also spread across the Gulf coast, some closer to where your vessel is (and will need to be) than others. You will also undoubtedly perceive a quality tradeoff: how long will it take a given yard to complete the work, and with what likelihood that it will fail or need to be repeated?

Thus, shipyard repair work is not a commodity like bushels of corn. There are tradeoffs between distance (which means time, which means money) and cost of work, and quality (which means time, which means money) and cost of work.

When the vessel market is tight and your ship rents for $50,000 per day, you're going to be less price sensitive regarding repair work. That's good for Conrad margins. Lots of work and lots of price-insensitive customers. No wonder that when their repair segment is good, it's really good.

We also know that when repair work is weak, Conrad's repair segment is really weak. Think of a soft vessel market. (Like right now in 2015, unfortunately, because of oil prices.) You forgo less revenue by moving your ship around for cheaper repairs. Also, with ships sitting idle you have some options to postpone maintenance. You have alternatives (which help your repair negotiating position), and you need to tighten your belt because of the soft market.

Think of all the whipsaws in the energy business since 2007. There have been three busts actually! In 2009, in 2010 (post-spill) and now! It actually speaks highly of them that they have been continuously profitable and have continuously built shareholder value over that time period.

However, it is hard to get a clear picture of Conrad's sustainable earning power. What if the tank barges never come back and GoM oil exploration is underwhelming since it's higher cost than the onshore shale basins? Seems like revenue and profit could fall quite a bit.

If you recall, the board was planning to spend a hefty $27 million on capital expenditure in 2015, and also to build larger ships like an LNG bunker barge. Rising capex and more difficulty getting business would explain why the all time high for the stock was more than a year ago.


John said...

This bust can be different from the previous ones:

CP said...

No need to be coy, what are you getting at?

James said...

I looked at Conrad in 2010 and passed. While it's undeniably been a successful investment since then, it actually illustrates one of the reasons why I almost never buy stocks. The company earned $16.70 from 2010-14, but it only paid out $5 in dividends in the same period. Including buybacks, the company distributed ~42% of its earnings to shareholders. Conrad has earned a lot, but relatively little of that has reached shareholders' pockets.

I get that they want to invest in growth capex, etc., but the already had a large net cash balance in 2010. They could have distributed 80-90% of their earnings and still spent money on growth projects. Management probably doesn't care whether or not they pay timely dividends because they would control the cash either way.

Am I being overly conservative? Maybe. A lot of companies have awful capital allocation-- they hoard cash, or they dilute shareholders with giveaway options grants, or they make awful acquisitions-- and the market rarely penalizes them for it. So the fact that a company doesn't pay prompt dividends doesn't mean it won't be a profitable investment. CNRD certainly has been profitable. But I still don't want to invest in companies like that.

GlennC said...

How much of Conrad's profits can be attributed to cyclicality in Jones Act shipping and other macro factors (e.g. huge boom in shale drilling)? I feel like they are in a commodity business. I've no idea if they are the lower or higher-cost operator.