Value Play: Gulf Island Fabrication (Nasdaq: GIFI)

Gulf Island Fabrication is a leading fabricator of offshore drilling and production platforms, including hull and deck sections of floating production platforms, and  also manufactures towboats, barges, lift boats, dry docks, offshore support vessels, and other marine vessels, . The company was incorporated in 1985 by a group of investors, including Alden J. “Doc” Laborde – the legendary founder of the offshore drilling industry and still alive at 98 — whose 64-year-old son Jack is Gulf Island’s current Chairman of the Board (not to mention King of New Orleans’ 2014 Mardi Gras festival).

With 1035 acres along the Louisiana and Texas coasts (688 acres developed), Gulf Island owns and operates the largest group of fabrication facilities serving the Gulf of Mexico market. Over the last three years (page 3), total revenues have averaged 64% for U.S. deep-water, 10% for foreign destinations, and 26% for shallow-water and marine vessels. Competitors include privately-owned Kiewit Offshore Services and McDermott International (MDR).

At its current price of 18.56, Gulf Island’s stock is trading near its 52-week low of 18.06 in reaction to reports that the offshore drilling industry is facing a cyclical downturn. As a contrarian value investor, I take to heart both Warren Buffett’s advice to “be greedy when others are fearful” and Sir John Templeton’s advice to buy companies when they reach “the point of maximum pessimism.” Consider these pessimistic facts:

• Day rates on offshore drilling rigs are falling and may take 18-24 months to recover.
  
  
• Exploration & production companies are cutting back on their capital expenditures because the current price of oil is not high enough ($130 per barrel is needed) to justify the increasing costs necessary to produce more oil (slide no. 43-47). Oil prices are not demand constrained, but supply constrained.
  
  
• The trough in drilling expenditures will not occur until 2015, primarily driven by delays to deepwater floating production systems (FPS) in Africa and Latin America.

Why buy into the offshore drilling industry now? Because stock prices anticipate and adjust to future economic events before they occur. So, even though the actual trough in drilling expenditures won’t occur until 2015, the trough in stock prices for the group may already (or soon) be at hand. For example, Johnson Rice energy analysts recently wrote:

With the offshore drillers in aggregate trading at ~6.5x EV/EBITDA on a blended ‘14/’15 basis and 1.1x P/B, we view valuations for the broad group as generally supportive nearing recent trough levels based on our estimates.

Gulf Island’s current valuation metrics are similar to the trough valuations mentioned above:

Gulf Island Fabrication is Cheap!

Source: Bloomberg

The good news is that capital expenditures on deepwater drilling will rebound strongly off of the 2015 trough and offshore drilling stocks will anticipate the rebound in spending before it happens:

• Deepwater capex is set to “soar” post-2016, driven by continued development of deepwater fields off Latin America and West Africa.
  
  
• According to Douglas-Westwood analysts:
  

  “Despite rising costs, the recent consistency in oil price has given operators confidence, and most deepwater developments are viable at current oil prices. Appropriately, DW forecasts growth in deepwater capex of 14% per annum.”

• Deepwater expenditures are set to grow by almost 130% compared to the preceding five-year period, totaling $260 billion (billion) between 2014 and 2018.
  
  
• According to the International Energy Agency (IEA) (page 2):
  

  “Over the period to 2035, the investment required each year to supply the world’s energy needs rises steadily towards $2 000 billion from 1,600 billion. This amounts to a cumulative global investment bill of more than $48 trillion, consisting of around $40 trillion in energy supply. The main components of energy supply investment are the $23 trillion in fossil fuel extraction, transport and oil refining. Compensating for output declines absorbs more than 80% of upstream oil and gas spending.”

First-quarter earnings were up 26% year-over-year, which beat analyst estimates, but revenues were down 1.5% and the backlog of future projects also decreased. In the conference call, CFO Jeff Favret called the financial results “solid” and attributed the revenue decline to the fact that the company’s contracts are lumpy and revenue from a large deepwater project was recognized in last year’s first quarter (the company reported record revenue in 2013). Most of the backlog reduction involved deepwater projects, which makes sense given the industry-wide deepwater slowdown.

CEO Kirk Meche didn’t try to spin things, but was honest about the slowdown:

There’s a lot of competition out there, especially in deepwater markets right now. There’s a lot of overseas competition. So, margins will be very tight going forward. Again, with a lot of competition out there.

And as, I think, some of the shipbuilding industry is starting to come down a little bit, you’re going to start seeing a little more pressure coming from those guys in terms of trying to get in fact small structure fabrication work done. Some of these guys have peaked out in terms of new construction going forward. There still are some opportunities out there for us and some very strong ones going forward. But again, you don’t see some of these boat builders going out and booking 40 and 50 vessels at a time. It’s more of the two or three-type vessel packages we’re looking at now going forward.

And again, our marine division is doing well, but we’re really doing well with our dry docking. I mean there’s lot of opportunities out there for vessel repairs. And certainly as these vessels get in to the marketplace, they’re going to have to be repaired, inspected and whatnot going forward. So we’re gearing up for that as well in terms of our repair.

Meche reminds me of Hill-Rom CEO John Greisch in his forthrightness and straight talk, which I really like in corporate leader. No surprise that Hill-Rom is up 19% since it was recommended in Roadrunner and I expect similar returns from Gulf Island.

With the reduced backlog, the company is looking for new growth opportunities, and Meche is optimistic thanks to the company’s move of its corporate headquarters to Houston (closer to potential drilling clients) and the addition of three new directors who have business “contacts”:

We’re challenged by our board of directors for always looking at different opportunities, as well as our shareholders. They are several things we are looking at. Nothing that’s imminent at the time. But we’ve got a strategic plan out there – especially with the addition of our three new board members, who are adding some much needed, I guess, contact information from our Houston market. These three guys are going to help us identify what projects and what opportunities we have for our company going forward. And hopefully, in the next couple of years or so, you’ll see some movement in that respect. But again, we’re always looking for new adventures and new opportunities going forward. And certainly, even now, I think it’s more prevalent as we go forward.

Gulf Island has a strong balance sheet with no debt, which affords the company time to wait out the deepwater slowdown with no financial stress. Furthermore, the company is diversified with significant exposure to shallow-water projects (up to one-third of total revenues) that continue to grow and do not face the capex headwinds of deepwater. CEO Meche is optimistic about the remainder of 2014:

We do see a little bit of activity picking up for the shallow water items that we typically have done very well in the past. And we continue to see that growth going forward. Bidding activities for non-traditional Gulf of Mexico marine related projects, overseas shallow water projects, and support work associated with deepwater structures are expected to increase from current levels over the next three quarters. We continue to work with several companies including partnering opportunities that exist for the latter part of this year and into 2015.

According to Douglas-Westwood analysts, shallow-water is the place to be in the short-term and Gulf Island is there:

Shallow-water developments provide a more robust outlook in the near-term, with an influx of new-build mobile offshore drilling rigs entering the market to meet increased demand and replace the aging fleet. Shallow water continues to comprise the majority of offshore production (84% in 2014), but deepwater production is increasing as a percentage. Furthermore, shallow-water reserves are dominated by [national oil companies], whose long-term view makes them less susceptible to current constraints in the market. Shallow-water fields provide a lower risk, lower cost option for operators, and thus have a more robust growth profile in the short-term.

Profitability is modest and has never fully recovered from the 2008-09 global financial crisis, but earnings are positive after two negative years in 2011 and 2012, and the annual dividend of $0.40 per share (2.2% yield) has returned to pre-2008 levels. Peak earnings were $2.18 per share in 2007 and they are now only $0.55, so there is plenty of profit runway to recover before any type of ceiling is reached. No wonder analysts expect earnings growth to average 31.6% over the next five years. It’s no coincidence that $0.55 per share grows to the prior peak level of $2.18 within five years at that growth rate. Gulf Island’s peak stock price in June 2008 was $52.59, almost triple the current stock price.

Gulf Island is run by the founding family (Chairman Jack Laborde is the founder’s son), and the Laborde family owns a substantial 7.3% stake in the company (page 15), so I am confident that management has the proper long-term focus for increasing shareholder value. With the stock price at a rock-bottom valuation, now is the time to pounce. Insiders agree, with both CEO Meche and COO Todd Ladd collectively buying 6,500 shares in May (one month ago) at an average price above $19 per share.

Gulf Island Fabrication is a buy up to $23; I’m also adding the stock to my Value Portfolio.

Sell Alert

To make room for Gulf Island, Roadrunner is selling:

• Carbo Ceramics (CRR)

Carbo Ceramics is a great company, but its stock price appears fully valued and has run up on speculation concerning its Kryptosphere proppant for deepwater drilling applications. Given the forecast deepwater slowdown, the excitement over Kryptosphere is probably overdone and setting the stock up for disappointment. In any event, Carbo Ceramics is the most expensive stock in the Value Portfolio, has a high short interest-to-float ratio above 20%, and no longer qualifies as cheap, so it’s time to let go.

Carbo Ceramics is Expensive

 Source: Bloomberg

Carbo Ceramics is being sold from the Value Portfolio.

Four Momentum Buys:

1. Inteliquent (Nasdaq: IQNT)

Inteliquent company provides competitive voice telecommunications services on a wholesale basis to wireless and landline telecommunications carriers. It is profitable (50% return on equity), has 11% insider ownership, and no debt. Looks like a “quality” momentum stock.

• Price gain between 12 months ago and 3 months ago = 214.34% (100 percentile)
• Price gain over the past 2 months = 4.97%
• Price gain over the past month = 2.46%
• Roadrunner Momentum Rating: 214.34 – (4.97) – (3*2.46) = 202.00

Inteliquent is a buy up to $19; I’m also adding the stock to my Momentum Portfolio.

2. Matador Resources (NYSE: MTDR)

Matador Resources is an exploration & production energy company that drills horizontal wells in oil and gas shale deposits located primarily in the Eagle Ford shale play in South Texas and the Permian Basin in Southeast New Mexico and West Texas. It is profitable (16% return on equity), has 17% insider ownership, and insiders bought more shares at a price of $25 in a recent public offering.

• Price gain between 12 months ago and 3 months ago = 161.72% (100 percentile)
• Price gain over the past 2 months = -3.28%
• Price gain over the past month = -10.50%
• Roadrunner Momentum Rating: 161.72 – (-3.28) – (3*-10.50) = 196.50

Matador Resources is a buy up to $29; I’m also adding the stock to my Momentum Portfolio.

3. Power Solutions International (Nasdaq: PSIX)

Power Solutions International is global producer and distributor of high performance, certified low-emission, power systems that primarily run on alternative fuels such as natural gas and propane.  One of its largest customers is Moser Energy, which provides natural gas engines for drilling rigs.  Converting raw natural gas from oil drilling sites into fuel for engines eliminates the need to haul diesel to remote sites that don’t have electricity. T. Boone Pickens recently made a large investment in Moser Energy and Power Solutions should indirectly benefit. Regulatory changes away from carbon-polluting fuels and toward green energy are a strong tailwind for Power Solutions.

The company is currently unprofitable but analyst earnings estimates are increasing. Power Solutions is the most speculative of the four new momentum portfolio holdings.

• Price gain between 12 months ago and 3 months ago =116.53% (99 percentile)
• Price gain over the past 2 months = 3.63%
• Price gain over the past month = -7.72%
• Roadrunner Momentum Rating: 116.53 – (3.63) – (3*-7.72) = 136.04

Power Solutions is a buy up to $82; I’m also adding the stock to my Momentum Portfolio. 

4. Anika Therapeutics (Nasdaq: ANIK)

Anika Therapeutics  is a pioneer in developing therapeutic products for tissue protection, healing and repair. Last February, the FDA approved Monovisc, Anika’s single injection supplement to the osteoarthritic joint, used to treat pain and improve joint mobility in patients suffering from osteoarthritis of the knee. The company is profitable (24% return on equity), has 18% insider ownership, and no debt. Looks like a “quality” momentum stock.

• Price gain between 12 months ago and 3 months ago = 169.00% (100 percentile)
• Price gain over the past 2 months = 20.47%
• Price gain over the past month = 4.37%
• Roadrunner Momentum Rating: 169.00 – (20.47) – (3*4.37) = 135.40

Anika Therapeutics is a buy up to $52; I’m also adding the stock to my Momentum Portfolio.

Sell Alerts

To make room for these four new momentum stocks, Roadrunner will be selling four price laggards:

• CommVault Systems (CVLT)
• HMS Holdings (HMSY)
• LeapFrog Enterprises (LF)
• Ocwen Financial (OCN)

LeapFrog and Ocwen are both value stocks with EV-to-EBITDA ratios below 10, so I will place them on the Value “Farm Team” (i.e., a watch list for possible future inclusion in the Value Portfolio).