Description

Algoma Central

Algoma Central Corporation (“Algoma”) is a Canadian shipping company that trades at a reasonable valuation with growth upside and is majority owned (74%) by Empire Life Financial (ELF.TO), a company which I and others have written about earlier. Given the significant control block, Algoma shares are illiquid and trade roughly $150,000 Canadian per day. As such, this idea is meant for smaller accounts.

Business Description

Algoma Central Corporation owns and operates the largest fleet of dry and liquid bulk carriers operating on the Great Lakes - St. Lawrence Seaway, including self-unloading dry-bulk carriers, gearless dry-bulk carriers and product tankers. Algoma also owns and operates ocean-going self-unloading dry bulk vessels trading in international markets and 50% interests in global joint ventures that own diversified portfolios of dry and liquid bulk fleets operating internationally.

Algoma's business operations are divided into four segments (excludes the corporate cost segment):

1. Domestic Dry Bulk (41% of net earnings): The Domestic Dry Bulk segment is the largest segment, which includes the Company’s 18 Canadian dry-bulk carriers that transport bulk commodities across the Great Lakes, the St. Lawrence Seaway and Atlantic Canada. This segment serves a wide variety of major industrial sectors, including iron and steel producers, aggregate producers, cement and building material producers, salt producers, and agricultural product distributors.
2. Product Tankers (14% of net earnings): This segment manages 7 tankers transporting various petroleum products, along with a third-party-owned vessel. Customers include major oil refiners, leading wholesale distributors, and large consumers of petroleum products. Algoma has recently expanded this fleet with two tankers, two more on order, and a 50% stake in a joint venture acquiring 10 newly built tankers for European operations. This is where the growth over the next few years will be generated
3. Ocean Self-Unloaders (25% of net earnings): This segment consists of 8 self-unloading vessels for ocean transport. Three new ships are currently on order to replace the three oldest vessels in this fleet, ensuring its modernization.
4. Global Short Sea Shipping (20% of net earnings): consists of the Company's NovaAlgoma joint ventures which focus on niche marine transportation markets featuring specialized equipment or services This segment involves three 50% joint ventures:
• NovaAlgoma Cement Carriers: Specializes in the transport of cement. The cement carrier fleet operates pneumatic cement carriers servicing large global cement manufacturers that support infrastructure projects.
• NovaAlgoma Short Sea Carriers: Operates mini-bulkers for short sea shipping. The short sea mini-bulker fleet comprises owned ships, chartered vessels, and vessels operated under third party management contracts. The fleet supports the agricultural, cement, construction, energy, and steel industries worldwide.
• NovaAlgoma Bulk Holdings: Manages handy-size bulkers, slightly larger than mini-bulkers. The handy-size fleet is an opportunistic vessel sales and purchase venture.

The write-up will focus on the Canadian Domestic Dry Bulk segment which is the largest source of earnings and the growth opportunity in the Product Tanker segment.

Shipping is a competitive business. However, in its own small way, Algoma seems to have navigated this issue in its Domestic Dry Bulk segment somewhat by focusing on specialized vessels, strong long-standing customer relationships and operating in an area where regulatory backdrop is supportive of incumbents.

Domestic Dry Bulk

Domestic dry bulk is Algoma's primary revenue generator and produced 41% of the company’s net earnings in 2023. The company believes that it has a strong competitive position as a result of a few factors:

1. The structure of the Great Lakes - The Great Lakes are at different elevations. As a result, numerous locks (such as the Welland Canal) have been built to allow vessels to navigate varying water levels. The Welland Canal has specific dimensions, making it so that not every ship can transport cargo on the Great Lakes. While a ship designed for the Great Lakes can be utilized elsewhere, most vessels used on these waterways are specifically built for this purpose. Making a large investment in specialized ships for use on the Great Lakes acts as a deterrent for new competitors. Estimates suggest that only 10% of ocean-going cargo ships can currently navigate these locks.
2. Regulatory Challenges - Operating on the Great Lakes requires navigating the regulatory landscapes of two distinct federal governments (US and Canada), each with its own set of laws and regulations, in addition to eight states and two provincial governments. This complexity may discourage many shippers from even considering entering the market. Key examples of these regulatory hurdles include the Jones Act, the Great Lakes pilotage regulations, and the Coasting Trade Act. For example, The Jones Act mandates that vessels transporting goods between US ports must be constructed in the US, registered in the US, crewed primarily by Americans, and owned by US companies with a minimum of 75% US ownership. This requirement significantly restricts the number of potential competitors in the region, as Algoma, for instance, doesn't meet these criteria and is therefore unable to engage in US-to-US freight transport.
3. Shorter Shipping Season - The shipping season is shortened due to the freezing of the Great Lakes. Depending on the severity of the winter, the shipping season might last only 9-10 months, with the Soo Locks mandatorily closing each winter. As a result, utilization suffers.

The impact of these challenges is evident in the limited number of carriers operating on the Great Lakes. The segment is a near duopoly with two companies (Algoma and Canada Steamship Lines) potentially representing 90% of the market. In total, there are approximately 20 fleet operators with Algoma being the largest and one of the oldest. The stronger competitive position is evidenced by Algoma’s consistent EBITDA profitability (measured annually) relative to other small shipping companies.

Product Tankers

Algoma's growth will be driven by its product tankers segment. At the start of the year, the company had 17 new vessels on order, with 12 of these being product tankers intended for expansion.

Two of these new tankers, in partnership with Irving Oil, will serve the Irving Oil refinery under long-term charters. The remaining 10 will operate in Northern Europe through a joint venture named FureBear. Additionally, Algoma acquired two existing tankers built in 2009 for further growth.

What is the opportunity in FureBear?

The FureBear joint venture in Northern Europe is a 50/50 partnership between Algoma Central and the Swedish company Furetank. It focuses on owning and operating a fleet of modern, eco-friendly product tankers for short-sea shipping in the region.  

Key points about FureBear:

• Fleet Expansion: Initially, the venture planned to build four dual-fuel ice-class 1A product tankers. However, they have since expanded the order to ten vessels, demonstrating their commitment to growth and meeting future demand.  
• Environmental Focus: The tankers being built are designed with sustainability in mind. They have dual-fuel capabilities, enabling them to run on cleaner fuels like LNG/LBG, and incorporate various energy-efficient technologies to reduce emissions.
• Market Opportunity: The joint venture aims to capitalize on the phasing out of older, less efficient tonnage in the market and the increasing demand for biofuels transportation in Europe.
• Operational Efficiency: Upon completion, the vessels will be operated by Furetank out of Gothenburg, Sweden, and will be part of the Gothia Tanker Alliance, ensuring efficient operations and customer service.

Overall, for now, across the industry, the newbuilds are fewer than the older ships that are being phased out. It is this plus the demand for more eco-friendly ships that the FureBear JV is taking advantage of.

By the end of 2026, without any additional acquisitions, the product tankers fleet will have significantly expanded from 7 to 11 fully owned tankers, plus a 50% stake in a JV owning 10 new tankers and a partial interest in an 11th.

EL Financial - the control block of 74%

E-L Financial's significant ownership in Algoma Central should be considered a positive. There hasn’t been any indication in the past of any issues or conflicts given their presence at Algoma. Algoma is run for the long-term with an insurance company as the main owner. There don’t appear to be any issues with capital allocation as Algoma has pursued a three-point strategy for generating shareholder value – growth, share buybacks and dividends. Executive compensation is primarily based on the company’s ROE, which should incentive proper capital allocation. There are very few related party transactions. Overall, there don’t appear to be any corporate governance issues at Algoma, which differs from much of the shipping industry.

Valuation

Algoma generates roughly $2 in earnings per year and trades at a 7x P/E. Their goal is to achieve an ROE of 9.5% but they have modestly exceeded that target over the last number of years generating an ROE of between 10% and 15%. Similar companies trade at 5x-7x P/E, so Algoma’s valuation at the higher end of the range reflects its solid corporate governance and competitive position in its Domestic Dry Bulk segment.

Over the next 3 years, Algoma will be adding 12 ships to their fleet at an estimated cost of $60 million per ship. Ten of those ships are in a 50/50 joint venture (FureBear). Algoma intends to finance the ships at a 50/50 debt equity split. Given the above, Algoma needs to fund $120 million for its two fully-owned ships plus another $300 million for its share of the 10 ships in the FureBear JV. At 50/50 debt/equity, Algoma’s equity is roughly $210 million. Using an ROE of 9.5%, Algoma is targeting generating roughly $20 million in additional net income from these ships. This would increase EPS by about $0.50 per share for roughly 25% growth over the next three years. This also assumes no increase or decrease in earnings in the other business segments.

Given the 5% dividend yield and the 25% growth over three years, an investor may achieve a 40% plus return over the next 3 years.

Conclusion

At the end of the day, you are getting a company with a 9.5% ROE target trading at 7x earnings with growth upside run by capable management which is a valuable asset in the shipping business.

Risks

This is the shipping business and can be highly volatile

Delays in receiving ships

Commodity Prices / Production

Catalysts

On-time delivery of the ordered ships so that they can be put to use right away

Catalyst

On-time delivery of the ordered ships so they can be put to use immediately