A. Investment Thesis

We believe that Aegean Marine Petroleum ("ANW", "Aegean") is at an inflection point and that the company will soon shift from a multi-year period of growth capex spend/asset-build to cash flow harvest mode with minimal ongoing cash flow requirements. As capex is dialed down, the company could begin to generate cash flow per share in the $1.50 context reflecting a ~15+% FCF yield. Given the inherent asset light nature of the core business, we believe this provides a compelling investment opportunity and recommend the Aegean equity.

 Investment Highlights

1. Indirect but much safer way (as in heads you win, tails you do not really lose) to benefit from exposure to gradual improvements in Shipping space (broadly defined) [Bunker demand should increase]

2. Major Capex spending from the last few years should abate; with normalized maintenance capex levels, FCF generation will markedly improve

3. Fixed asset base (sunk cost) provides operating leverage which will magnify earnings/cash flow with additional volume

4. Regulatory environment increasing complexity of supply chain - ANW assets well positioned for this

5. Upside to run rate cash flow levels not apparent in the numbers due to Hess M&A and opening of Storage Facility in Fujairah

6. Company appears much more levered than it already is; large chunk of debt is simply working capital financing (and company operates at Working Capital Surplus even net of Short Term borrowings)

7. Well Positioned for Growth – Ample Liquidity

B. Company Overview

Aegean is a global marine fuel logistics company that markets and physicallysupplies refined marine fuel (aka bunker fuel) and lubricants to vessels in port and sea. In short, they are the gas station that brings the ‘gas’, or in the case of ships, marine fuel, to the ships. Ships cannot operate without fuel so getting it is critical. We bolded the word physically above as there are two basic camps within the marine fuel logistics space – 1) Companies that are more akin to brokers like World Fuel Services (INT), rarely taking physical ownership of the supply. These players are intermediaries capturing a spread for facilitating the ships ability to get its required bunker fuel; 2) Companies like Aegean that take physical ownership of the product and engage in the physical delivery of the product to end users (ships). The bulk of Aegean’s business is the delivery of bunker fuel but it is worth noting it has been rapidly increasing its supply of lubricants (volume wise a rounding error on total delivered volumes) which carry a much higher margin than bunker fuel.

Assets

ANW operates a fleet of 53 bunkering tankers (9/30/13) with an additional 9 tankers chartered in (leased). The company also operates 5 land based storage facilities with a major facility at Fujairah (UAE) under construction and expected to be completed in early 2014. Additionally, the company has 3 floating storage vessels in each of Fujairah (will likely be sold/scrapped once the land based facility in Fujairah comes online in early 2014), the Mediterranean and in the ARA (Amsterdam-Rotterdam-Antwerp) regions.

Value Chain:

Aegean’s business aim is to capture as much value as it can across the entire marine fuel logistics supply chain through integration of all components. The following sketch simply shows the different parts of the supply chain and which when integrated into a single entity allows for margin to be captured along the way.

 

In short, through controlling as much of the supply chain as it can, ANW is able to extract more value for itself (keeps more of the ‘margin’). 

Summary of Vessel Ownership Benefit:

Through owning bunkering tankers, the company avoids paying third party fees, is positioned for fixed cost operating leverage, can take advantage of product arbitrages (cheaper in one port than another – can go source product from elsewhere and bring it to the port where it has demand) and can more easily enter new markets as it did in Jamaica where without its own vessels, there was limited to no third party vessels available to lease to perform delivery had it wanted to enter without owning assets. All this notwithstanding, with ANW’s assets currently underutilized, it is possible that not owning the assets would be better under current market conditions. As outlined below, however, the difference between owning and not owning does not appear as material as one may think (i.e. one may think the fixed cost drag is more meaningfully negative).

Summary of Storage Capacity (Owned or Leased) Benefit:

·         Volume discounts (cannot buy in bulk without a place to store it); lack of storage is in part reason for lower margin in ARA region (discussed below by Verbeke Acquisition)

·         Can blend product which enables sale of higher margin fuel; particularly important as regulations are moving toward lower sulfur fuel

·         Third party revenues via leasing (Fujairah facility is geared for this)

C. Key Financial Drivers: Volume & Gross Spread

The key drivers for ANW’s profitability are volume of bunker fuel sold, measured in metric tons and the gross spread per ton that it achieves (akin to merchandise margin in the world of retail). Gross spread for marine products (bunker fuel) is just the difference between the cost of the product sold and the price achieved. The company does not remove the costs associated with its physical delivery or even storage facilities from gross spread which helps explain in part why its margin appears much higher than peers like Chemoil who utilize third party delivery systems and hence sell the product for lower/deduct the cost of delivery from the realized price or increase the cost – all of these adjustments just get to the same place which is lower net spread:

 

 

Volume

ANW has had impressive volume growth in the last few years (in 2005, the last full year before its IPO, ANW had 1.7mm MT in volume). Growth has been driven both organically (through opening up operations in new locations, helped by a growing fleet) and through acquisitions. In 2004, the company was in 3 markets and today operates in more than 22 markets:

 

 

 

On the M&A front, the company acquired two companies in 2007 for total consideration of $5.8mm (entered Northern Europe and the UK respectively), one company in 2008 ($9mm consideration), two companies in 2010 (Verbeke for $59mm – the largest acquisition in the company’s history to date and which helped the company enter the important ARA region, and Shell’s Las Palmas Terminal [Canary Islands, near the northwest coast of mainland Africa] for $10mm) and recently the North American bunkering operations of Hess.

The Verbeke acquisition is notable for two reasons: 1) It gave ANW a presence in the ARA region, the world’s second largest bunkering market (after Singapore; Fujairah rounds out the top 3 globally); 2) It materially increased the companies volumes: ANW sold 6.1mm tons in volumes in 2009 while Verbeke sold approximately 3.5mm tons.

Gross Spread

Similarly, while Gross Spreads have moved around, they have averaged $25/MT a level which management (ANW President, E. Nikolas Tavlarios ) on its last earnings call (Q313) maintained is a sustainable base level though with upside to that number:

“I think we sort of averaged $25 in 2012 and that's kind of – I don't know – I'd like to tell you how to think about it, but that's what we saw in 2012. There are drivers in the future as I talked about, again earlier that the movement toward low-sulfur fuels and gas oils will help what spreads look like in – as we get out there in 2015. So spreads should go up. But right now, we're a conservative company, and that's the way I think about it right there around”

So why $25/MT? What is special about the number $25?

The simple answer is nothing is special about $25. The company has been able to generate spreads north of this though at times has been lower. Overall the average has been in the $25/MT zip code and given we believe there are several tailwinds that can push spreads higher, we are comfortable assuming $25/MT as a base line level for the business (to be a little conservative, our 2014E number actually models $24.5/Mt). Upside, for example, could come from increased volumes (volume discounts, more blending) at the Fujairah facility which will increase storage capacity markedly in Fujairah and through benefits stemming from regulation on Sulfur emissions discussed below.

 

 

 

2010 Gross Spread Decline – Verbeke Impact

On an annual basis, 2010 was clearly a bad year in terms of Gross Spreads. Some of this was blamed on the market (admittedly, according to ANW, the “market” seems often to be the culprit whenever things do not go as planned – an answer/explanation we find lacking) but a primary driver was the impact of lower gross spreads achieved post the acquisition of Verbeke. In early 2010 (4/1/10), ANW closed on the acquisition. Although it had large volumes, the ARA market in which Verbeke operated was structurally different from the bulk of ANW’s prior business and generated lower gross spreads. The ARA business is different for two basic reasons: 1) There is limited storage capabilities which removes one component of the value chain (volume discounts on purchases and value added services via blending); 2) Vessels utilized are mostly river barges not ocean tankers; the bunkering takes place at the dock, not at sea and as a consequence while this drives high volume per barge (high utilization since not moving around a lot) the value add is less: bunkering vessel pulls up to a dock, fills up with fuel and then moves to another part of the port where it supplies a ship at dock. This is more akin to a pipeline. The ports are relatively compact and the bunkering is done in a few areas so do not go very far to get the fuel. Accordingly, the value that is added on the shipping side is lower (limited margin on transportation component of the value chain).

Importantly, the year following Verbeke, ANW Gross Spreads began to recover back to the $25 range which is notable given the absorption of the Verbeke business.

Spreads Post Hess

Company wide spreads will likely decline as the Hess business (discussed below) does roughly 1.8mm MT (high teens % of total volume) on gross lower spreads lower than the company’s existing base (number not disclosed but we do know that the business generated ~$16mm in EBITDA on 1.8mm tons which is EBITDA/MT of $8.9 so the Gross Spread is likely below $25/MT). For modelling purposes, however, we are modelling out the legacy ANW business and adding in the expected Hess contributed run rate EBITDA (will get a better sense for how it impacts specific line items when the actual results start flowing through the financial statements). We use $24.5 for our run rate 2014E numbers rather than $25 to be somewhat conservative.

D. Investment Highlights

1. Indirect but much safer way (as in heads you win, tails you do not really lose) to benefit from exposure to gradual improvements in Shipping space (broadly defined) [Bunker demand should increase]

Bunker demand should rise 1) in line with GDP (more trade) and 2) improved earnings in various pockets of the shipping sector will lead to decreasedslow steaming/increased vessel speeds which leads to higher fuel consumption:

1)      Global Trade: According to IHS Global Insight, the global marine market is expected to expand 5-6% annually through 2015 (ANW Q313 Presentation). The key driver is increased global trade driven by global GDP which is very much tied to total cargo (be it dry, wet, containers etc) moved by sea:

 

 

 

Source: Q313 Presentation

2)      Slow Steaming: Additionally, volumes should rise as with rising rates expected over the coming years across many sectors within the Shipping space, operators are incentivized to minimize any Point A to Point B fastest, as slower speed leads to lower fuel consumption over the same distance). Higher rates means operators are incentivized to deliver the cargo as quickly as possible and pick up the next cargo (earnings of next load outweigh cost savings of moving more slowly and consuming less fuel on current load).

Rates have picked up in the last few months from where they were a few years back in select sectors such as the dry bulk (Capesize rates have gyrated but have returned to much higher levels than seen in 2011through most of 2013, hitting on many routes $40K+ TCE in December 2013 compared with 2011/2012/2013 averages of $17K, $7K and $15K per the latest Clarkson’s Shipping Intelligence Weekly ), Product and even Crude where in in recent weeks spot earnings have risen north of any level in at least the last two years.

An operator on the ground in Greece who we spoke with gave an example which brings this point to light: In the contracts between vessel operators and cargo owners (contracting to bring cargo from Point A to Point B), he has seen an increase recently (December 2013) in the required speed for VLCC vessels to travel at, going to 13.5 knots versus 11.5 knots in the May-September 2013 period.

 

 

Recent Trends – Volume declines

YoY Volume on a percentage basis declined in the single digits in 2013 (high single in Q313). The company has not provided a clear cut answer but this trend was seen in other areas (Chemoil also showed a decline in 9 Mos 2013 though lower YoY %). The company has blamed a tough operating environment for shipping companies (rates).  The same Greek operator we spoke with attributed the decline in Q313 to slower vessel speeds (slow steaming) which can be seen in the speed of the charter parties: Panamax charter documents specifying 13.25 knots as opposed to 13.5 knots; Container speeds reduced from 15.5 knots to below the 14.75 knot level (Containers are the most fuel intensive ships – think Hummers on the sea – and slower speeds by Containers has a disproportionate impact on the overall global demand for bunker fuel. To be clear, we do not have granular data on the various vessel types and their percentage of total fuel demand. Furthermore, it is important to note that the Container space has not seen the signs of recovery seen in some of the other spaces and in the near term may cap global bunker volume growth but conversely, due to the high fuel consumption of Container vessels, if and when the market recovers, the Container space can have an outsized impact on global volumes = underappreciated potential future tailwind).

 

Key Volume Takeaway:

Assuming at a minimum constant market share (currently we estimate it is in the 1-5% range globally), ANW should benefit from the increase in global volumes. This is part of why we think 10.5+mm tons for the existing business (pre the newly acquired Hess assets & pre any impact from the start-up of the onshore Storage facility in Fujairah in early 2014), is reasonable as a baseline volume assumption. Any upside to this number over the coming years would be meaningful as described below due to the operating leverage inherent in ANW’s fixed cost asset base.

Global Bunker Fuel Demand – Volume Caveats

There are two important concerns worth discussing:

1)      Increase of what are called Eco friendly vessels, basically newer built vessels designed to burn less fuel. Ships burning less fuel is obviously trend negative for global bunker volumes. The idea of fuel efficiency is not new, however, and engines have progressively become more efficient over time. The focus on Eco stems in part from shipping rates being in a trough the last few years which prompted operators to look for areas to save in, resulting in an increased focus by the shipyards to make even more efficient ships.

a.       The counter to this point is that Eco as a % of the global fleet remains small and furthermore, to be absolutely clear, an Eco designed vessels does not eliminate the need for fuel, it simply reduces consumption at a given speed. In an improved environment, the negatives of lower fuel required for a given speed is countered by increased speeds (notably reduction of slow steaming) as vessels race to deliver one cargo and pick up the next as the money to be made from the cargo delivery becomes more meaningful relative to the cost of fuel.

This point was summarized by ANW President E. Nikolas Tavlarios on the ANW Q113 Earnings Call (addressed both the impact of Eco and the expected onset of increased vessel speeds):

 

 

“Yeah. I think the eco story, I mean, it's such a small part of the business right now. There are so few eco ships out there and they're a bear market. They're the kind of ships that are great in a bear market. Once you had a bull market, you got to go as fast as possible in those – when ships are going fast, they burn a lot more fuel.

 

 

 

 

2)      Shift to alternative fuel sources: there are some people in the industry who think that down the road, ships will run on an alternative to bunker fuel such as LNG. At the present, it would seem this would certainly not take place in a meaningful way for at least a decade as the global fleet would either need to be retrofitted somehow or replaced over time by ships running on another fuel source. This is obviously a long term risk of the core ANW business model but one we are comfortable with. It is questionable whether even such a shift will occur, and if it does in fact occur the impact seems far out into the future, and who knows, maybe ANW will be able to position itself to provide the LNG (or whatever energy source replaces bunker fuel) since, hey, ANW is at its core a logistics company!

 

 

2. Major capex spending from the last few years should abate; with normalized maintenance capex levels, FCF generation will markedly improve

At its IPO in late 2006, Aegean had 12 owned bunkers (10 double hull/2 single hull). At the time, the company stated that it planned to take advantage of the phasing out of single hull vessels by increasing its fleet by at least 31 new double hull bunkering tankers through mid-2010. 

Why?

 In 2003, the International Maritime Organization (IMO) introduced regulatory guidance for the phase out of single hull tankers carrying Heavy Grade Oil by 2008 (simple as it seems – double hull has a second hull which engulfs the first hull, thereby reducing likelihood of oil spills into the open sea). Different countries adopted the IMO regulation in different ways but generally, ANW’s thinking was that the phase out would lead to a supply and demand  imbalance (number of vessels being phased out was less than the number of newbuilds expected to come on the water due to constraints driven by lack of shipyard capacity). ANW’s Q407 Presentation cites Lloyds Marine Intelligence Unit projections which projected a decline in total bunkering vessels from around 3,400 in 2007 to 1,500 in 2012 (not weight adjusted so if newer vessels replacing phased out vessels had more capacity than the vessels they replaced, capacity would not decline by as much).

Over the next 6 years through the present, ANW engaged in a massive capex undertaking boosting Gross Vessel assets on its year end 2005 balance sheet of $47.5mm to 9/30/13 Gross Vessel Assets of $519mm with 53 period-end owned bunkering vessels.

Storage Capex

The company has used its larger vessel base to help its planned expansion into more markets and increase overall volumes. To this end, in addition to vessel acquisitions, the company has over the last several years increased its owned storage presence, at times through leasing (i.e. 52,000 cubic meters of storage capacity in Barcelona, a market entered in 2013, shows up in opex) and at times through building (capex). Other fixed assets have increased from $1.2mm year end 2005 to $146mm at 9/30/13. The majority of the increase in other fixed assets relates to the company’s construction of a 465,000 cubic meter Storage Facility in Fujairah with expected total cost in the ~$150mm zone and $142mm paid to date.

With the bulk of the capital spending behind it (Fujairah Storage facility expected to be complete by Q1 2014 with less than $20mm in payments remaining) and no new vessels on order, the company is well positioned to have the proverbial 7 years of cash flow plenty following  close to 7 years of cash flow famine.  Capex should revert to maintenance levels which are approximately $10mm ($10mm is in line with drydock incurred in 2010 and 2011 for the fleet; in 2012, costs incurred were $6mm). $10mm of capex on a growing EBITDA base should lead to material cash flow generation in the coming years.

The completion of the capex intensive period and the shift to cash flow harvest mode was summarized on the Q213 Conference Call by ANW Chairman, Peter C. Georgiopoulos:

“But we really do believe, again, Fujairah facility will be finished. There are no more ships to order. We still have plenty of capacity on that side. So we think that the company is going to be building up substantial amounts of cash.”

 3. Fixed asset base (sunk cost) provides operating leverage which will magnify earnings/cash flow with additional volume

Following its decision to greatly increase the size of its owned fleet, the build-up of which came amidst a slumped Shipping sector, Aegean has been left with a high fixed cost base and underutilized assets.

For context, volume per bunkering vessel per day has been range bound in the 400-500 MT/daily range more or less for the last few years, failing to reach the peak utilization levels of late 2006 through 2008 in which daily tonnage per vessel was generally in the 500-600 MT/daily range and in some quarters exceeded  600 (excludes the Verbeke Assets which are much smaller than the rest of the ANW fleet – mostly river barges with carrying capacity of ~ 800  DWT compared to the majority of the remaining fleet which are ocean going bunker tankers with several thousand DWT in carrying capacity).

The costs of maintaining an owned fleet are more or less fixed: 90-95% per chats with management (outside of fuel which is obviously variable depending on fuel pricing).  Management is well aware of the opportunity though admittedly, just because you have capacity does not mean it will be filled. Management has claimed on earnings calls that it could increase volumes dramatically if it wanted to but due to prudent credit underwriting (which is supported by the company’s minimal credit loss despite billions of credit underwritten to customers) will not take volume just to take volume. Here is a sensitivity table put together by management to show how annual volumes would increase with higher vessel utilization:

 

 

 

 

Source: Q313 Presentation

Fixed costs on underutilized assets presents tremendous operating leverage which if realized can rapidly increase the company’s EBITDA and FCF generation. Here is a sensitivity table of EBITDA at different Gross Spreads and Volumes (note: no credit given for Hess acquisition and pick up in earnings/reduced cost from the Fujairah facility coming online which should bring ~$25mm of EBITDA on top of this number):

 

 

 

4. Regulatory environment increasing complexity of supply chain - ANW assets well positioned for this

The IMO has enacted regulation which aims to reduce sulfur emissions at sea (cleaner fuel). This translates into lower Sulphur oxides (SOx) within the fuel used. The regulations however, are both tiered in their implementation and apply differently in different areas. The controls distinguish between Emission Control Areas (ECA) and non ECA areas. Within the ECA areas, the SOx allowed as a percentage of the fuel is as follows:

 

 

 

Source:http://www.imo.org/OurWork/Environment/PollutionPrevention/AirPollution/Pages/Sulphur-oxides-%28SOx%29-%E2%80%93-Regulation-14.aspx

 

 

Ships will be sailing both in and out of ECA areas and therefore at times may use different grades of fuel (with different sulfur content). This provides the following opportunities for ANW in the coming years:

1) ANW has newer and more complex vessels with multiple tanks (albeit average age is 10 years old). This enables it to deliver various grades of fuel (segregated by tanks) which is a service not all local operators which may have much older and simpler vessels can undertake

2) Further blending margin in its storage facilities – ability to sell higher margin fuel as the more work that needs to be done to make the product comply with the regulations, the more opportunity there is for the companies operating the storage facilities blending the fuel to sell product at a higher price

 

ANW is positioned to increase its volumes (can take share from smaller less sophisticated bunker vessel operators) and to generate higher gross spreads. We do not give ANW credit for this in our financial analysis below but believe this to be upside to current run rate levels that may pan out in the coming years.

 5. Upside to run rate cash flow levels not apparent in the numbers due to Hess M&A and opening of Storage Facility in Fujairah

In 2014, ANW will benefit from two new additions to the business:

 

1) On 11/12/13, the company announced the acquisition of the U.S. East Coast bunkering business of Hess Corporation. The purchase price is $30mm. The business has sold around 1.8mm tons on average the last few years and generates $16mm in EBITDA. Hess is in a transformation in which they are aiming to become a pure play E&P so shedding the bunkering assets is part of its aim to shed non-core assets. To be clear, the business acquired is asset light (no vessels or terminals). There is a lease contract in place for capacity in a former Hess terminal (sold to a third party) and distribution of fuel to ships is accomplished by third parties (driven by Jones Act requirement which would prevent the ANW vessels from operating on the US coast in any event). The deal was likened by management on the Q313 earnings call to the Verbeke deal and we believe the core similarity is that in both, the company acquired a large volume base albeit with lower gross spread on that volume (relative to the rest of ANW’s business). We model the core business and add $15mm as run rate contribution of the Hess assets to total EBITDA. Upside can come if ANW succeeds in using its new US East Coast presence as a way to build up more volume or as a toehold for expansion into other nearby markets.

 

2) Opening of the ANW’s 465,000 cubic meter storage facility in Fujairah. The company has stated it plans to lease out to third parties up to half of the capacity from this facility. This facility will replace ANW’s existing 83,890 DWT floating storage vessel in Fujairah (large vessel which holds product). The total cost of the facility is in the $150mm range. For context, Fujairah is in the UAE and is one of the world’s three largest ports in terms of bunkering volumes. Fujairah’s role in global trade is expected to increase as it sits outside the Arabian Gulf and therefore accessibility is not subject to Iranian influence through Iran’s control of the Strait of Hormuz. This is important as instability from Iran makes Fujairah a more attractive location for vessels to both pick up cargo (traditional crude product from the region as well as the increased levels of refined product as Saudi Arabia and other countries continue their refinery build out) and refuel.

 

 

The impact of opening the new Fujairah facility to EBITDA is two-fold:

a.       Direct impact from the leasing of up to half the facility. The company believes it can achieve $15mm in EBITDA from third parties leases. The facility is roughly 50% /50% for clean products (gasoline etc. which the company is not in the business of distributing) and dirty products (either crude or bunker fuel). Per a recent chat with the CFO, 50% of all the clean capacity (~25% of total) plus another 30% of the dirty capacity (~15% of total) is expected to go to third parties though these numbers are not fixed (sounded like target is 40-50%). If we assume a total of 45% is leased out, that is total capacity of roughly 210K cubic meters. Lease rates are roughly $4-5 per month in the market which would equate to $4.50*210K*12 = $11mm in revenue at the midpoint. We spoke with an operator of a storage facility in Fujairah of similar size who pegged the full facility monthly operating costs of his facility at $350K (annualized to ~$4.2mm). On the half then that would be leased by ANW, EBITDA along these lines would be in the $9mm range. [While there is a large amount of onshore storage capacity coming online in Fujairah, some think that this will simply replace existing floating storage (Fujairah is incentivized to minimize/ban floating storage as with onshore storage, vessels are forced to come to port and thereby pay fees which accrue to Fujairah; with offshore storage, Fujairah does not share in the pie)]

b.    Indirect benefit from larger storage which is 1) increased purchasing discounts on larger volume, 2) increased blending (can add a few dollars to the Gross Spread), 3) reduced operating costs of the floating storage that the new facility replaces: assuming $8K daily opex for the existing floating storage (an Aframax; conservative as possibly higher as $8K is rate roughly for a new Aframax whereas the Leader, the Aframax used for storage in Fujairah was built in 1985), total vessel opex saved (not to mention fuel) is roughly $3mm. This compares to $2mm in annualized costs on the storage not leased which together with fuel savings should be a few million saved.

 

 

 

 

Putting it all together, we see a path for how the company can achieve at least $15mm off of the facility (though maybe not $15mm alone from the leasing side) and are giving them run rate credit in 2014 of $10mm (with upside very much in place for future years).

Together, Hess + Fujairah should add ~$25mm in EBITDA on a run rate basis to the existing businesses EBITDA in 2014 (Fujairah coming end of Q1 but we are valuing the business on an estimated 2014 run rate basis).

 6. Company appears much more levered than it actually is; large chunk of debt is simply working capital financing (and company operates at Working Capital Surplus even net of Short Term borrowings)

A screen of the company, particularly on unlevered metrics (EV etc.) will make the company higher valued than we believe is the case. The company generally operates with high levels of Working Capital, much of which is financed with short term borrowings. For example, over the last 4 quarters, Receivables + Inventory less Payables + Short Term Borrowings (which help fund the corresponding short term assets) have been north of $100mm, and was $131mm at 9/30/13 (this excludes debt classified as long term which relates to WC which at 9/30/13 we estimate was roughly $150mm [$490mm less $340mm of short term borrowings]).

More specifically, the company identified $490mm of its total 9/30/13 balance sheet as Trade Finance debt (the remainder is debt tied to fixed assets such as vessels). We think it is reasonable to view this trade debt similar to an operating liability as opposed to a financial liability (particularly since it has corresponding easily liquidated asset which it is financing and which is the very business in which ANW operates; ignoring those assets [receivables/inventories] makes the company appear more levered than a full view of the balance sheet indicates).

Accordingly, the company would have the following debt profile (We recognize people may dispute this way of looking at the company and are sensitive to the argument that WC is ANW’s PP&E (as in this is the base on which the company’s business operates!) but conversely, precisely because it is a WC business, we think there is an argument to treat the trade finance debt as simply an operating liability and exclude from the EV calculation). We think, however, that given the bulk of the debt is to finance liquid assets which the company needs to operate but simultaneously, could liquidate and pay down much of the debt in short order, giving credit to these current assets is not a terrible way to think about it when considering unlevered valuation metrics. Some analysts add back NWC to their Net Debt, some only look at Long Term Debt and just ignore Short Term Borrowings and the company (to be expected) takes an even more aggressive approach (includes Other Current Assets in its Net Debt Calculation that it publishes in its earnings presentations). Here is how we are looking at it:

 

 

 

This takes a company from having $646mm of Net Debt (PF for October Convert [debt and cash net of fees] and $30mm in cash spend for the Hess M&A) and LTM EBITDA of $80mm (8x; no credit given for Hess EBITDA) to having $198mm of Net Debt which is optically much more appealing 2.5x and we think a better representation of ANW’s true credit profile.

7. Well Positioned for Growth – Ample Liquidity

Access to liquidity is very important in the bunker supply space. More liquidity means a company can handle more volumes. This becomes even more important when fuel prices rise as a given credit line will not support lower volumes though the ships coming in need the same volumes to operate all else being equal without regard for what those volumes cost. Those companies that have ample liquidity are at a competitive advantage when compared to local and smaller suppliers worldwide.

ANW is very well positioned liquidity wise and recently announced the completion of a $1 billion secured multicurrency revolving credit facility to fund working capital as well as issued $86mm in Convertible Debt in October 2013. The company had north of $500mm of liquidity (excluding cash) under its bank facility as of 9/30/13. Pro forma for the convert, this figure would have gone up by roughly $35mm as proceeds from the convert were used to repay a portion of the bank debt.

E. Identity Question: Is this an Asset light or Asset Intensive business? Critical question for thinking about Valuation

A critical question in valuing ANW is whether ANW is an asset intensive business or an asset light business. The difference is crucial as not all EBITDA’s are created equal and if recurring capex to maintain a large fleet was necessary to ensure the continuity of the business, then the multiple we would be willing to ascribe to such an EBITDA would obviously be lower. In contrast, if ANW is really an Asset Light business which happens to own substantial Assets, then that kind of business ought to command a premium valuation to more asset intensive companies.

When evaluating companies with depleting assets, and Shipping companies in particular, we think it is prudent to assume a theoretical fleet renewal capex when looking at FCF metrics.

 

 

 

Alternatively one can look at EBIT as a proxy, the difference being EBIT will capture historical cost (though for many Shipping companies due to excessive buying at peak price levels, D&A overstates the annual amount that would be required to be withheld to replace the fleet, inflation not withstanding) whereas theoretical renewal capex captures how much the company would need to save in order to buy new vessels as its current fleet depletes over time. To be clear, this is NOT an actual cash flow item but a check to ensure investors do not overstate the actual economics available to the equity (if all the cash flows are valued akin to a sustainable manufacturing company, while in actuality the vessels deplete and will be scrapped in year 25, clearly the valuation will be overstated as a ~25 year cash flow stream would have been valued as a perpetual annuity).

We believe that in fact, while ANW owns a lot of assets, the core business is and remains a logistics operation which does not require the ownership of assets. The fact that ANW owns assets is function of a historical decision, which may or may not prove to provide an economic advantage (time will tell over the coming years). It is impossible to know the exact impact but ANW could exist (with obviously lower Gross Spreads but conversely lower fixed distribution costs) without owning any assets. This speaks to the intangible value inherent in ANW’s industry know-how, customer relationships and on the ground infrastructure (i.e. the intangibles that enable Chemoil to generate the sale volumes at the level that it does). In short, what appears to be an asset intensive business is really at its core just a logistics operation, focused on facilitating the delivery of fuel to end users through controlling as much of the supply chain as it can. It happens to be that there are sunk costs in the business that give it an asset intensive façade but this does not alter the very nature of what it is that ANW is, namely an asset light logistics player across the bunker delivery supply chain. ANW can theoretically easily sacrifice the physical delivery part of the supply operating as an owner and outsource it via short term leasing of bunker vessels/utilizing third parties for delivery. We do recognize that part of the value chain would be lost so there are in fact tradeoffs (fixed costs would go down, perhaps currently at the loss of some margin along the supply chain).

“Chemoil-ing Aegean”

Chemoil is a global competitor which is similar in size to ANW (specifically on the Retail sale which is where it engages in physical delivery of bunker fuel to end users – i.e. ships – as opposed to its ex-wharf /cargo sales which are to intermediate buyers who stand between Chemoil and physical delivery) which more or less is the asset light version of ANW – it physically supplies but has minimal assets, specifically ~10% of ANW’s net fixed assets despite comparable size (Chemoil PP&E on its 9/30/13 Balance Sheet was $57mm compared to ANW 9/30/13 Balance Sheet comparable assets of $587mm).

 

If ANW was to lose its vessels (we could assume it keeps its storage which have longer lives, do not per se deplete: they are facilities but to make it more comparable to Chemoil I will adjust) it more or less would become Chemoil. It would maintain a global presence, a large customer rolodex and the know how to effectively capture value along the distribution chain. We can get a sense for how this would look through the following exercise. In short, this removes ANW's Selling and Distribution costs associated with owning its own vessels and storage facilities and replaces it with the implied per metric ton cost that Chemoil pays for delivery of product per its financial disclosure:

 

 

Interestingly, EBITDA does not move that much, especially in the last few years. In 2008-2009, the difference is more pronounced (EBITDA much higher under the owned asset method). This is in part due to two things: 1) First, ANW owned fewer assets so the actual cost is lower (seen as % of Gross Profit); 2) In the earlier years, Chemoil cost per ton was higher so converting it takes a bigger toll (it was actually better to own vessels than to outsource). Lately, Chemoil distribution costs have come down to the $7/MT range. Accordingly, the numbers indicate a degree of indifference between owning (ANW) and leasing vessels (Chemoil). We should be clear that by losing part of the value chain, it is quite possible if not likely that overall Gross Spreads (held even in this analysis) would compress. Furthermore, as noted above, regardless of whether looking back it was a good capital allocation decision, with its current assets, ANW has an underutilized and fixed cost asset base which provides operating leverage should it succeed in increasing volumes. And if volumes stagnate, the fixed costs are already baked into current numbers

F. Valuation

ANW is currently trading at 9.6x Unadjusted EV/EBITDA 2014E, 5.8x WC Adjusted EV/2014E EBITDA and at a 15% 2014E FCF Yield. The 2014E numbers are run rate – i.e. they give full year credit for Fujairah though the facility is not expected to come on line until the end of Q1 2014 (accordingly 2014 full year actual numbers may come in a little lower). We view these numbers as a base line run rate level for the business. Going forward, however, there are numerous levers as outlined above that should drive earnings higher over time (growing volume with overall market and potentially above market levels if take market share, more spread captured via blending etc.). [Basic financial is shown at the end for context].

 

 

 

Comps

No real good comp (that has the asset intensity) for ANW. Chemoil’s business (Physical delivery) is the closest publicly traded business. World Fuel is another comp though it is not engaged in the physical delivery part of the business (more or less a broker). Could look as well to broad logistics players like EXPD/CHRW in the US and KNI/Panalpina in Europe though those businesses are quite different despite logistics/delivery component (notably they are more brokers of supply provided by others). On consensus 2014E EBITDA, here is what the grouplooks like (per CapIQ). I think using the Asset Light Freight Forwarders is a stretch but show it to get a sense, given this is at its core a logistics business:

 

 

 

 

I think 8x EBITDA is a fair (if not low) multiple given the true asset light nature of the business, especially going forward. This gets you a stock north of $15. While some may challenge how we calculate EV (whether to adjust the debt for WC), when shifting our attention to levered metrics, it is hard to see why this business on levered basis ought to trade at such a rich FCF yield as is implied based on our numbers. Given the current assets supporting the trade finance debt, this is not a situation of a ‘highly levered stub’ equity in which high FCF yields are justified. If valuing on a FCF yield basis, a yield in the 9.5-10% range gets you a stock in the $15 context. On a $10.05 purchase, that is 50%+ upside.

 

 

 

G. Other considerations / Management (Risk?)

It is worth noting that management is perhaps both a positive and a negative. On the one hand, management controls ~30% of the stock (22% held by Dimitris Melisanidis, the company’s founder and head of Corporate Development – the on the ground and behind the scenes controller of the company from Athens according to some people I spoke with) and 10% held by Peter Georgiopoulos (Chairman), whose Shipping empire includes General Maritine, Genco and Baltic Trading. On the positive side, management has skin in the game and will make money if the stock goes up or dividends are paid out. On the other hand, management’s interests may not always be aligned. Related party transactions do exist at ANW, notably an ongoing relationship with Aegean Oil which the Melisanidis family controls. Aegean Oil is one of the largest fuel distributors in Greece (think gas stations). The company provides ANW with roughly 7% in dollar value of its volume with a Platts based pricing mechanism (2012 marine fuel costs from Aegean Oil of $458mm out of total companywide level of $6,939mm cost of marine petroleum products sold). There is nothing that indicates that the relationship is anything but arms-length (it is Platts based as noted though HOW it relates to Platts is not disclosed).

More importantly, there are those out there that hold Melisanidis (a quick google search reveals claims of threatening to kill people, a prison sentence, as well as other criminal charges) and Georgiopoulos in low regard. I did speak with some buyers in the space who refuse to deal with ANW.

While this is worth noting and hard to handicap per se, we think at the end of the day, numbers matter and the company has been quite consistent in demonstrating its ability to grow, consistently generate operating cash flow and has set itself up well to generate meaningful cash flow in the coming years.

Should there be some embedded management valuation discount? Perhaps. But we think certainly not to the extent of the current investment opportunity afforded by ANW’s valuation in the market.

H. Risks

Risks are fairly straightforward: volumes get light, competition drives spreads down, Fujairah does not contribute EBITDA as expected, management does something imprudent with the cash generated or simply not in the interests of the minority shareholders

I. Basic Model