Havyard Group ASA – Overlooked Recent IPO: HYARD.NO

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I’ve run across an interesting recent IPO by the name of Havyard Group ASA. Based in Norway, Havyard designs and builds specialty service ships. Havyard is majority owned by the Saevik family through their private company Havila ASA.

For completely unoriginal reasons, I rarely find IPOs worth investigating. Companies usually go public after a run of strong business performance and are priced for perfection, often resulting in disappointment if results show the slightest weakness. Also, many companies go public to raise funds to bridge over operating losses during their high-growth phase, and I tend to focus on mature companies that are already generating positive cash flow. However, neither of these factors applies to Havyard. First, Havyard is not riding high on a wave of growth. While still strongly profitable, the company’s results have actually dipped somewhat since 2012 highs. Expectations for Havyard’s future growth likely aren’t demanding. Second, Havyard’s IPO was an ownership shift, not a capital raise. The parent company, Havila, simply monetized a part of its investment in Havyard by offering it to the public. Havila CEO Pers Per Sævik released the following statement concerning the IPO:

”Our family has broad interests in the offshore supply industry. In light of this, and because we see that we need to optimise the conditions for continued growth for Havyard Group, both on technology and ship equipment, we choose to reduce our ownership. Havyard has a significant potential for growth, but the further development of the company requires more than we as a family company have the possibility to contribute.”

Havyard’s original intended IPO price was NOK 36.00, which was then discounted by 7% to NOK 33.50. The discounted IPO price reaffirms my belief that expectations and enthusiasm surrounding Havyard are not high. Since the IPO, shares have slipped another 4.5%.

Before discussing Havyard’s history and business segments, let’s review the company’s history in brief. Havyard was founded in 1999 in Norway and got its start building platform service vessels for the North Sea’s active offshore drilling market. Over time, the company expanded into various other types of specialty vessels and built up a world-wide clientele. Havyard has expanded beyond the oil and gas industry and now designs and manufactures ships for the fishing and aquaculture and offshore wind farm industries. The company expects these new markets to offer great growth potential. Havyard notes that most fish consumption is likely to increase substantially as the world’s population continues to increase and wild fisheries remain in danger of over-harvesting. Offshore windmills will only become more common and economical as wind technology improves and the world’s energy needs increase. Today, Havyard bills itself as a ship technology company focused on “Improving Life At Sea.” Havyard’s self-identification as a technology company is not mere marketing puffery; fully half the company’s operating income is earned by its ship and systems design segments.

Here’s an example of Havyard’s output. The Lewek Inspector is a 110 meter inspection, maintenance and repair vessel designed for fuel efficiency and maneuverability in rough conditions. It was delivered to Forland Shipping in late 2013.

Havyard has four operating segments. The largest by far is the “Ship Technology” segment, responsible for the actual construction of the company’s vessels. Havyard’s hulls are manufactured under oversight by a partner in Turkey, then tested and finished in Norway. This segment is responsible for the large majority of Havyard’s revenues, but only about half its operating income. Havyard’s “technological” segments, “Power & Systems” and “Design & Solutions” accounted for just 20% of the company’s 2013 revenues, but contributed 52% of operating income. The final segment, “Fish Handling & Refrigeration” is a newcomer. Havyard made its initial investment in this segment in 2012. Fish Handling & Refrigeration accounted for 14% of 2013 revenues, but scarcely contributed to operating income. While this segment currently does not provide much in the way of earnings, Havyard considers it a strategic segment with good growth potential. The chart below breaks out Havyard’s 2013 results by segment. The figures diverge slightly from the company’s financial statements due to slight differences in presentation methods and are shown in millions NOK.

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Havyard’s 2013 results were off somewhat from 2012, even though revenues increased substantially due to the acquisition of the fish handling and refrigeration segment. The company attributes the decline in margins and earnings to the expense of developing and producing product prototypes, though I suspect the company also willingly sacrificed some margin to win contracts that allowed it to expand into new industries. Perhaps not a bad long-term strategy, even if short-term results suffer. Nonetheless, the company remains solidly profitable. Management expressed satisfaction with results for 2013 and the first quarter of 2014, noting successes in attracting first-time customers and in delivering new vessel models on time and on budget. Financial results for the trailing four quarters through Q1 2014 as well as for 2013 and 2012 are presented below.

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Havyard’s balance sheet is healthy, with plenty of liquidity and net debt less than trailing EBITDA. Pinning down Havyard’s exact net debt is somewhat subjective due to the presence of substantial investments in associates. As of the end of 2013, Havyard listed a total of NOK 422.7 million in loans to and investments in associated companies, plus NOK 133.2 million unrestricted cash against total debt of NOK 295.2 million for net cash and securities of NOK 260.6 million. Assuming the level of restricted cash remained constant from the end of 2013, Havyard now has unrestricted cash of NOK 50.5 million after deducting dividends payable. The graphic below sets out the various assets and liabilities that go into estimating Havyard’s net cash and securities positions. “Other Non-Current Receivables” is Havyard’s term for long-term interest-bearing loans to asociates, the terms of which are set out in note 20 of the annual report. At quarter-end, Havyard had net cash and securities of NOK 34.4 million.

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At a recent trade price of NOK 32.00, Havyard’s valuation is enticing. The NOK 721.0 million market capitalization, combined with a positive net cash and securities position, yields an EV/EBITDA ratio of just 3.7 and an EV/EBIT ratio only slightly higher at 4.1. The company is cheap on an earnings basis as well at only 5.6 times trailing net income.

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These ratios are simply too low for a conservatively-financed, asset-light company with good prospects. I expect some raised eyebrows at my characterization of a shipbuilder as “asset light,” but you can check the financial statements to see for yourself. Depreciation accounts for less than 1% of Havyard’s annual revenues, an astonishingly low figure for an industrial company. In 2013, Havyard managed EBIT of NOK 180.6 million on average invested capital of only NOK 474.3 million, a 38.1% EBIT/Invested Capital figure. Havyard accomplishes this feat by outsourcing the capital intensive part of its manufacturing process, hull-building, to other companies.

Though Havyard’s low valuation and reasonably good business prospects support a valuation much higher than where shares currently trade, the company does face risks that must be evaluated. The primary risk is a slowdown in the global oil and gas industry, and in the North Sea in particular. Though it has had success in entering new markets, Havyard’s results are still sensitive to the level of demand for oil and gas support vessels. A sustained decline in demand would have a serious impact on Havyard’s results. The company also has large exposure to the performance of its associated companies, mostly ownership stakes in and loans to ships and shipping companies. The book value of these holdings is equal to 61% of Havyard’s current market value, so their performance may have a serious impact on Havyard’s results and value. If these assets perform poorly, large writedowns may result. Investors should also remember that Havyard remains a controlled company. Havila ASA has a long track record of success in the maritime industry, but investors still must trust the Saevik family to manage Havyard well.

Alluvial Capital Management, LLC does not hold shares of Havyard Group ASA for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Capital Drilling – CAPD:L

Now that I’ve done a few consecutive posts on US companies, I hope my readers will indulge me as I profile another foreign stock. Today’s topic is Capital Drilling, a former high-flier that now trades at a discount to asset value. Capital Drilling’s earnings have suffered along with other terrestrial drillers, but the company is in fine position to weather the slow period with little debt, a modern fleet and multiple contracts with blue-chip operators.

Capital Drilling owns a fleet of drilling rigs that it provides to mining companies. The company focuses on emerging and frontier markets, with the large majority of its rigs operating in Africa. These rigs are contracted to major operators such as BHP Billiton, Kinross, and Barrick. Capital owns six different categories of drilling rigs, all suited for different types of drilling activity such as blasting and grading. Capital Drilling was founded in 2004 with only a few rigs, but the company now owns 96. Capital Drilling went public in 2010, using the IPO proceeds to expand its drilling fleet. Capital Drilling also provides drilling management and communications services, though the great majority of revenues and earnings are attributable to its rigs.

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Rocketing gold prices following the financial crisis had Capital Drilling riding high. Its rigs were in great demand and the company enjoyed high utilization and contract rates. Revenues and earnings rose steadily as the company expanded its fleet. However, it was all too good to last. Gold prices took a tumble, leading miners to curtail their exploration and production programs. Capital Drilling’s rig utilization fell from the upper 80%s to below 50%, and operating income dropped to nil. Below are figures showing Capital Drilling’s results for the past five years. Note the extent of the drop-off in revenues and earnings in 2013, the price of gold having fallen 25% during the year. Figures are in USD, Capital Drilling’s reporting currency.

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While 2013 was undoubtedly a disappointing year for Capital Drilling, a few factors helped keep the company alive to drill another day. First, Capital Drilling never leveraged itself to the hilt in order to build its fleet. Even at its most leveraged, Capital Drilling’s net debt never surpassed 22% of equity. While competitors were forced to scramble to stay solvent, Capital Drilling simply used its operating cash flow to reduce its net debt as business slowed. At year end, the company’s net debt stood at only 10% of equity. Second, Capital Drilling’s young, efficient fleet allowed it to maintain a higher utilization ratio than its competitors. As of year-end, the average age of the company’s rigs was only four years. In any commodities slow-down, the first projects to be mothballed are those with the highest operating costs, and the same holds true for drilling equipment. Capital Drilling’s ability to offer more efficient, reliable rigs than its competitors enabled it to keep more of them in the field and earning income while its competitors’ rigs sit rusting.

All this is not to ignore the fact that 2013’s results were decidedly uninspiring. Rig utilization for the year may have been higher than competitors’, but was still just 55%. Fortunately, there are signs of improvement in Capital Drilling’s fortunes. The company has not yet released official results for the first half of fiscal 2014, but it has released interim trading updates. These reflect multiple positive data points.

  • Revenues for the first half of 2014 were approximately $52.9 million, an increase of 21% over the second half of 2013. The company is nowhere close to achieving its previous revenue highs, but the boost in revenues is an encouraging sign that the worst of the washout in mining activity is over.
  • Average revenue per operating rig rose to $194,000 in the second quarter of 2014, compared to $186,000 in the same quarter a year earlier. This 4.3% increase helps the company’s margins, even as utilization rates remain tepid.
  • The company won two new five year contracts, one a drilling contract for AngloGold Ashanti in Tanzania, and the other a production contract for Centamin in Egypt. The company spent $11 million acquiring suitable rigs for these contracts, but still managed to avoid increasing its leverage.
  • The company expects strong free cash flow in the second half of 2014, having already completed most of its capital expenditures for the year.

So what’s Capital Drilling Worth? Shares currently trade hands at 28.5 GBp, giving a market cap of £38.4 million , or $64.5 million. At year-end, Capital Drilling had a tangible book value of $88.4 million. The company’s current trading price represents a discount to tangible book value of 27%. Assuming the company’s cash and receivables are worth book value, the current market cap implies a haircut of 41% to the book value of Capital Drilling’s rigs and rig-related assets. That figure might make sense for distressed rig operator with poor quality, aging rigs, but I’d argue it’s far too conservative for a modern fleet like Capital Drilling’s. If Capital Drilling is capable of earning its cost of capital over time (and I believe it is) then the proper value of the company is much closer to the book value of its assets.

Alternatively, we can value Capital Drilling by normalizing its return on invested capital and comparing the company’s current enterprise value against normalized operating income. From 2010 through 2013, Capital Drilling’s EBIT/Invested capital (which I am defining as EBIT/(Net Debt+Equity)) ranged from -0.2% to 37.6%, averaging 22.6%. These figures represent both boom and bust years, so we can reasonably assume the company’s long-term average ROIC will fall between these numbers. I shy away from choosing a number toward the top of that range, believing gold’s rocket trajectory from 2006 to 2012 to be something of a fluke and not likely to be repeated any time soon. That said, I also believe it to be unlikely that Capital Drilling will stagger along earning mid single-digit returns on capital indefinitely. Such poor returns over a long enough period of time would decrease rig supply and tilt the competitive balance more toward rig owners’ favor, sending ROIC numbers upward. I think the most likely case is the Capital Drilling’s long-term return on invested capital settles between 10% and 15%, neither of which is an aggressive figure.

The chart below illustrates Capital Drilling’s implied valuation at various long-term ROIC rates.

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At a very modest normalized pre-tax EBIT/Invested Capital estimate of 10%, Capital Drilling’s implied valuation is an undemanding 7.3x normalized EBIT. In this case, 10% is a very conservative estimate of ROIC, as the standard post-tax ROIC calculation would be well below 10%. Higher but still quite reasonable estimates of 12.5% and 15% imply bargain EV/Normalized EBIT ratios of 5.9 and 4.9 respectively.

Capital Drilling’s short-term returns will likely be determined by levels of mining activity in Africa and by the movement of gold prices, but today’s price may represent an attractive value for long-term investors. Buying well-financed cyclical companies during business troughs can often work well, provided investors forecast normalized earnings power conservatively and management is reasonably competent.

 

Alluvial Capital Management, LLC does not hold shares of Capital Drilling Limited for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.