Description

Overview

Kirby Corp is the largest inland tank barge operator in the US and is cheap to normal while entering a cyclical upswing in its largest business. Before Covid-19, people started to notice the upswing and the stock hit a high of $92.30 (vs. today at $46.30). 

This is a decent but unspectacular business, and it hasn’t changed much over decades. Kirby is by far the largest tank barge operator, and scale advantages have let them compound book value per share by 14%, Revenue by 12%,  and EPS by 8% (where the end point is cyclically low) over the past 20 years. Barges are an extremely efficient method of transportation, and all the worries about things like driverless trucks running in convoys should not affect this business in the future. If anything, we will get a tailwind as shale gas continues to incentivize new petrochemicals capacity. 

Why is it cheap?

The tank barge industry goes through regular cycles. The last was caused by the massive crude differentials we saw as shale drilling took off. Because tank barges were one way to take advantage of that arb, the industry overbuilt and has had overcapacity since then. In the peak of the last boom (2014) Kirby’s Marine Transportation segment had operating income of $430mm (vs. $216mm in ‘19). This excess has been worked off. Utilization has trended higher in recent quarters, and the outlook for industry barge builds is low. 

Kirby also sells and services diesel engines. Because 60% of that business (by ‘19 revenue) is oil & gas related, that business is suffering and is expected to lose money this year. 

I’ll focus mostly on the tank barge business in this write-up because it accounts for 74% of EBIT in my mid-cycle scenario. 

Business Overview

Before I get into the segments, it is important to note that investors looking at recent results see a business split evenly between Marine Transportation, which is mostly inland tank barges but also coastal tank barges, and Distribution and Services. But these numbers reflect a cyclical low in Marine Transportation, and a number above mid-cycle for Distribution and Services. 

Marine Transportation

Kirby operates tank barges on inland waterways to move chemicals, petrochemicals, agricultural chemicals, black oil, refined products and other liquids. Kirby is twice the size of the next largest competitor, and Kirby operates about 25% of total industry barges. 

Scale brings advantages that have allowed Kirby to earn its cost of capital over a cycle. 

Scale advantages are as follows:

- Flexible horsepower: Kirby charters 1/3rd of its horsepower (tugboats) and can quickly lay off this horsepower in downturns. Small operators do not have the financial or reputational ability to hire charterboat operators because these operators would rather work for Kirby.

- Horsepower matching: because Kirby has a large fleet, they can match horsepower to towboat size and needs. As an example, they might match an 800hp towboat to a single barge in a canal, but they might use a 3000hp towboat for larger river movements. 

- Fleeting operations: Kirby has facilities that are basically parking lots for barges throughout the inland waterways. These locations let Kirby match capacity to need, stage river movements, and clean out barges if they change products. 

- Barge variety: tank barges are set up specifically for the products they are moving. Tanks might need to be heated or pressurized depending on the product. Most importantly, it is very expensive to clean a barge to allow a different product in it, and having a large fleet of tank barges lets Kirby avoid the expense of cleaning much more than smaller operators. 

- Barge utilization: large barge fleets let Kirby avoid the barge equivalent of deadhead miles. 

- Countercyclical asset acquisitions: Kirby has done a great job over the years in acquiring and building barges in times of industry stress. 

Dry barges are much more fungible (they avoid the need to set up tanks for a specific product and the need to clean tanks) and for those reasons the dry barging business is worse than tank barges. 

The business is now in a cyclical upswing, and the drivers for a healthy cycle are in place. The ability to build new barges is somewhat limited. Barge builder Jeffboat shut down, and Trinity (Arcosa now) shut-in capacity they bought from ACL. During the prior cycle the industry could build 300 units, but Kirby believes that might be less than 200 today. Demand is growing as well. Half of Kirby’s volume is petchem, and the petchem industry has expanded and will continue to as long as shale gas has an advantage. With that said, I’ll go through what the cycle could look like. 

Here you can see the effects of utilization on contract renewal pricing:

And here you can see utilization vs. operating margins: 

Putting these together. I see operating income per ton mile moving well above 2 cents in the coming cycle: 

In my valuation below, I assume 2 cents is mid-cycle. 2 cents per ton-mile is a 10 year average, and it also squares with new barge economics: if you assume a 30,000 barrel barge costs 2.5mm, a new tow costs another 2.5mm, and you run close to 4 barges per tow and 18.5mm ton-miles / year. 2 cents of operating income gives 9% returns on this capital, and that is for assets run at scale by Kirby.

Cash flow should at least match taxed operating income for the inland business. Kirby’s fleet is younger than usual, and maintenance capex shouldn’t exceed depreciation.

Kirby also has a coastal tank barge business that had operating income over $100mm at the peak ($16.5mm in ‘19). My mid-cycle EBIT for this business is 1/10th of the inland business in my valuation, so I won’t go through it here in depth. Below you can see my margin assumptions for the coastal business:

Distribution and Services

The distribution and services segment comprises 20% of my mid-cycle EBIT. The business is a distributor and servicer of engines and transmissions (Kirby is the largest distributor of on and off-highway Allison transmissions and the largest distributor of MTU engines) as well as the largest manufacturer and remanufacturer of frac equipment in the US. The oil & gas related parts of this business are getting killed right now. The following graphics from an investor presentation provide a good overview of end markets:

Because this business is half of my mid-cycle EBIT, and because oil & gas is half of that, Kirby stock is not a bet on the recovery of pressure pumping in the US. I’ll also give some context around the $78mm of mid-cycle EBIT I use. 

In the 10 years before Kirby acquired Stewart & Stevenson in 2017 - which expanded the oil & gas business but also brought in more distribution for Allison, MTU, DTNA, EMD, and Deutz as well as rental equipment including generators and fork lifts - the D&S business did $38mm of EBIT on average. The acquired Stewart & Stevenson business did another $38mm of EBIT on average in the six years before the acquisition. In 2018 and 2019, segment EBIT averaged $116mm. So I think it is safe to say that mid-cycle is somewhere north of about $80mm. 

Note also that the Distribution and Services business is $960mm of my $4.9b valuation, and half of the EBIT here was acquired for $756mm. 

Valuation

Since this is the Value Investors Club, I’ll bust out everyone’s favorite metric, price-to-book, to start the valuation discussion. The following charts show P/B over the past 10 and 20 years for a business that is largely unchanged (some expansion in the Distribution & Services business but this is still mostly a barge business). 

Book value is an appropriate metric for context here because Kirby’s earnings in the tank barge business are directly tied to the returns on the cost to build new barges and boats. On these assets, Kirby should earn a commodity return plus something for scale advantages. 

Kirby looks cheap relative to its assets, but I mostly rely on a multiple of mid-cycle NOPAT for my valuation. For this I’m assuming 2 cents per ton-mile of operating income in the inland tank barge business ($302mm of operating income), about $27mm of operating income in the coastal business (vs. ‘19 OI of $16.5mm and a $117mm peak), and about $78mm of operating income in the Distribution & Services business. There is about $14mm of corporate cost, and I add back intangibles amortization of $16mm as well. Taxed at 25%, NOPAT is about $305mm, which at 16x gets you to a stock price of $59. Using today’s capital structure, that implies EPS of $4.40, or around 13x earnings. By this math, Kirby is an 80 cent dollar, but in good times people end up putting higher multiples on the stock.

Risks

- The oil & gas portion of Distribution and Services is even worse than I contemplate. The business is losing money today and I’m effectively assuming about $40mm of EBIT in normal times.

- The up cycle in tank barges doesn’t last long.

- Long term secular decline in petrochemicals leads to poor capacity utilization. 

Catalyst

Cyclical upswing in the tank barge business.