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It has taken a little longer than I expected, but Kirby (NYSE:KEX) is finally seeing operating conditions in its core inland barge business improve to a meaningful extent. A strong economy and limited new barge capacity should make for a much more profitable operating environment for at least the next two or three years, while the long-suffering Distribution & Services business benefits from increased power generation, trucking, and energy sector demand.
These shares are up about 12% since my last update, beating both the S&P 500 and the Dow Jones Transportation Index over that time – neither of which are great proxies for this company, but you have to take what you can get sometimes. With the stock off sharply since the announcement of an agreement to supply barges for an offshore wind project, this seems like a good time to revisit the name.
An Ill Wind Following A New Revenue Opportunity
Kirby shares are down almost 15% since the late March announcement that the company had reached a long-term framework agreement with Maersk Supply Service, a unit of A.P. Møller – Mærsk A/S (OTCPK:AMKBY), that includes supplying coastal barging services for the construction of offshore wind turbines as part of Maersk’s contract for the Empire Offshore Wind project.
The selloff is interesting to me, given that this isn’t exactly a shot out of the blue – management has indicated on multiple occasions that offshore wind power construction was a market that they were looking at as a long-term opportunity. That said, I think I can come up with a couple of reasons why the market has reacted this way.
First, the company won’t be using its existing fleet to handle this new business. Instead, the company will be spending $80M to $100M on two new feeder barges and tugboats. While the project won’t begin until 2025/2026 and the payments for the new equipment won’t begin until 2023, $90M isn’t a trivial amount for Kirby, particularly given that part of the bull story here has been a downward trend in capital spending.
Second, while the Empire Offshore Wind project is just the first project in what the companies described as a 20-year framework agreement, I believe some investors may be looking at the generally poor historical results of companies that supply offshore energy installations (whether via helicopters or boats) and extrapolating that weak performance history.
I’d reference some of those companies here, but most of the ones I’m familiar with went bankrupt over the years, though Bristow (VTOL) does have a current market cap close to $1B. So I can see why some investors may question the long-term value of this contract even though the nature of the anticipated work is different.
I might be tempted to say that investors should trust management and trust that the contract provides adequate compensation and safeguards, but I’m not going to do that. Honestly, the track record of ROIC here isn’t that good, and the company has in my opinion been too aggressive with expansion (M&A or new-builds) in the past. Likewise, the acquisition of Stewart & Stevenson (which added exposure to onshore energy equipment) has not created value for shareholders. So while I will say that the reaction here seems outsized (a $600M decline in market cap), I can understand the concerns at least to a point.
Meanwhile, Back At The Base Business…
Investor concern over the Maersk deal shouldn’t outweigh a meaningful improvement in the company’s inland barge business, an improvement that I believe will set the stage for at least two or three years of meaningfully better results.
Inland
The Chemical Activity Barometer is in expansion now, with the economic recovery driving strong demand for all manner of chemical products. Moreover, not only is existing capacity being utilized, but new growth/expansion projects are coming online. At the same time, refinery capacity is over 90% (92.5% most recently).
So on one hand of the ledger we have increasing chemical and refined product output, as well as demand for oil and other inputs. On the other side of the ledger, the last downturn in the inland barge industry (as well as high scrap demand/prices) sent a lot of barges to the scrapyard and there isn’t much new capacity coming anytime soon.
That’s a positive mix for Kirby, and barge rates are inflecting up. Management talked about mid-to-high-80%s inland barge utilization in the fourth quarter of 2021, and that should be even higher in the first quarter and throughout 2022. Contracts were already renewing at prices up 10% year over year, with spot prices up high single-digits year over year and mid-single-digits quarter over quarter, as based on some digging around I’ve done, it sounds as though prices are up another 7% to 8% on a qoq basis (and up over 20% yoy).
Kirby won’t see all of the benefit all at once, as about two-thirds of the business is on long-term contracts and contracts roll over and renew at different times, but I think 2022/2023 should allow Kirby to reprice most of its business at attractive levels.
Higher barge utilization and improving prices will do a lot of good for margins, particularly given that the company will see waning negative impacts from the pandemic (including having to hire-in transportation to compensate for sick crews). Mid-teens margins seem like a solid bet for FY’22, with 20%+ margins in 2023 for this business.
Coastal
The coastal business isn’t nearly so strong, even though utilization was at 90% in the fourth quarter, but management has been rightsizing the fleet and exiting less profitable businesses. This is not going to be a major near-term positive driver, but the company will still benefit from better performance.
Distribution & Services
Revenue in the DES segment was up over 26% in the fourth quarter and the business posted another modestly profitable quarter (reversing a year-ago loss), and I believe this segment, too, should see improving results.
Strong demand for trucking is leading to demand for maintenance and overhaul, while strong demand in the HVAC sector is helping the company’s Thermo King distribution business. Kirby is also seeing a pickup in energy industry activity. While producers have been cautious about committing to expanding production despite high energy prices, drilling activity is picking up and that is helping demand for the fracking-related business of DES. Last and not least, increased industrial activity is driving improved demand for power generation services.
The Outlook
Unless the economy rolls over and goes into outright recession within the next 18 months or so, I think Kirby is going to enjoy a solid run of improved performance on the basis of strengthening demand for barge capacity and limited industry supply growth (as well as significant operating leverage from utilization/pricing).
I’m looking for more than 22% revenue growth in FY’22, followed by 13% growth in FY’23 and high single-digit growth in FY’24. On a long-term basis, I’m looking for over 6% revenue growth from the FY’21 starting point or about 3.5% growth from the pre-pandemic starting point. Were the company to really commit to offshore wind as a new market, there could be upside to the revenue numbers, but I’m not sure what the margins on that revenue would look like.
As is, I’m expecting EBITDA margins to approach 17% in FY’23 and expand further in FY’24. I’m not looking for massive long-term FCF margin expansion, as my long-term averaged outlook is only about 130bp above the long-term trailing average, but I do expect FCF margins to reach the low double-digits again in FY’25 and help drive mid-single-digit FCF growth.
What management will do with that cash flow is an important question, particularly as it pertains to future capex plans. Capex intensity has always been elevated here and I would like to see some of that cash flow through to shareholders.
The Bottom Line
Between discounted cash flow and margin/return-driven EV/EBITDA, I believe these shares are undervalued below $70 and priced for a long-term annualized total return in the high single-digits. That’s admittedly not a lot of undervaluation, but I would note that the shares have traded above, and sometimes well above, “fair” EBITDA multiples in the past when the cycle really got going and there could still be upside to my margin estimates.
All in all, I still think Kirby is a somewhat off-the-radar stock worth watching, particularly with this recent sell-off. While capital allocation / capital spending is a definite watch item, I think the turnaround in inland barge operating conditions (and Kirby’s future profitability) isn’t fully reflected in today’s price.
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