Description

Long International Shipholding Corporation Preferred A or B.

The A and B preferred shares rank equally in the event of liquidation.
The B shares offer a lower nominal yield but usually trade lower due to lower liquidity.
The B shares however trade on the grey market, making it harder to acquire them.

For the price above, I have taken the average of the A and B preferred (being 36 for the A preferred, and 30 for the B preferred).

Fall to the OTC market

The company had already lowered the dividend because cash-flows came under pressure.
The dry bulk market, which reached new lows around that time had been dragging down company performance for a few years.
Then in Q2 of 2015, one of their Jones Act vessels (their most profitable division) was grounded and this started a domino effect. The lower profitability in the Jones Act triggered the loan covenants. ISHC had to restructure and sell vessels to lower debt. In the meantime, the preferred dividend got suspended. On top of all this, the shares (common and preferred), which had been trading on the NYSE for about 3 decades, got delisted to the OTC market. The market cap of the company was lower than 15 million for a period of 30 trading days. As of this moment, the shares still trade on the OTC market.

Needless to say, if you have been a holder of this company, you were in for a terrifying ride in the last few months.

The result of all this calamity is that the preferred A now trades at a yield of 27% (B is yielding 30%) and a yield to call of 74% for the A preferred and 70% for the B preferred.

Since the debt covenants had been triggered in Q3 2015, the company has sold assets to reduce debt outstanding from 215 to 124 million (some assets are still on sale and are expected to reduce debt to 100-110 million by june 2016). These asset sales came from divisions which can be considered non-core or had been underperforming for a number of years.

A bit different

Buying shares in shipping companies is a bit like going into business with the mob. You know they are going to steal from you, just not when and how.
And if they will not steal from you, the low returns will frustrate you.

International Shipholding is a bit different.
Run by the third generation, they are a very niche operator in the shipping space.
They focus on 3 things:
- having a barrier to entry
- stable, long term contracted cashflows with strong counter-parties
- Long standing customer relationships

While management had strayed somewhat from this course in the last few years (increased the size of the dry bulk division and some more specialty contracts) the focus is still on niche sectors.

3 niche operating businesses:

ISHC is interesting because it operates in very niche businesses (from now on at least), limiting competition and somewhat protecting margins.

Rail-Ferry:

By any measure, one could call this part of the business a failure. Started in januari 2001, this business provides shipping services to loaded rail cars between Mobile, Alabama and Coatzacoalcos, Mexico.
In essence, this is an arbitrage business by providing cheaper transportation to the south of Mexico by shipping rather than rail or truck. They are the only company which provides this sort of business in the Gulf of Mexico.

In the first 6-7 years of operations this business had been loss making and large impairments were made. Despite this, the business had always been cash-flow positive.

In 2007-2008, they decided to almost double the carrying capacity of the 2 ships by adding a second deck. Related to this improvement, the Alabama State Port Authority provided a loan for this upgrade (on infrastructure). This loan is repayable with an operating lease of 2.13 Million per annum until H2 2017.

Since this upgrade, profitability has dramatically improved. In 2012 they made an additional acquisition of 2 rail-car repair facilities to provide some synergies and increase profitability in this segment.

The Rail-Ferry segment generates between 4.5 and 8 million in Ebitda a year in the last few years. Starting in H2 2017, the 2.1 Million operating lease will have been repaid, increasing Ebitda quite substantially.

One drag on performance will be the sale of the Rail-car repair facilities.
This is an obligation to the lenders in order to lower debt. I expect them to get between 4 and 7 Million from the sale of segment. It is thus quite reasonable to assume this business added about 1 million a year to the profitability of the Rail-Ferry division.

PCTC

Operating 5 vessels (2 of them leased after a sale and lease-back transaction and the sale of 1 vessel to reduce debt for the restructuring) they offer Pure-car/Pure-Truck services to Asian car manufacturers. The PCTC market has been a stable part of the shipping sector since it’s almost entirely dependent on long term contracts to transport cars and trucks manufactured in Asia (mostly Korea and Japan) and ship them to other countries.

It is thus quite useless to have a ship and not have these contracts. This dynamic restricts entry into this market and creates a stable operating environment for PCTC owner/operators.

ISHC charters these PCTC vessels on contracts of longer term duration (the average remaining term was about 3 years). ISHC is entitled to its full charter hire irrespective of the number of voyages completed or the number of cars carried, providing some revenue visibility. The charterers are responsible for voyage operating costs such as fuel, port, and stevedoring expenses, while ISH is responsible for other operating expenses including crew wages, repairs and insurance.

The problem is that it is not a very profitable business. This is somewhat compensated by taking additional cargoes with them (usually cargoes unsuitable for container transport like railcars or small yachts).

Despite this, the segment has been quite consistently profitable (except for 2014), but profit is very reliant on these supplemental cargoes. This had been somewhat neglected during the 2014 period, but management again aims to ship an additional 6-8 million dollars of cargo every quarter. At first sight, they are on the right track again. In 2015, profitability had been restored to previous levels.

Management has been pretty opportunistic in this segment. They made quite a few lucrative transactions. In 2012, they “swapped” some older vessels for newer ones at a negligible cost. Similar transactions had been done before 2012.

The sale of their last vessel however, the Glovis Countess was done at 3/4ths of book value. This was mostly related to the speed at which they had to unload the vessel, and not related to the value of the vessel. Other transactions in the past were done closer to book value (usually at a small profit).

The Jones Act segment

As long as the Jones Act will continue to exist, vessels in this space will be somewhat shielded from international competition.

ISHC own a fleet which is the largest Jones Act dry bulk fleet by cargo capacity. On top of that, all contracts are long term contracts with credit worthy counterparties.

The profit of the Jones act was impaired during 2015 due to the grounding of a vessel. This created a follow on effect which mixed up their whole schedule of operations. The volumes are contractually committed and because one vessel fell out during the year, they had to move around schedules in order to fulfill their commitments. The result of this was a lot of non-operating days on some vessels which impacted profitability. And since the shipping sector has such a large operating leverage, these effects proved quite ugly.

This division has also experienced some margin pressure from the weakness in international dry bulk rates. Management expects to maintain around 20% gross margins, on a somewhat larger revenue base since they want to take on extra cargoes.

The restructuring has kept this segment in pretty good shape. Just one laid up tug-barge unit had been sold at around half of book value.

Specialty contracts

Specialty segments is an amalgamation of some vessels on long term lease, which on their own are not of big enough to influence the results in a big way.

The specialty fleet owns one ice strengthened multi-purpose vessel, one mini bulker and provides the logistics for Freeport McMoRan’s Grasberg mine in Indonesia until at least 2021.

One important thing about this segment is related to a note receivable. In 2009, the company sold the vessels it uses to service the Grasberg contract to an Indonesia company (PT Amas). Related to this sale they were paid with a 10 year note of 45 million at a 7% interest rate, of which 24 million is still outstanding. These notes are secured with a first mortgage covering the vessels until the note is fully satisfied. It is somewhat ridiculous that these notes are still outstanding while they pay 9 and 9.5% on their preferred shares.

The contribution of the specialty segment should be similar to the past, except for the sale of the 30% minority investments in the Asphalt and Sulfur carriers, which added 1.4 Million to net income in 2015.

Dry Bulk and its wind down

The dry bulk segment was part legacy investment, part investment in mini and handysize bulker vessels on the belief this segment would show improved economics. This turned out to be wrong, and the business suffered over the last few years. This segment was not part of their core strategy to focus on niche segments and it was decided to sell these vessels.

Since Q4 15 all vessels in this segment have been sold and the negative performance of this segment won’t impact the profitability of the company anymore. In the last few years, the dry bulk segment generated very little EBITDA (around 4 million in the last 2 years) and lowered net profit while more than 120 million was tied up in these assets.

This led to the sale of all the vessels in their dry bulk division, the wind-down of many of their “specialty” contract minority interests and large impairments on these assets. The rationale was very understandable, namely to focus again on the core pillars of the company. These were parts where the company had deviated from their path.

All in all, the sale of vessels has almost halved their net debt to more manageable levels.

Insider holdings:
Since the company is third generation run, the Johnsen family has an insider holding of 20.5%. That is calculated on the amount of issued shares, and not taking into account the treasury stock. When treasury shares are included, it is closer to 25%.

The family is quite pride about the company and its history, as is made clear by the book they wrote about it (it’s called “Not for Widows and Orphans: The Chronology of International Shipholding Corporation From 1947 to 2007”).

Very unusual for a shipping company is the fact that they had almost no dilution in the shares over all these years.

There is some concern that management hasn’t added to their common share holdings since the sharp decline in the share price. Due to the leverage in the common equity, this is somewhat understandable I believe.

Going forward

I suspect the future will look pretty similar to the past, but with a lower amount of leverage.

The 3 divisions they maintained were the ones that were responsible for about 85% of EBITDA in previous years while debt has been cut in half. The sale of the PCTC vessel Glovis Countess will lower profit and EBITDA but the renewed focus on additional cargo should probably compensate for this loss.

The Jones act segment will again look very similar to the past. Somewhat lower margins are expected, since the weakness in the dry bulk segment is felt in this segment despite the more protected market. The focus however to start carrying additional cargoes on the return journey should compensate for some of this weakness.

The Rail-ferry segment will experience some lower profitability due to the sale of the repair facilities but the repayment of the lease will compensate for this in the coming years.

Valuations

Management guides for EBITDA between 30 and 40 million (very similar to previous years), largely dependent on the performance of the Jones Act segment. At the current price of the preferred equity this means they trade at an EV/EBITDA of 4.3 times at the lower range of the EBITDA estimate. It is not very hard to imagine the preferred being made whole, at 5.5 times EV/EBITDA using the lower range of the estimated EBITDA.

In the Q4 2015 conference call, management reiterated their belief in the current carrying value of their vessels.

It is my belief that at current prices the preferred should be safe in the event of a liquidation (thus, implying the remaining assets are at least worth 2/3^rd of book value), while offering the potential to be made whole if management is successful in implementing their strategy of refocusing the business.

Catalyst

Re-instatement of the dividend

Improved operations from Jones Act segment

Continued debt reduction