Description

Trailer Bridge represents a compelling investment opportunity. Recent positive events both in the US-Puerto Rico shipping market generally, and specifically at Trailer Bridge, along with Trailer Bridge’s existing status as lowest-cost operator have combined to set the stage for enormous free cash flow generation.

Because the company was written up previously in 2001 and 2003, I will do my best not to rehash old arguments. While the stock is up several-fold since then, it nonetheless merits renewed interest.

The favorable industry event was predicted by jon64 back in the 2001 writeup. The largest operator in the industry, NPR, was sold to Sea Star and liquidated in mid-2002. This immediately removed roughly 20% of industry capacity, at a time when excess capacity was roughly 30%. Not surprisingly, utilization rates have risen considerably. There was a lag in price increases, but with mostly annual contracts, 2004 pricing is roughly 8-10% higher than the prior year. The favorable supply/demand dynamic is expecting to continue for the foreseeable future, with industry participants expecting continued healthy price increases. Note that current rate levels are still on the order of 20% below peak rates achieved in the mid-1990s.

Trailer Bridge has also just completed a highly accretive series of transactions. It simultaneously raised $85mm of HY debt, bought several barges and other equipment that had previously been operating-leased, retired its preferred stock, and paid down other debt. According to the company’s Dec 1 press release, the net result was a decrease in fixed cash expenses of $5mm per year (even after the increased interest payments on the new HY debt) and the elimination of $2mm of annual preferred dividends (while non-cash, they were still senior to the common). So net-net, a $7mm annual boost to the shareholders, on a market cap of $91mm.

Trailer Bridge’s maintenance capex is zero (dry-docking costs are expensed as incurred). The company also had $80mm of NOLs at Dec 31, which should last for years, particularly since depreciation is well in excess of capex. Therefore, EBITDA less interest is a simple, but accurate, proxy for levered free cash flow. With stable market demand and minimal seasonality, annualizing the last quarter’s results is a reasonable way to get at normalized earnings power (before the benefit of future rate increases). Note that $11.5mm of annual rent expense is absent going forward. This leaves us with roughly $22mm of last quarter annualized “adjusted” EBITDA. Annual interest expense should be less than $10mm annually, giving $12mm of levered FCF on a market cap of $91mm, representing an after-tax levered FCF yield of 13%.

With a highly fixed cost structure, TRBR’s contribution margin on volume increases is roughly 65% and on price increases is 100%. On a revenue base of $96mm LQA, just a 5% blended average rate increase could translate into an incremental $5mm of after-tax cash flow. Note that management’s guidance for potential earnings in a healthy supply/demand environment has always been around $30mm, which pro forma for the recent accretive transaction becomes north of $35mm. That potential FCF yield of nearly 40% illustrates how absurdly cheap the company appears to be.

Moreover, Trailer Bridge is well-positioned within the industry, with the lowest cost structure and the newest equipment. The average age of its barge fleet is just ¼ that of its competitors, and the attendant cost advantage grows each year. In addition, the tug-barge system uses half the fuel, 1/3 the labor, lower-cost labor, lower cost load/unload equipment at the port, and releases nearly 20 times less emissions than the self-propelled vessel system used by 2 of its major competitors. TRBR utilizes 53’ containers, which are considerably less costly on a per-unit basis than smaller containers (the trucking industry’s standard container size moved from 40’ to 53’ roughly a decade ago for the same reason).

Notwithstanding its low cost status, Trailer Bridge does not appear eager to ruin the present strong pricing environment to steal market share. But the longer term potential for steady share gains exists and Trailer Bridge has historically gained share year in and year out, yet still represents just 13.3% market share in 2003, excluding automobiles (so probably in the high teens including autos). Moreover, the other two main Jones Act markets (Hawaii and Alaska) have just two major operators, compared to 4 in the Puerto Rico market. Most in the industry would predict that eventually the Puerto Rico market will also consolidate down to two operators, with the two tug-barge operators combining and the two self-propelled vessel operators combining.

Trailer Bridge is also in a position to add capacity more quickly than anyone else, as two of its barges are presently laid-up, and a third is being chartered out. Bringing all 3 back online would increase TRBR’s capacity 79%. Its 3 major competitors have minimal spare capacity. This should provide further price discipline as TRBR’s competitors don’t have additional capacity to fill at present and TRBR seems satisfied with its present profitability, even with its idle capacity.

A new entrant to the market seems unlikely for the foreseeable future, as it would require the minimum efficient scale of barges (self-propelled vessels would not be brought online as they are many, many times more costly to build/buy, in addition to being more costly to operate). Because the US-Puerto Rico market is regulated by the Jones Act, it is unlikely that any existing ships could be transferred into the shipping lane. A new entrant would need to acquire newly-built barges. And presumably TRBR would have enough visibility or “lead-time” to preempt a new entrant by first bringing online its idle capacity.

Finally, management seems strong. CEO John McCown has been at the helm since 1995 and has 20 years of industry experience. He has been buying up stock in the open market recently (owns over 5% of the company) and does not appear to have sold any shares.


Risks

Tugs are chartered from the parent company of one of TRBR’s competitors. However, the presence of other tug operators should mitigate this risk to some extent.

The stevedoring arrangement in San Juan expires near the end of 2006. However, TRBR has renewed it several times previously and the stevedoring company needs TRBR as much as TRBR needs it.

Repeal of the Jones Act. This seems highly unlikely given the broad congressional support it enjoys.

A hurricane could destroy TRBR ships or port equipment and disrupt operations.

Competitor adds capacity. Self-propelled ships would be prohibitively expensive and it seems unlikely that self-propelled operators would bring on new barge capacity as it would represent the “admission of defeat” with the rest of their existing fleet. The other barge competitor could certainly add new barges, though it seems unlikely for the foreseeable future given TRBR’s existing laid-up capacity that could be brought very quickly and TRBR’s lower cost structure that would help protect TRBR in the event of a future price war. Though people can indeed have short memories, especially when given the incentive to, most in the industry would agree that the 4 operators have “learned their lesson” in recent years and are in no hurry to ignite a price war.

Lack of liquidity. The market cap is small to begin with, the float smaller yet.


Catalysts

Tremendous free cash flow generation and the attendant uses for it (share repurchase, cash dividends, etc.).

Greater understanding of the company’s true earnings power as contracts continue to get renewed at higher rates and as the cash flow accretion from the recent transaction rolls through the P&L going forward.


Note

Please note that I am using Friday’s closing price when calculating market cap and FCF yield. I think this is probably unreasonably conservative since it looks like someone may have “marked it up” in the half hour prior to the close on minimal volume, but I am not in the business of predicting short term price movements!

Catalyst

Tremendous free cash flow generation and the attendant uses for it (share repurchase, cash dividends, etc.).

Greater understanding of the company’s true earnings power as contracts continue to get renewed at higher rates and as the cash flow accretion from the recent transaction rolls through the P&L going forward.