Ocean Wilsons Holdings Ltd – LN:OCN

Ocean Wilsons Holdings Ltd is a holding company that trades at a substantial discount to the market value of its assets: a majority stake in Wilson, Sons, and a diversified investment portfolio. Ocean Wilsons is based in Bermuda and trades on the London exchange with the ticker OCN.

Wilson, Sons

Ocean Wilsons’ primary asset is a 58.25% stake in Wilson, Sons. Ocean Wilsons owned 100% of Wilson, Sons until 2007, when Ocean Wilsons floated a 41.75% stake in Wilson, Sons on the Brazilian exchange.

Wilson, Sons’ roots stretch back to 1837, when two Scottish brothers founded the enterprise in Salvador, Brazil. In its early years, Wilson, Sons transported coal from Europe and North America and built a network throughout South America. Over time, the company expanded into rail, navigation, logistics, tugboats and shipbuilding. Wilson, Sons’ fortunes rose and fell with those of Brazil and South America during the twentieth century, enduring war, trade disruptions, a nationalization and several changes in ownership. However, the operation survived and today the company is one of Brazil’s largest logistics, port and maritime services companies in Brazil.

Wilson, Sons has an extensive network of operations throughout most of Brazil’s states.

mapa_de_atuacao

The company has experienced strong growth, more than doubling its revenues since 2004. The company identifies three drivers for continued growth: increasing international trade, increasing oil & gas activity, and growth in Brazil’s domestic economy. (Wilson, Sons results are reported in USD. Results prior to 2007 may not be fully comparable, as the company’s results were consolidated with Ocean Wilsons’ other assets.)

Wilson Sons Results

Growth in net income has been less steady, but such is the nature of many maritime industries. Businesses like shipbuilding can be very lumpy, alternatively flush and flat as contracts are won and completed. While not consistent from year to year, Wilson, Sons has generated reasonable returns on shareholders’ capital. From 2008 through 2012, return on average equity averaged 14.4%.

Throughout, Wilson, Sons has been a prodigious generator of operating cash flow. Free cash flow, on the other hand, has been nowhere in sight. The cause is an extensive investment program in which Wilson, Sons invested nearly $1 billion in infrastructure, increasing port and shipbuilding capacity and upgrading its fleet of tugboats and support vessels. With the investment program completed, the company says it expects “increased free cash generation going forward.”

Wilson, Sons has a market cap of $952 million USD. Its trailing P/E is 16.0 and trailing EV/EBITDA is 6.6. These ratios look quite reasonable. Wilson Sons occupies a dominant position in its sector, in an economy with good growth potential. Port and logistics services will be necessary for as long as international trade is, and the company faces little threat of new entrants. What’s more, the company’s enterprise value could fall substantially as free cash is generated, compressing the valuation.

At a market cap of $952 million, Ocean Wilsons’ stake in Wilson, Sons is worth $555 million.

Investment Portfolio

In addition to its Wilson, Sons holding, Ocean Wilson has long maintained a separate investment portfolio that invests globally with a goal of absolute returns. When it divested 41.75% of Wilson, Sons in 2007, Ocean Wilson contributed the lion’s share of the proceeds to its investment portfolio.

The investment portfolio is managed by Hanseatic Asset Management, an affiliated party.  Hanseatic is run by William Salomon. The Salomon family has been a major investor in Ocean Wilson and Wilson, Sons since the 1950s.

Ocean Wilsons is extremely transparent with respect to its investment portfolio, disclosing the complete list of holdings. At present, the portfolio is invested mainly in global equity strategies, with smaller allocations to private assets, fixed income and market neutral strategies.

allocationPerformance since inception has been good. The portfolio’s blend of aggressive and defensive investments allowed it to avoid some of the losses of 2008-2009, while still performing well during bullish periods.

performanceSince June 30, the market value of Ocean Wilsons’ investment portfolio has climbed to $243.6 million.

Sum of the Parts

Ocean Wilsons has practically no assets at the holding company level besides its investment portfolio and its majority stake in Wilson, Sons. That makes putting a value on Ocean Wilson shares a simple exercise.

Valuation

The value Ocean Wilsons’ assets sums to $798.6 million, or $22.58 per share. However, shares in the company can be had for a good deal less. Last trade in London was at £10.88/$17.62, a discount of 22.0%.

Of course, there’s no guarantee that the discount will close any time soon. But holding company discounts have a way of closing eventually, often through corporate actions like spinoffs and buyouts. In the meantime, Wilson, Sons’ value is likely to increase as the Brazilian economy grows and company’s investment program begins to pay off. Increasing intrinsic value combined with a narrowing holding company discount could provide attractive returns.

No position.

 

 

Awilco Drilling Reports Great Earnings, Raises Dividend, But The Real Action Is Yet To Come – AWLCF

I don’t typically do follow-up posts on companies I’ve written about before, figuring that all you readers out there are more interested in fresh ideas. However, Awilco Drilling continues to present such a compelling value proposition that it richly deserves another look.

I’m proud to say I was the first investing blogger to profile Awilco Drilling. That was back in May, when the stock traded around $14 and had not yet begun paying dividends. A lot has happened since.

  • Dividends – True to its word, management has paid out substantially all free cash flow to shareholders – $1.00 per quarter thus far.
  • Contract extensions – In May, the revenue backlog for WilHunter and WilPhoenix was $358 million. Now the revenue backlog is $800 million, with WilHunter fully-contracted until late 2015 and WilPhoenix fully-contracted until mid-2017.
  • Improved liquidity and increasing market awareness – Until recently, Awilco’s trading volume was scant. Often fewer with 2,000 shares would change hands in the course of a trading day. Now, daily trading volume regularly exceeds 100,000, allowing many more investors the chance to accumulate a significant stake. This explosion in trading volume has been driven in part by some breathlessly optimistic Seekingalpha articles.

Awilco Drilling released its third quarter results yesterday, and the numbers could hardly have been better. EBITDA rose 19.9% over the previous quarter and net income rose 24.5% on the strength of higher contract rates and controlled expenses. Revenue efficiency was an amazing (and likely not sustainable) 98.9%. What that means is Awilco’s rigs were able to earn revenue on something like 182 of the 184 rig-days in the third quarter.

Notice the continued sequential improvement in Awilco’s results.

results

 

For the four trailing quarters, Awilco’s EBITDA was $151.4 million and net earnings were $113.7 million. Total debt has fallen by 12% since the end of 2012. The company has $43.6 million in cash on hand.

Despite a 50% run-up Awilco Drilling’s shares since May, the company still trades at remarkably low multiples of trailing results.

valuation2

All of these ratios are mouth-watering, particularly for a firm with low financial leverage and extremely high earnings visibility multiple years out. And yet, these ratios are misleading. Awilco’s earnings are set to rise dramatically in 2014. For one, Awilco’s rigs were employed at significantly  lower dayrates for much of the trailing twelve months than now, and will soon bring in even more. Wilhunter entered 2013 earning a dayrate of $315,000. Wilhunter now earns $360,000 and will see its dayrate rise to $385,000 mid-way through 2014. WilPhoenix entered 2013 earning $290,000. WilPhoenix earned a dayrate of $315,000 in the third quarter of 2013, and the rig’s daily revenue will soon rise significantly, hitting $387,500 in late 2014 and continuing for at least another three years. Awilco’s reduced debt load will also be a source of increased income as the company makes quarterly principal payments.

The higher dayrates and shrinking debt load should be good for Awilco’s dividend, which the company announced will rise 10% to $1.10 for the next quarter. The company reiterated its intent to pay out all free cash flow as dividends, while maintaining a healthy cash buffer and funding capital expenditures. 2014 could see further dividend increases as the company’s earnings rise. For now, investors will have to console themselves with Awilco’s 20.1% yield.

Awilco also outlined capital expenditure plans for the scheduled 2016 SPS (scheduled periodic surveys). Awilco will use the required inspection and repair period to upgrade each rig’s blowout preventer, or BOP. Awilco notes that BOP failure is the number one downtime risk for semi-submersible drillships, and that being fitted with brand new premium BOP systems will ensure that WilHunter and WilPhoenix can be hired by the supermajor operators. Critics of Awilco’s investment potential often bring up the risk of rig failure or blowout (suffering, I believe, from recency bias) so the news of upgraded BOP systems on the way should allay some of that concern.

Awilco’s detractors also claim the company’s rigs have only a limited lifespan remaining, but the company reiterated its rig life projections: 18 years for each rig. Some company staffer created this graphic for the quarterly report, which I find oddly hilarious.

milkrigs

 

Finally, the company used its quarterly presentation to express confidence in the North Sea rig market for 2014 and beyond, citing barriers to entry, sustained decommissioning and well abandonment work, and friendly UK government policy.

The market is slowly waking up to Awilco’s potential, but it’s a slow process. For now, investors still have a chance to buy into a high quality operation at a startlingly low valuation.

SoTHERLY Hotels, Inc. – SOHO

SoTHERLY Hotels, Inc. owns nine upscale hotels located mostly in coastal markets in the American Mid-Atlantic and Southeast, as well as a minority interest in another hotel in Miami. SoTHERLY’s properties produce nearly twice the EBITDA they did in 2005 and the company has made great progress in replacing expensive financing with mortgage debt. Despite its solid operations and improved balance sheet, SoTHERLY offers a distributable cash flow yield more than twice its competitors. SoTHERLY Hotels is a REIT and is listed on the NASDAQ as SOHO.

Here’s a map of SoTHERLY’s properties from a presentation the company made in June.

HoldingsSoTHERLY’s corporate structure is a little convoluted, and has potential for conflicts. (These potential corporate governance issues are SoTHERLY’s biggest weakness, so I want to discuss them up front.)

First, a little explanation. Like many real estate companies, SoTHERLY conducts its business through a limited partnership. SoTHERLY’s limited partnership is called MHI Hospitality, L.P. SoTHERLY is general partner and holds a 77.6% ownership interest in the LP. The remaining units are largely held by management, chiefly the Kim family that founded the company back in the 1950s. SoTHERLY reports its funds from operations on a per share/unit basis, so shareholders must be careful to adjust the reported funds from operations for the 22.4% economic interest that belongs to limited partners other than SoTHERLY Hotels, Inc. This is not a potential conflict, just something shareholders must know and adjust for.

Then there’s the fact that a REIT cannot actually operate or manage the properties that it owns. To deal with this restriction, SoTHERLY leases its hotels to one of its subsidiaries,  MHI Hospitality TRS, LLC. That subsidiary is required to pay federal taxes, which are then rolled up into SoTHERLY’s results. The effect is that SoTHERLY Hotels, Inc. is a tax-paying REIT, a truly strange animal.

MHI Hospitality TRS, LLC has entered into contracts with a management-owned company called MHI Hotels Services to operate and manage the leased hotels. The company discloses in its annual report that these management contracts were not negotiated at arm’s length and the company could potentially pay less to an independent company. These contracts also contain provisions for large cancellation fees.

The company also discloses that its decision-making may be affected by the Kim family’s desire to avoid taxation. The Kims enjoy a partial tax indemnification agreement with the company, though this expires in 2014.

These conflicts are worth noting and investors should monitor management carefully. However, thus far management seems to be reasonably focused on creating value for all shareholders. Compensation for top officers is reasonable, and the Kim family has adequate incentive to increase dividends and share value because the value of their ownership stakes far exceeds their annual compensation.

With those caveats on the table, let’s take a look at the financials. Hotel occupancy and profitability has risen steadily over the last several years. Here’s a look at yearly hotel EBITDA before corporate costs, adapted from the June investor presentation.

EBITDA trendGrowth in hotel earnings has been increased by additions to the portfolio, but also by improved occupancy. The financial crisis hurt hoteliers badly as businesses and consumers reduced travel. Average occupancy in SoTHERLY’s hotels in 2006 was 69.7% and daily revenue per available room was $78.26. In 2009, occupancy fell to 60.4% and daily revenue per available room was $64.71. Only recently have results improved to close to pre-crisis levels. SoTHERLY’s 2012 figures show occupancy of 68.9% and daily revenue per available room of $78.65.

The company’s improved results at its hotels have driven operating income to record levels: $10.31 million in 2012 and $11.29 million for the twelve months ended September 30, 2013.

Balance sheet improvements are the other half of SoTHERLY’s improved cash flow equation. The company has made huge strides in replacing expensive financing with cheap financing, pushing out debt maturities along the way. Here’s a comparison of the company’s debt load at year-end 2011, year-end 2012 and now.

Debt ScheduleSince year-end 2011, SoTHERLY has managed to reduce its cost of debt by 131 basis points, from 6.76% to 5.45%. The financing mix has been shifted away from lines of credit and redeemable preferred stock in favor of mortgages and unsecured notes. The average debt term has grown worryingly short, but the company has been making progress in extending its maturities, including refinancing the Doubletree Hilton Brownstone University hotel to a 2018 maturity and the Holiday Inn Laurel property to a 2021 maturity.

Improving hotel results and lower cost debt have enabled SoTHERLY to generate increased funds from operations. As usual with real estate companies, the income statement provides a poor picture of actual earnings. Funds from operations is a better metric that strips out depreciation and amortization as well as unusual or non-recurring items like gains on property sales and in SoTHERLY’s case, non-cash losses due to the increasing value of its outstanding warrants.

For the trailing twelve months ended September 30, SoTHERLY Hotels produced 92 cents per share/unit in adjusted funds from operations, a 26.1% increase over 2012.

FFO

At a share price of $4.67, the 92 cents per share in adjusted funds from operations represents a rich AFFO yield of 19.70%, much higher than any of SoTHERLY’s public competitors. The eight smallest hotel REITs I could find have FFO yields averaging 6.1%.

Peers

 

On a cash flow basis, SoTHERLY trades much cheaper than its peers. Then again, relative valuation matters little to me unless a company is cheap on an absolute basis in terms of P/E, free cash flow yield, or assets. Funds from operations tells part of the story, but it doesn’t include the cash drag of necessary capital expenditures. While a large part of a hotel operator’s depreciation charge is non-economic, some level investment is still necessary to maintain the competitiveness of its properties. Even assuming all of SoTHERLY’s capital expenditure goes toward maintaining its properties at their current levels of quality, SoTHERLY still offers a generous free cash flow yield.

In both 2012 and over the last twelve months, SoTHERLY produced enough free cash flow to yield over 10% at the current share price. By comparison, some of its competitors offer scarcely any free cash flow after taking capital expenditures into account.

fcf

 

In a few quarters, SoTHERLY’s trailing cash flow could look even better. Remember that trailing numbers are depressed by the expensive preferred stock that was paid off only very recently. If the US economy picks up steam, hotel occupancy could push results even higher. Sustained higher cash flow will enable the company to continue increasing its dividend, which currently only consumes 31% of free cash flow. I expect the market will eventually notice SoTHERLY’s improved results and healthy yield and award it a more reasonable price.

One last big consideration for SoTHERLY. Now that its balance sheet restructuring is complete, the company is on the acquisition trail once again. In its earnings call for the most recent quarter, the company confirmed it is very close to announcing an acquisition. If the acquisition is attractively priced and easy to integrate, all will be well and shareholders will benefit from increased cash flow. If the company overpays for the new hotel and has trouble integrating it with the existing portfolio, there could be trouble. Management has been in the hotel game for a long while, but that’s no guarantee that things will go smoothly.

Accounts I manage hold SoTHERLY Hotels, Inc.