Conrad Industries, Inc. (CNRD, Financial) constructs, converts and repairs steel and aluminum marine vessels at four facilities in the vicinity of the Gulf of Mexico. It has been in operation for 62 years and, astonishingly, still has the founder on its Board of Directors, at 94 years old! The company trades in the Pink Sheets, which has no disclosure requirements and is less regulated than other markets. CNRD does, however, provide financial information each quarter that is far more clear and detailed than many of the companies I have looked at on the larger markets.
CNRD trades around $10/share, for a market cap of around $65 million. The company has just $3.5 million of bank debt and is repaying it quickly. The company has NCAV of about $6.00, and cash per share around $5.80. Moreover, the company has excellent free cash flow generation and has recently reinstated its share repurchase program (which was put on hold in 2008 in response to concerns over the economy). Previously, it had been repurchasing in the $11 range, 10% higher than its current price.
The company uses steel as its primary material in building and repairing vessels. One might be concerned that fluctuations in the price of steel would have an effect on the company’s earnings. It turns out that there is little reason to be concerned, as the company has been building in steel escalation clauses into its contracts for several years (the name is a bit of a misnomer, as the client also received the benefit of declines in the price of steel). Effectively, the contracts provide CNRD safety from variable input prices.
When analyzing small caps, a common problem is revenue concentrated among just a few customers, the loss of any of which would deal a major blow to the company. Not a problem for CNRD! The company sold to between 199 and 262 different entities between 2007 and 2009, with no single customer comprising 10% or more of revenues.
Corporate governance is also a cause for concern for analysts looking at small caps, but not in this case. The company is majority owned by the Conrad family (the patriarch being the 94 year old founder mentioned above), which holds 50.6% of the company. Despite a controlling position, the Conrads seem to have missed the memo distributed amongst people in similar situations to treat the company like a personal piggy bank. They have extremely reasonable salaries for their executive and directors, less than a third of what I have seen companies pay with less than a quarter of CNRD’s revenues. There is a shareholder rights plan (aka Poison Pill) which I’d like to see disappear (it prevents a takeover offer, which could be a major catalyst event for unlocking value here).
As if the above weren’t enough, the company operates in an industry which has a regulatory monopoly free from international competition. Due to the Merchant Marine Act of 1920 (section 27), any vessel that transports goods between two American ports must be built in the United States. As the company notes, many operators choose to have vessels built in the United States simply to keep the option open to use the vessel there in the future. Though this angers the free trade advocate in me, it definitely appeals to the value investor side!
Now, to get to valuation. Is CNRD undervalued? I believe it is, though you will have to do your own analysis and draw your own conclusions. As mentioned, the bulk of the current purchase price is cash, and the company has very few liabilities. This is not an asset play, so we have to turn to earnings.
On a conservatively estimated value of EPV (as a no-growth perpetuity), I calculated a value in the $21 range, using a higher cost of revenue than the company has had in the last three years and revenues of approximately $130m, which is below the average it has earned over the last three years ($168 million). I believe the company’s revenues are rebounding, as evidenced by the fact that it now has the highest backlog it has had in at least the last five years (it currently stands at $86.1m, vs $38.3m at Dec 31, 2009, an increase of 125%). This does not take into account any growth expectations.
We are lucky in that a competitor in the industry was recently purchased. This gives us a useful point of reference in triangulating the value of CNRD. The comparable transaction was Todd Shipyards Corporation (TOD, Financial), which was purchased at an EV/EBITDA multiple of approximately 3.8x. CNRD is currently trading at an EV/EBITDA multiple of approximately 1.8x. Using 3.5x as a conservative multiple for CNRD, we would value the company’s shares at $13.20, a 30% premium to today’s price. Additionally, TOD is trading at a price slightly higher than the announced purchase price (rather than the usual discount to reflect time value of money), meaning that the market (and five different law firms which have announced investigations into whether TOD’s Board violated its fiduciary duties!) believes a higher purchase price will be negotiated. But wait! TTM EBITDA is a flawed measure given the disruption in the company’s business due to the Gulf of Mexico drilling moratorium. Rather than using TTM EBITDA, I used the three year average EBITDA with the same multiple, and the value per share is around $22.50. This is using a multiple less than TOD (which the lawyers think may be low) and actual average EBITDA generated. What’s more, it is close to the value reached through the EPV analysis above.
The company trades at a P/E ex-Cash of 2.81x. TOD currently trades at a P/E ex-Cash of 6.19x. Applying a P/E ex-cash multiple of 6 to CNRD and we get a value around $15.00, a 50% premium to today’s price.
Why is the company trading at such a discount based on so many metrics? It has been suggested that the fact that the company trades in the Pink Sheets gives it a substantial discount. I agree that this would lead to some discount, but a 1/3 or more discount seems to be unjustified on that count alone. The other idea that I have heard is that there is still fear over the ultimate regulatory framework that will be imposed on Gulf drilling. I don’t find this to be a compelling argument for several reasons. First, an overly onerous regulatory system requiring increased capital expenditures throughout the offshore drilling industry will likely help CNRD, which will be one of the companies hired to help with the retrofits. Second, the company’s revenues from the energy industry plummeted this year as a result of the Deepwater Horizon incident. Unable to keep a good company down, CNRD turned to bidding (and winning!) government contracts and other commercial contracts, helping it maintain a shockingly stable level of revenues (and achieve the previously mentioned backlog growth too).
I have a relatively higher level of conviction regarding CNRD than others I have made. Failing a double dip in the economy or other macroeconomic factors (though, the company did fine during the first dip!), I think this company has a great deal of potential as an investment. When you conduct your own analysis (which you should!), if you come to a different conclusion, please let me know – I would love to discuss it!
Talk to Frank about CNRD
Author Disclosure: Long CNRD
CNRD trades around $10/share, for a market cap of around $65 million. The company has just $3.5 million of bank debt and is repaying it quickly. The company has NCAV of about $6.00, and cash per share around $5.80. Moreover, the company has excellent free cash flow generation and has recently reinstated its share repurchase program (which was put on hold in 2008 in response to concerns over the economy). Previously, it had been repurchasing in the $11 range, 10% higher than its current price.
The company uses steel as its primary material in building and repairing vessels. One might be concerned that fluctuations in the price of steel would have an effect on the company’s earnings. It turns out that there is little reason to be concerned, as the company has been building in steel escalation clauses into its contracts for several years (the name is a bit of a misnomer, as the client also received the benefit of declines in the price of steel). Effectively, the contracts provide CNRD safety from variable input prices.
When analyzing small caps, a common problem is revenue concentrated among just a few customers, the loss of any of which would deal a major blow to the company. Not a problem for CNRD! The company sold to between 199 and 262 different entities between 2007 and 2009, with no single customer comprising 10% or more of revenues.
Corporate governance is also a cause for concern for analysts looking at small caps, but not in this case. The company is majority owned by the Conrad family (the patriarch being the 94 year old founder mentioned above), which holds 50.6% of the company. Despite a controlling position, the Conrads seem to have missed the memo distributed amongst people in similar situations to treat the company like a personal piggy bank. They have extremely reasonable salaries for their executive and directors, less than a third of what I have seen companies pay with less than a quarter of CNRD’s revenues. There is a shareholder rights plan (aka Poison Pill) which I’d like to see disappear (it prevents a takeover offer, which could be a major catalyst event for unlocking value here).
As if the above weren’t enough, the company operates in an industry which has a regulatory monopoly free from international competition. Due to the Merchant Marine Act of 1920 (section 27), any vessel that transports goods between two American ports must be built in the United States. As the company notes, many operators choose to have vessels built in the United States simply to keep the option open to use the vessel there in the future. Though this angers the free trade advocate in me, it definitely appeals to the value investor side!
Now, to get to valuation. Is CNRD undervalued? I believe it is, though you will have to do your own analysis and draw your own conclusions. As mentioned, the bulk of the current purchase price is cash, and the company has very few liabilities. This is not an asset play, so we have to turn to earnings.
On a conservatively estimated value of EPV (as a no-growth perpetuity), I calculated a value in the $21 range, using a higher cost of revenue than the company has had in the last three years and revenues of approximately $130m, which is below the average it has earned over the last three years ($168 million). I believe the company’s revenues are rebounding, as evidenced by the fact that it now has the highest backlog it has had in at least the last five years (it currently stands at $86.1m, vs $38.3m at Dec 31, 2009, an increase of 125%). This does not take into account any growth expectations.
We are lucky in that a competitor in the industry was recently purchased. This gives us a useful point of reference in triangulating the value of CNRD. The comparable transaction was Todd Shipyards Corporation (TOD, Financial), which was purchased at an EV/EBITDA multiple of approximately 3.8x. CNRD is currently trading at an EV/EBITDA multiple of approximately 1.8x. Using 3.5x as a conservative multiple for CNRD, we would value the company’s shares at $13.20, a 30% premium to today’s price. Additionally, TOD is trading at a price slightly higher than the announced purchase price (rather than the usual discount to reflect time value of money), meaning that the market (and five different law firms which have announced investigations into whether TOD’s Board violated its fiduciary duties!) believes a higher purchase price will be negotiated. But wait! TTM EBITDA is a flawed measure given the disruption in the company’s business due to the Gulf of Mexico drilling moratorium. Rather than using TTM EBITDA, I used the three year average EBITDA with the same multiple, and the value per share is around $22.50. This is using a multiple less than TOD (which the lawyers think may be low) and actual average EBITDA generated. What’s more, it is close to the value reached through the EPV analysis above.
The company trades at a P/E ex-Cash of 2.81x. TOD currently trades at a P/E ex-Cash of 6.19x. Applying a P/E ex-cash multiple of 6 to CNRD and we get a value around $15.00, a 50% premium to today’s price.
Why is the company trading at such a discount based on so many metrics? It has been suggested that the fact that the company trades in the Pink Sheets gives it a substantial discount. I agree that this would lead to some discount, but a 1/3 or more discount seems to be unjustified on that count alone. The other idea that I have heard is that there is still fear over the ultimate regulatory framework that will be imposed on Gulf drilling. I don’t find this to be a compelling argument for several reasons. First, an overly onerous regulatory system requiring increased capital expenditures throughout the offshore drilling industry will likely help CNRD, which will be one of the companies hired to help with the retrofits. Second, the company’s revenues from the energy industry plummeted this year as a result of the Deepwater Horizon incident. Unable to keep a good company down, CNRD turned to bidding (and winning!) government contracts and other commercial contracts, helping it maintain a shockingly stable level of revenues (and achieve the previously mentioned backlog growth too).
I have a relatively higher level of conviction regarding CNRD than others I have made. Failing a double dip in the economy or other macroeconomic factors (though, the company did fine during the first dip!), I think this company has a great deal of potential as an investment. When you conduct your own analysis (which you should!), if you come to a different conclusion, please let me know – I would love to discuss it!
Talk to Frank about CNRD
Author Disclosure: Long CNRD
