Description

Quick pitch

Kirby Corporation (KEX), an operator of tugboats and tank barges on the inland US waterways, is a long because it’s trading at 1.3x tangible invested capital (vs a historical average of 1.7x), its core inland barge fleet representing 65% of assets has generated an average 11% ROTIC/18% ROE over the past 50 years, assets are understated due to rapid inflation in barge newbuild costs, and pricing/margins are inflecting higher on rising demand and falling supply.  KEX is historically recession-resilient, but experienced a double-whammy of unprecedented events over the past 7 years:

1. Crude-by-barge hangover.  Starting in 2012, the industry increased the fleet size by ~15% to meet demand for transporting crude, only to see that demand disappear starting in 2015 when pipelines were built.  It took until 2019 for the market to start tightening up again when suddenly…
2. Covid hit in 2020, reducing demand for petrochemical barge transportation, tipping the industry back into oversupply.  This oversupply was not structural (as with crude-by-barge) but rather cyclical (reduced petrochemical demand due to lockdowns).

We expect pricing to continue marching higher over the next year, taking earnings well above consensus and the book multiple back to historical levels or higher.

Business description

KEX is a collection of three businesses that have been built up organically and through M&A over the past 50 years.

• Inland Marine (65% of TIC, 11% historical ROTIC, 18% historical ROE): fleet of ~1,000 barges and ~300 tugboats, primarily transporting refined petrochemicals on inland US waterways.
• Coastal Marine (19% of TIC, 6% historical ROTIC, 10% historical ROE): Fleet of ~50 barges and ~50 tugboats, primarily transporting crude and petrochemicals along the eastern seaboard.
• Distribution and Services (16% of TIC, 11% historical ROTIC, 16% historical ROE): distribution and servicing of diesel engines, primarily for marine and pressure pumping applications.

After diversifying into coastal from 2005-2015, and D&S from 2015-2017, the mix of TIC has recently shifted back toward the higher ROTIC inland marine business.

The ROTIC for the core inland business had been remarkably stable at around 11% for ~50 years prior to the crude collapse and covid.  KEX has been able to fund 10-20% of assets with deferred taxes (via accelerated depreciation) and another 30% of assets via debt (KEX is investment grade), generating ~18% ROEs in the inland business and ~10% ROEs in the coastal business.

Combining strong ROICs, leverage (both debt and deferred taxes), and accretive capital allocation, KEX has grown BVPS by 12-13%/yr over the past 20-30 years.

KEX is a $5.1B cap, $6.3B EV, and trades $25-30M/day.

Segment deep dive

Inland Marine.  The core inland marine business consists of transporting refined petrochemicals to/from refineries and chemical plants located along the Mississippi River System and Gulf Intracoastal Waterway.

KEX’s inland business primarily ships petrochemicals, with the split very roughly as follows:

• ~70% petrochemical (Benzene, Styrene, Methanol, Acrylonitrile, Xylene, Naphtha, Caustic Soda, Butadiene, Propylene)
• ~5% agricultural chemicals (Anhydrous Ammonia, Nitrogen-Based Liquid Fertilizer, Industrial Ammonia)
• ~5% refined petroleum products (Gasoline, No. 2 Oil, Jet Fuel, Heating Oil, Diesel Fuel, Ethanol)
• ~20% black oil (Residual Fuel Oil, Coker Feedstock, Vacuum Gas Oil, Asphalt, Carbon Black Feedstock, Crude Oil, Natural Gas Condensate, Ship Bunkers)

The US petrochemical industry is growing as low-cost feedstock gives the US a comparative advantage vs other geographies worldwide. 

Barge is the cheapest way to move goods across the country, so many customers purposefully locate their chemical plants on inland waterways to take advantage of the savings:

• Air: 137.49 cents per ton mile
• Truck: 18.83 cents per ton mile
• Rail: 4.23 cents per ton mile
• Pipeline: 2.96 cents per ton mile
• Barge: 2.94 cents per ton mile

Source: Bureau of Transportation Statistics

The inland barge business is one characterized by economies of scale.  Large, established players earn big returns while marginal players struggle to break even through the cycle.  This is due to:

• Higher price realization
• Customers prefer larger players with long track safety track records due to the risk of accidents and spills
• Transportation is a small cost to the customer, so inertia prevails
• Higher barge utilization
• Larger fleet provides more operational flexibility to reduce “empty legs”
• Lower unit operating costs
• Scaled purchasing
• Insourced maintenance
• Centralized fleet management
• In-house training (helps address qualified labor shortages)
• Lower capex
• Larger, better capitalized businesses buy barges at market bottoms when pricing is cheaper
• KEX is investment grade and so can get financing much more cheaply than competitors

We estimate that Kirby can earn ROEs that are ~600 bps higher than mid-sized competitors through the cycle.

Scale also gives KEX the ability to run a “line haul” business along key waterways.  Line haul is essentially like a bus service, where one towboat moves up and down the waterway, picking up and dropping off barges along the way.  Line haul tows can be 5-25 barges, whereas standard “unit tows” typically only have 2 barges.  Inland line haul is essentially a duopoly between KEX and ACL, who are the only players with sufficient scale to make the economics work.  We estimate line haul to be 20-25% of Inland Marine and ~15% of company-wide TIC.

Beyond the benefits of scale, there are other barriers to entry in inland marine:

• Jones Act.  All vessels going to/from US ports must be built by Americans and crewed by Americans.  This limits the influx of competition from lower labor cost countries.  All KEX vessels are Jones Act vessels.
• Barge supply.  The number of major barge manufacturers has shrunk down to only one, so there is a more limited capacity available to build new barges.

KEX is well aware of the risks of oversupply, so prefers to purchase barges in asset sales at the bottom of the cycle rather than build new capacity, and prefers to retire old barges rather than sell them to competitors.  This led to a long-term equilibrium in industry ROTIC and ROE.  Even recessions were fairly benign to KEX earnings, as downturns in petrochemical plant utilization have historically been very short-lived.

In 2012, however, the shale boom created a surplus of crude, and barges were needed to move it to refineries for processing.  400 tank barges were built specifically to service this crude market, such that by 2016, 550 barges out of a total 3,900 tank barge fleet were used for transporting crude.  Barges used to transport crude are considered “dirty” due to the heavy viscosity of crude, but they can be cleaned up at a cost of ~$40k each (~2% of fair value) to make them “clean” barges suitable for transporting petrochemicals.  Unfortunately for the industry, in 2015-16, demand for crude-by-barge crashed as new pipelines came online.

This led to an oversupply of barges and a collapse of day rates.

With underlying demand for barging growing 2-3%/yr as new petrochemical plans come online in the inland waterways, it took ~4 years for the market to absorb this excess capacity.  The market was just starting to tighten up in 2019 when Covid hit, tipping the market back into oversupply as refinery and petrochemical plant utilization fell.

Meanwhile, newbuild costs for barges went up 80% due to higher plate steel costs, tight shipyard labor, more stringent regulatory requirements, and more expensive components.  Bonus depreciation is also winding down, which reduces the incentive to build new.  Only one shipyard, owned by Arcosa, remains that produces tank barges.  As a result, retirements (typically a couple percent per year) exceed newbuilds.  25-30 barges have been ordered for 2024, which is <1% of the 4,000 barge US fleet, and ostensibly just replace existing equipment specific areas of the market.

In addition, many barges are out for maintenance and regulatory repair work over the next 12-24 months.

This is driving day rates dramatically higher.  Day rates for a clean 30k unit tow peaked at $8,000/day in 2015, troughed at ~$6,000/day in 2017 (crude-by-barge hangover), peaked at $8,000/day in 2019, troughed at $5,500/day in 2021 (Covid), and are now at $10,000 day, steadily rising almost every month.

Day rates need to get to $12,000-15,000 in order to induce any new capacity additions, and at those prices Kirby would be doing almost $10 in EPS.

Finally, it’s worth noting that the industry has consolidated, so should be structurally even better than it was in the past.  HHI has risen from .08 to .12, the number of players has fallen from ~40 to ~30, and the top 5 share has risen from 52% to 62%.

Coastal Marine.  Coastal marine is <20% of TIC, and shrinking as a % of the total as KEX refocuses on its inland marine business.

Coastal marine has historically been a bad business, but falling supply, and stable demand is causing the industry tighten.  Coastal barges are very large capex items with ~3 year lead times so we are likely entering a period of rich profitability for the next several years.

Distribution and Services.  This segment began as a marine diesel engine servicing business that was complementary to the Inland Marine business.  That competency was particularly well-suited to distributing and servicing pressure pumping equipment in newly tapped shale formations, so the segment’s exposure to oil and gas has grown with time.

The commercial and industrial portion of this business is stable, but the oil & gas business is volatile.

We have no idea where oil prices are heading, so we estimate mid-cycle margins on mid-cycle revenues, valuing D&S at 1.2x tangible capital, representing 10% of our projected EV.

Risks

There is insider selling.  The management team has been around for a long time, the stock is finally back to where it was in 2019, so we interpret these sales as diversification following a Covid recovery.  We track the market very closely via broker contacts, so have trouble figuring out what management would know about the trajectory of supply/demand and pricing that we aren’t aware of.

Management made a mistake buying Distribution and Services businesses.  The management team gets a 5-star rating for its allocation of capital within the inland barge business, but their attempts to diversify away have resulted in shareholder value destruction.  We strongly believe they have learned their lesson, and time/attention/capital is once again focused on the core inland barge business.

Refined products.  Some of what they transport is fuel like diesel and crude.  There is a risk long term of volumes shifting away, but conversely much of that volume could be replaced by renewable projects like renewable diesel.

Current valuation

• 10x the earnings required to induce capacity additions
• 17x consensus earnings, which is 80-85% of the market multiple.  Over the last 30 years, KEX traded a median 10% premium to the market.
• 1.3x TIC vs historical average of 1.7x TIC
• 0.8x replication value (on a depreciated basis, ie what it would cost to buy a used fleet like Kirby’s)
• We believe it costs around 80% more to produce a new barge today than it did 5-10 years ago
• Replication cost = net PP&E * 1.8 + NWC = $3.9B * 1.8 + $745M = $7.7B
• EV is $6.3B so we’re at 0.8x replication cost.

Disclosure:

We and our affiliates are long Kirby Corporation (KEX US) and may buy additional shares or sell some or all of our securities, at any time. We have no obligation to inform anybody of any changes in our views of KEX. This is not a recommendation to buy or sell securities. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion.

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