|Shares Out. (in M):||6||P/E||3.7x||5.1x|
|Market Cap (in $M):||46||P/FCF||3.6x||4.9x|
|Net Debt (in $M):||6||EBIT||19||14|
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Investment Thesis: The shares of CNRD.PK offer micro cap investors a very attractive opportunity to invest in a profitable, healthy cash flow generating, well established cyclical company with a 20% ish ROIC business model selling for a an enterprise value of less than 1x LTM free cash flow and 1.6x my no-growth 2010 EBIT forecast, with about 60% of its market cap covered by net cash and trading at 68% of tangible book value. In addition, there is evidence to suggest that business conditions in the cycle have already bottomed and are improving. I believe such a pick up in business would be a strong catalyst for the stock when it begins to flow through the company's financials. As I have not factored any of this improvement in my no-growth off the trough, lower margin forecasts, this gives investors a free call option on any potential future growth. Note, given the size of the company and the limited float, this investment idea is targeted at more nimble investors.
Company Profile: Based in Morgan City, Louisiana, Conrad Industries specializes in the construction, conversion and repair of marine vessels for customers located around the Gulf of Mexico. The company operates four shipyards, with three in Louisiana and one in Texas. The company's customer base is divided into three categories: oil & gas, government and commercial. While the business is cyclical in nature and there are a number of competitors, the company proudly states that it has been in business for 62 years and has endured many business cycles. A fair amount of additional details are available in the company's quarterly and annual reports.
Current Price: $7.10
Market Capitalization: $45.9M
Enterprise Value: $23.2M
Cash: $27.7M ($4.28 per share)
Debt/Equity Ratio: 7.5%
Tangible Book Value Per Share: $10.39
LTM Revenue: $164.9M
LTM EBITDA: $29.6M
LTM EPS: $2.67
LTM FCF: $29.1M
Shares Out. (FD) - 6.46M
Float - 5.34M
Insider Holdings (%) 53%
Historical P&L and Forecasts: Conrad's historic annual P&L results along with my forecast are illustrated in the following table. The numbers show the cyclical nature of the business. In addition, further volatility in the financial results were caused by a number of additional factors. From the 1999 period when Conrad operated just two facilities and was focused primarily on the Gulf of Mexico oil & gas industry, the company's growth over the next few years was driven by: an expansion in the number of facilities, moving its dry docks to larger facilities, broadening the product mix (including a move into the aluminum vessel business) and diversifying its customer base. These expansion efforts coincided to some degree with the post-9/11 downturn in the economy and weakness in the oil & gas industry during the late 2001 thru 2004 period. Beginning in late 2005 and lasting through 2008, the combination of improved economic conditions, higher oil & gas prices and the impact of hurricanes Katrina, Rita, Gustav and Ike combined to create an unusually strong lift to both demand and pricing. The business turned down with the economy and weakness in the oil & gas industry in late 2008.
While there are some indications that business conditions have begun to improve (see below), I have adopted conservative assumptions in my forecasts for Q4 FY 2009 and FY 2010, including: no growth from the current trough level of sales (about $35M per quarter) and a decline in margins from the most recent level (17.4%) to the 14% level. Regarding my cash flow estimates, while somewhat volatile on a quarterly basis, I assumed that changes in working capital would be roughly flat over the period and that growth related capital expenditures would be minimal and depreciation would match overall capital expenditures. These assumptions show that Conrad would generate free cash flow of just under $10 million on an annual basis. Assuming no further reduction in debt or any share repurchase, net cash could rise from about $3.74 (at 9/30/09) to approximately $5.50 by the end of 2010.
|Conrad Industries, Inc|
|Cost of Revenue||25.6||29.2||37.0||35.7||32.8||37.1||60.6||107.5||133.3||149.2||123.8||120.4|
|Gross Margin %||21.3%||24.3%||21.1%||13.1%||2.0%||0.0%||6.3%||11.7%||20.9%||21.9%||16.9%||14.0%|
|Tax Rate %||45.5%||42.8%||51.9%||NM||19.1%||19.1%||-15.6%||38.0%||36.2%||36.1%||37.2%||37.0%|
A non-filer, but not dark, with plenty of available information: Beginning in March 2005 Conrad voluntary de-listed its shares from Nasdaq as management decided to not file financial statements with the SEC and comply with SOX requirements. Management states in its financial reports that this decision was made "primarily to reduce expenses". Thereafter the shares began trading on the Pink Sheets electronic exchange. Despite this, the company did not go dark as it makes what I would describe as a well above average job of providing plenty of financial data available to investors and I have had the opportunity to speak with management. Noteworthy, in addition to the normal quarterly and annual P&L, balance sheet and cash flow statements, the company provides quarterly and annual divisional sales and profit breakouts as well as providing backlog figures for each of its divisions. Detailed financial information for the company can be found at the web site: www.pinksheets.com. That said, this issue is no doubt a reason why I believe the stock is not efficient and has worked against the company gaining a broader base of institutional investors and a higher valuation.
In addition, in its annual report the company states the following: "Our Board of Directors has also adopted a process by which stockholders may communicate with our directors. Any stockholder wishing to do so may write to the Board or any of our directors at our corporate offices... or by writing care of our outside counsel. All such stockholder communications will be delivered to our Board's Independent Directors Committee. The Committee will review and consider all written communications from stockholders, and recommend appropriate responses thereto to our Board."
A more diversified and well balanced customer base: Historically, Conrad primary served customers in the oil & gas industry in the Gulf of Mexico. In the 2003/04 time frame the company embarked on an effort to both expand its capacity and diversify its business to new customers. As illustrated in the following table, the percent of revenues from customers in the oil & gas industry dropped from about 67% in FY2001 to about 18% for the nine months of FY 2009. Conversely, government customers increased from about 12% to 21% during this period. More meaningful was the jump in the revenue contribution from commercial customers increasing from 22% to 61%, with the largest increase coming post the 2003/04 diversification efforts. Unfortunately this diversification effort came at a bad time when industry growth slowed significantly during this time. This resulted in the company recording meaningful losses during this period. However, the end result of these efforts has been to transform Conrad into a company with a more diversified and well balanced customer base. The importance here is that these different customers not only provide more growth opportunities, but they remove some of the volatility of the company's financial results during an industry downturn in a particular sector. This was clearly evident during the recent 2008/09 downturn, helping the company remain profitable and able to generate a healthy amount of cash flow.
|Conrad Industries, Inc|
|Customer Segments - Annual|
|Oil & Gas||31.3||24.4||12.4||12.7||14.6||55.4||73.0||52.3||20.9|
|% of Total Revenues:|
|Oil & Gas||66.8%||59.4%||37.0%||34.1%||22.6%||45.5%||43.3%||27.4%||18.3%|
|Oil & Gas||-22.2%||-49.2%||2.3%||15.4%||279.4%||31.7%||-28.3%||-49.5%|
A possible recovery in business momentum; but not in my forecasts: Given the recent signs of economic improvement in the US economy and the significant rebound in oil prices, there is some evidence that business conditions have at least stabilized in the company's major markets. Conrad's order backlog has rebounded modestly over the last two reported quarters, with all of the increases coming from the commercial and government sectors. This trend would be consistent with a recovery in general economic activity. However, the one area to date that had not shown any improvement has been the oil & gas sector. Noteworthy, as illustrated in the following table, the order backlog from oil & gas related customers have been zero over the last four quarters and effectively nothing since the beginning of 2008.
|Conrad Industries, Inc|
While the company has recorded minimal revenues from this sector, all of this appears to be quick-turns small jobs as opposed to major construction/repair work. While I would not consider myself an expert on the oil & gas sector, the research I have done on the business indicates that there are a fair amount of data points suggesting that Conrad's oil & gas business may improve over the next couple of quarters. If such, that could be a significant positive catalyst for the shares. The most notable data point has been the significant increase in oil prices over the last few months. Oil prices have risen from $35 about a year ago and $60 about six months ago to approximately $80 currently. A number of sell-side analysts have recently increased their forecast for oil prices for both the short and long term, with some suggesting prices could rise further over the next few months. Historically there has been a strong correlation between the price of oil and exploration activity in the major areas such as the Gulf of Mexico. Noteworthy, one industry report suggested that at the $80 price, the economics of oil exploration radically improve due to the ability of returns to exceed the cost of capital. Not surprisingly, in graphing the two variables there is very strong correlation between changes in oil prices and the number of total active drilling rigs in use at any time. Data from the Baker Hughes Weekly Drilling Report (which is broken down both on/off-shore by state) shows a notable pickup in the number of active offshore drilling rigs in Louisiana. While clearly below its 2 year high of 66 set in October 2006, the number has risen steadily from a low of 24 set in August 2009 to 39 in early January 2010. With the tide of drilling activity increasing, this should bode well for the ecosystem of companies that do business within the sector. Checks with a number of infrastructure companies that service the Gulf of Mexico oil & gas industry seem to confirm a pick up in business tied to an improvement in offshore drilling activity. Noteworthy, the following quotes are from a 1/7/10 investor presentation by Hercules Offshore, a major provider of drilling and marine services to the oil and natural gas exploration and production industry in the U.S. Gulf of Mexico:
-- "recent bid activity has increased dramatically from levels during the summer."
-- "since August 20, average days backlog per marketed rig has increased to 75 from 19."
-- industry-wide rig count has recovered from a low of 14 in July to the upper 20's."
-- after a slow year, approved U.S. Gulf of Mexico shallow water drilling plans have trended up for the past several months."
While the data points may indicate that Conrad's oil & gas may be poised for a recovery in the near future, I have not factored any real growth into my revenue forecasts. Thus, at current prices I believe the shares are not discounting a recovery in this business. Conversely, the share price of some of the other companies whose business is tied to this market have seen a significant increase over the last few months.
Thoughts on Management: My limited communication with management and my background research suggests that the leadership team at Conrad is: capable, stable, conservative, properly motivated, not overly compensated and somewhat take into consideration the interests of shareholders. Noteworthy, most senior managers appear to have long tenure with the company. The company has been run by two members of the Conrad family since its inception in 1948. Management, directors and other insiders own 53.6% of the company, so I believe their interests are aligned with shareholders. Management has used the healthy cash flows from the business over the last couple of years in what I believe to be a very prudent fashion. The company has reinvested cash in capital expense projects to: improve capacity and efficiency ($37M over the last 8 years), repay debt (the debt/equity ratio has dropped from about 100% in 2005 to about 10% currently) and repurchase shares. Looking forward while management has noted that they will use some cash to make modest investments in the business, the recent filings point out that "the board has indicated to management their desire to be prudent and if conditions are not favorable to postpone the less important expenditures." Noteworthy, in a move that indicates to me the Board of Directors awareness of shareholder interests, the company hired an investment bank in FY 2007 to assist in reviewing strategic options. The outcome of that evaluation was to initiate a $10M share repurchase program. The vast majority of these shares were repurchased before the program was canceled in November 2008 to conserve cash.
What is the real underlying earning power of the company? Given the volatility in earnings and cash flow over the last couple of years, I believe that a key question in evaluating Conrad as a potential investment is to gauge what the true underlying earnings power of the company will be going forward. I would submit that the while the company is clearly influenced by cyclical factors, the swings in earning recorded over the last few years were really the result of a confluence of a number unique issues not typical of a normal business cycle. To some degree the Charles Dickens quote "it was the best of times, it was the worst of times" could be applied to the volatility see saw in the financial results during the last few years. The significant downturn in profitability in the 2002-2005 period was due to the combination of an ill-timed and somewhat problematic expansion program coinciding with a significant down turn in both the US economy post 9-11 and the company's major market (oil & gas). Likewise, the boom years of late 2005-2008 were heavily influenced by the combination of a pick-up the oil & gas industry (driven by a significant rise in oil prices and exploration activity) as well as the impact of hurricanes Katrina, Rita, Gustav and Ike, which drove an unusual demand for the company's products and services. While one can not rule out any black swan type of scenarios (positive & negative) in the future, I believe that with the success of the company's customer diversification efforts, the financial volatility going forward is likely to be less. I believe this should positively influence the appeal of the company to shareholders.
Looking forward, I have modeled what I believe are a set of conservative assumptions into my forecasts listed in the earlier table. I would label these forecasts "my no growth off the trough, tough competitive environment model". As previously stated, there is evidence to suggest that the company's business should grow from current levels, especially from oil & gas customers. Notwithstanding this, I use these forecasts not because I think this is the most likely scenario (which I don't), but just to create a margin of safety in my analysis. The assumptions in my forecast include: quarterly revenues approximating the $35 million level of Q3, no real increase in business from oil & gas customers, a decline in gross margins from the 17.4% Q3 level back to about the trough level of the past three years of 14% and little growth related capital expenditures. Under these assumptions, I show the company producing GAAP EPS of $1.40 per share and generating free cash flow of just under $10 million for the 2010 year. All told, still not a bad performance and one that supports my belief that the shares are very attractively priced on even these results. In addition, as previously pointed out, under this scenario, I submit investors are getting all future growth for free.
On the other hand, I think investors should evaluate what the potential earnings power of the company would be during a more normal recover in the business cycle. Given some improvement in business from oil & gas customers (for all the reason described previously) and a lift in the commercial & government sectors from improvement in general economic activity, I think quarterly revenues could reach a $40-$45 million quarterly run rate, which is still below the peak late 2007-early 2009 run rate of about $50 million per quarter. Assuming a more favorable pricing environment, gross margins could approximate the Q3 level of 17% level (still well below past peak levels of 20%-22%) with operating margins of about 13% and more normal capital expenditure outlays. Under this scenario, GAAP EPS would approximate $2.00-$2.30 per share and free cash flow would approximate $13 million. These numbers are clearly not discounted in the current stock price and if realized, would likely translate into significant share appreciation from current levels.
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