Description

American Commercial Lines (ACOM)

Most of the investment opportunities that I’ve seen that have involved a bankrupt company emerging into the front end of a supercycle with a new, respected management team have been highly profitable. American Commercial Lines (ACOM) is such an opportunity.

ACOM is one of the largest inland barge companies in the country. It emerged from bankruptcy in January and currently trades on the pink sheets. The management team came over from a successful turnaround of Wabash National (WNC) at the behest of Sam Zell, and are just starting to implement the same best practices at ACOM.

First, some background on dry barges, since this segment will likely be the driver of the stock’s performance. The inland river system hauls a large amount of heavy freight, at a price that is a fraction of competing transport (rail, mostly)—grain, steel ore/pig iron, coal, fertilizer and cement are the main commodities being carried. Back in the late 1970’s, a combination of factors (tax shelter legislation and the expansion of barge fleets by agricultural cooperatives) led to an explosion of dry barge supply, going from an average of 300 built/year in ’74-’77 to 1,000/year in ’77-’81. Look at the chart in the ACOM S-4 from April to get a sense of the magnitude. Since barges last roughly 25-30 years, these barges have started to be removed from the fleet already. However, the big move is still coming—40% of the current fleet will be over 25 years old in the next 4 years. While barge lives can be extended in a limited fashion, I’ve spoken with many people who confirm that this lifespan is largely fixed, as the steel literally corrodes to the point of being unusable. With the high rate environment that currently prevails, operators have been doing everything in their power to squeeze out a few more trips, but admit that the large scale scrapping will have to start within the next year, as the barges are literally falling apart. It is unclear if the shipyards can produce enough barges to replace the barges being scrapped, but even if they could, buyers are reluctant to jump in due to historically high steel prices; either way, supply will likely continue to shrink for a few more years.

So supply has been reduced over the last 3 or 4 years (I believe from over 20k to around 18k), but the real drop has yet to occur. In the mean-time, demand from coal, cement, iron ore, fertilizer and grain has grown steadily (NB: the size of a given corn harvest has only a limited impact on total demand; look at longer-term trends to get a sense) and has created the conditions for record pricing. However, if we look to a proxy such as the Baltic Dry index—which tracks the same cargoes moving through different waterways—and the rates that resulted in that market when demand exceeded supply dramatically, then rates may have just started their climb.

The liquid side of the fleet never saw the same supply spike, and is inherently less cyclical. Nonetheless, refined product/chemical demand is extremely strong right now and rates are very healthy on that side of the business as well. There is less of a dramatic impact on rates since more business is under long-term contract with large customers (Exxon, Dow), but the underlying dynamics are very good.

It is probably easiest to think about ACOM in terms of 3 segments: barge manufacturing (through its Jeffboat subsidiary), liquid barges, and dry barges.

Barge Manufacturing
Barges operate in US waters and are thus subject to the Jones Act, such that they must be made at US shipyards. There are really two sizable manufacturers left of barges in the US: ACOM and Trinity Industries. Both operated at break-even or money-losing margins in the last few years due to the escalating steel price and low demand for new barges. That situation has largely reversed itself. As you can see from Trinity’s press releases and results, there is some pickup in demand for new dry barges (shippers are forced to replace some of their decrepit fleet), and the manufacturers are being much more disciplined on the pricing. ACOM has said that while all the barges they are building through ’06 are locked in at 5% ebitda margins, any new order has a hurdle rate of at least 15% (Trinity guided me to a similar hurdle rate for their newbuilds). This division should be able to build 350 dry barges at $350,000 a barge by ’07 (once existing contracts roll off), for an ebitda of 18m. For reasons discussed above, this area should show very healthy growth for the forseeable future. Trinity trades at a higher multiple, but I think a 5x ebitda multiple is conservative, for a segment value of $90m.

Liquid Barges
Liquid barges largely haul chemicals and petroleum products. The customers are large and the contracts are frequently longer-term. The business is fairly steady relative to the dry business. Kirby (KEX) is a pure-play comp in this area. With a barge fleet of 2.4x as large as ACOM, it has an enterprise value of $1.4b. It has some long-term contracts with large oil companies, but we can argue about whether that is good in such a healthy spot-rate environment. Nonetheless, KEX is a quality company with a stable past, so ACOM deserves a discount. I give it a 15% discount to the pro rata fleet valuation, which gives a segment value of $490m

Dry Barges
Several industry participants with whom I spoke have said that this is literally the best dry barge environment they’ve ever seen. There is simply too much grain and steel and there are too few barges (and the number is shrinking). But to be conservative, it is instructive to look at the replacement value of the fleet. Currently, a new barge costs $400,000, but let’s assume this price drops to $350,000; scrap value is about 10% of cost. ACOM has 38% of its fleet slated for scrap in 3 years; with a life of 30 years, this is 10% of the expected useful life. In addition, the scrap value adds another 10%. So value this segment of the fleet at 10+10 = 20% of replacement value. Just as a gut-check for the conservatism of the estimates, these barges can currently get $140 of cashflow a day on the spot market, so buying this barge for $70,000 pays for itself in a year (without accounting for the scrap value). The remainder of the fleet should be looked at as 50% depreciated (probably conservative) + 10% scrap value, so 60% of replacement. The total is 38% x 20% + 62% x 60% gives 45% of replacement value on a blended basis, or $450m.

The total value is thus a little over $1b, less $400m of debt, leaves $660m of equity or $95 a share, 30% upside. The biggest risk to the story is a collapse of steel prices (hurting both the market value of the fleet and the demand side of the picture), so if you believe that is imminent, then you should hedge against it. A second risk is that there may be an equity offering coming, though my guess is that this could help the story as it would improve visibility and liquidity. However, I have assumed a 1m share offering that is used entirely for capex/fleet replacement (no debt paydown) in my calculation above. Note that management believes they can wring enough efficiencies out of the current fleet that they only need to replace 80% of the old fleet.

On an ebitda basis, I think the company will get to 130m ebitda on a run-rate basis ($85m ebitda at current rates + 45% of contracts reprice in 2h06 at 12% higher rates gives $36m + $8m sg&a removed in 6/05 + $10m benefit from jeffboat), which places the company at 6.5x, and $200m by ’07 (if all dry barges reprice at current rates, not assuming any increase in rates from here), or 4.5x. Every ebitda turn is $20 upside to the stock price, assuming the equity issuance mentioned above.

I feel like the valuation is conservative and probably represents a bottom for the stock, in that I am a) using discounts to net asset values, when in healthy markets companies frequently trade for a premium, b) using replacement values of $350,000 per barge when current prices are in excess of $400,000 c) not giving any credit to value creation to the management team (or Sam Zell, who owns 27%) on an historically mismanaged company, despite the fact they’ve seen this story before at Wabash d) assuming equity is increased 15% with no corresponding economic benefit and e) discounting the investor excitement that could result as the management revamps the company, registers the stock, gets analyst coverage, and starts telling their story to the Street—I think there is the potential for what I like to think of as “cyclical excitement”, with investors bidding up the stock to participate in what could be one of the last early-cycle stories.

Catalyst

registration; management roadshow; contract repricing