An Australian Achiever on the Cheap

The other day I decided to take a look at some Australian stocks. As luck would have it, I had only flipped through a few before landing on a company with an interesting name and line of business. A little more research revealed some eye-popping statistics.

How many companies anywhere in the world have managed this kind of performance?

5 Year Average Revenue Growth: 25.3%

5 Year Average Net Income Growth: 28.30%

5 Year Average EBIT Margin: 23.4%

5 Year Average ROE: 20.5%

5 Year Average ROIC: 16.6%

And all while paying a dividend and using modest debt.

What industry would you guess this company belongs to? Consumer electronics? Maybe a pricy teen retailer or trendy restaurant chain? Your guesses probably wouldn’t include a provider of marine services to the oil & gas industry.

But that’s what Mermaid Marine Australia (Australian Exchange ticker: MRM) is, and it is the largest provider in Australia. Mermaid Marine operates a fleet of 41 service vessels that support the offshore petroleum industry in Northwest Australia and Southeast Asia, as well as Africa and the Gulf of Mexico. These 41 vessels include tugboats, supply vessels, barges, accommodation ships and more. Basically, all the various vessels that keep massive offshore drilling rigs staffed, supplied and in good repair.

Mermaid also owns and operates two supply bases in Northwestern Australia. These are the wholly-owned Dampier Supply Base and the Broome Supply Base, a joint venture. These bases are strategically located next to the North West Shelf, a major oil and gas-producing  region. These bases provide logistical support to ships that service the oil & gas industry, including maintenance and repairs.

Finally, Mermaid owns a slipway at its Dampier base, a facility used for docking ships for repair. The company notes that its slipway is the only such facility located in close proximity to the North West Shelf.

I’ve mentioned the North West Shelf a few times without explaining its significance. The NWS is Australia’s most important and developed petroleum-producing region. Production has been ongoing since the 1980s, with the involvement of many of the world’s foremost extraction companies.

3Activity in the NWS and surrouding areas is strong and is expected to remain so. Tony Howarth, chairman of Mermaid, made these comments in the 2013 annual report.

“Activity in the Australian oil and gas sector remains strong with four major LNG projects currently under construction in the North West of Western Australia with a combined capital cost of $125 billion. Exploration activity is also buoyant with nine oil and gas companies currently undertaking drilling programs in the region and significant gas discoveries announced by Santos and Chevron during the year.”

The four LNG (“Liquefied Natural Gas”) projects under construction are extremely significant for Mermaid. Due to high regulatory burdens and construction costs for land-based LNG facilities, some extractors are turning to “Floating LNG” technology. Shell is in the process of building the world’s first FLNG vessel, with BHP Billiton and Exxon Mobil to follow. These offshore LNG facilities will require the support services that Mermaid offers, and should provide revenues for decades to come. Exploration and production are also important opportunities for Mermaid. The company recently won its first drilling support contract, serving Santos’s Ensco 109 rig.

Let’s take a look at Mermaid’s historical performance and see what insights arise. All figures are presented in millions USD, converted at $1.00 AUD: $0.94 USD.

Historal resultsRevenue, EBIT and net income growth are all strong since 2008. Margins have varied a few hundred basis points in either direction, but are consistently high. Free cash flow is negative on average, but that’s not a bad thing. When a company has as many great investment opportunities as Mermaid does, I don’t want it to produce free cash flow. I want it to use every dollar of operating cash flow and more to capture those opportunities. The success of these capex expenditures can be seen in the revenue, EBIT and net income lines. Spending far beyond annual depreciation on capital assets has clearly been a great use of shareholder capital.

While Mermaid’s consolidated results have been extremely strong, these results have been generated by a changing mix of revenues. Slowing growth in the vessels division has been offset by rapid increases in supply base revenues.

by sectorMost of the revenue growth in Mermaid’s vessel division was realized between 2008 and 2011. High utilization rates during those years pushed up EBIT margins, which have since declined. Additionally, vessels segment revenues and earnings growth have not kept up with asset growth, reducing profit per dollar of assets employed. The vessels segment is still a strong contributor, but is no longer the company’s crown jewel.

That mantle has passed to the supply base segment. Though its 2013 revenues were only just over half those of the vessels segment, its EBIT was 18% greater. The company credits strong growth at the Broome Supply Base with the segment’s remarkable 2013 performance. In 2013, the segment produced nearly 30 cents in EBIT for every dollar of assets employed, an impressive figure that has only grown over time.

The Dampier Slipway accounts for only a small sliver of revenue, but is a solid contributor in terms of EBIT and EBIT per asset employed.

So what must an investor pay for a such a high-achieving company with great prospects for continued growth? Answer: surprisingly little.

ValuatoinMermaid Marine’s trailing P/E is only 14.36, less than one must pay for the broad US and Australian indexes. I find it very hard to believe that Mermaid’s future growth will trail the average company in either of these economies.

Mermaid’s valuation may be weighed down by fears of a slowdown in the Chinese economy, and by fears that Australia’s currency will continue its recent decline. I view both of these factors as short-term in nature and unlikely to interfere with Mermaid’s long-term success. The most important factor in long-term equity returns is a company’s ability to reinvest earnings at consistently high rates, and Mermaid has demonstrated its aptitude.

Finally, for income-oriented investors, Mermaid Marine Australia pays an annual dividend of 12.5 Australian cents, an increase of 13.6% over 2013. At current prices, this dividend is good for a 3.3% yield.

No position.

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11 Responses to An Australian Achiever on the Cheap

  1. Nathan says:

    Great rview.

    Mermaide Marine is fairly priced. There is no MOS. Here’s another simple check:

    Assume go forward Roe = 20% p.a.
    Assume go forward dividend payout = 50% of earnings as at present (1.e. 12.5c of 26c)
    Fair market discount rate/cost of equity = 10% p.a
    Current book value of equity = $1.26

    Fair market intrisic value:
    = $1.26 [(0.5 x 20/10) + (05 x {20/10}^2)]
    = $1.26 [Dividend redturn multiple + Reinvestment multiple]
    =$1.26 x 3
    = $3.76

    I find this quick check works consistenly to see if there is value terriory, over pice or under price.

    • otcadventures says:

      That’s an interesting approach, and if it’s worked for you, I won’t try to talk you out of it. But I think you’ve made a few mistakes.

      First off, Mermaid’s book value of equity is $1.75 AUD, not $1.26. Second, when using a dividend capitalization model, it’s important to model in the convergence of ROE to the mean over time. Not even a quality company like Mermaid can maintain a 20% ROE with a 50% dividend payout forever. 10% annual growth sustained over decades would eventually lead to it surpassing the size of the whole economy.

      For instance, let’s say today’s 20% ROEs continue for another 10 years, after which ROE drops to 15% for 10 years, after which it drops to 10% and remains there indefinitely. Dividend payout remains at 50%. (I think the terminal figure of 10% is too conservative, but that’s what we want to be.)

      Using those assumptions and a 10% discount rate, it’s an easy matter to project dividends and the company’s book value. The present value of the company will be the present value of the dividends and the company’s book value in 20 years. (The company will be worth exactly its book value then because its ROE will equal the discount rate.)

      Dividends start in year one at 17.5 cents and grow to 85.0 cents per share in year 20. The present value of these dividends at a 10% discount rate is $3.00. The book value of the company in 20 years would be $9.36, equal to a present value of $1.39.

      Total present value of $4.39 is 18% above today’s close.

      Obviously, Mermaid’s value depends on whether is is able to sustain high returns on equity for a long time. I think the chances are good and if it can, today’s stock price is cheap.

      Thanks for your comment.

  2. nick says:

    MRM’s share in the broome joint venture was over $3m in 2013. it’s carried at less than $9m on the balance sheet… it is likely worth far more than this

    interesting opportunity

    • otcadventures says:

      Thanks for the comment. I agree, the Broom asset is worth far more than its balance sheet entry, justifying MRM’s premium to book value.

  3. Doe says:

    “How many companies anywhere in the world have managed this kind of performance?”

    Oh, I know one! It’s EBIX. There’s a lot of headline risk and overhang due to fluff lawsuits/investigations. If you can discount the issues into the price and stomach the inevitable volatility, there’s a lot of value.

    This is a good summary here: http://seekingalpha.com/article/1559172-ebixs-valuation-says-guilty-until-proven-innocent-worst-case-25-upside

    • otcadventures says:

      I wish you luck with EBIX, but it’s too dangerous for me. “Where there’s smoke, there’s fire” as the saying goes and I suspect the SEC will level charges against the firm and its executives. If the company is really so cheap/innocent, why are executives not buying shares?

      • Doe says:

        There’s definitely no telling what SEC will do here and there was no telling what SEC would do to IMAX, IBM, GM, DELL during their probes. And like Buffett said, if a cop follows you for 500 miles, you’re going to get a ticket.

        But the seminal question is whether the company is worth something or worthless. I think it’s worth something if it (1). has generated cash in the past and (2). whether it will continue to generate cash 5 years from now.

        Checking for the (1) is rather easy – one just has to check if their cash outflow (from buybacks, dividends & payment for acquisitions) exceeded their cash inflow (from issuing shares & debt). I did and see that difference closely matches the total cash generated from operations.

        Checking for (2) should be answered by asking whether customers are leaving or staying. Their business model seems sticky so it’s not easy to leave. Indeed, the revenues haven’t dropped after the announcement of investigations. The company confirmed on the conference call that it has not lost a single customer because of the investigations. Just like the salad oil scandal of AmEx, it’s the shareholders running away, not the customers.

        As for “why are executives not buying shares?” CEO already owns 10% of the company. Incentives couldn’t be more aligned.

        Finally, the current share price already discounts a big fine and a sizable haircut to the future earnings power.

        With that said, at what price would you be a buyer?

  4. PJN says:

    What do you think about the company issuing shares…and SIMULTANEOUSLY paying dividends…it’s acting in a way that’s totally opposite to what a undervalued company should act.

    • otcadventures says:

      You’re correct in that issuing shares and paying dividends is merely taking funds from investors only to give them back. But I don’t believe Mermaid has been raising substantial capital through share sales. The dilution I see comes from options grants to executives and the dividend reinvestment program. For example, the most recent share issuance announced on October 1 is solely the result of dividend reinvestment.

      Given the extraordinary success of the company, I don’t begrudge the executives their share-based compensation. A large part of the expansion in shares outstanding comes from the excellent performance of the company’s share price and the in-the-moneyness of executive options the rise has produced.

  5. J says:

    Are you still keeping watching this one? The market cap has dropped to 561.36M

    • otcadventures says:

      I keep watching it. I am somewhat amazed at how far the price has fallen. I understand these are not the best times for the Australian resource complex, but some of these names are trading as if demand for oil&gas/ore has been permanently reduced, which I think is far from the case.

      I continue to view management favorably, but this newly announced acquisition is large and will be tough to integrate. The price seems reasonable at 7.8x EBITDA pre-synergies, but we’ll see if those synergies will materialize or not. Jaya’s fleet appears to be attractive, very new and technologically advanced, and the acquisition may help Mermaid achieve global scale. The debt load will continue to be reasonable for the combined entity.

      I hate the Mermaid sold shares so cheaply to pay for the acquisition. However, the combined enterprise looks cheap. Mermaid projects pro forma 2013 EBITDA for the combined operation of AUD $183 million. The post-transaction enterprise value is about AUD $1.16 billion, for trailing pro forma EV/EBITDA of 6.3.

      So the valuation is still modest for a business that should enjoy good long-term growth. The high dividend yield may lend some support for shares at this level.

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