Description

Thesis

Log-In Logistica is involved in coastal shipping and the operation of a port and various terminals in Brazil. As the last remaining independent Brazilian cabotage company, the company is a major beneficiary of the structural shift in cargo transportation from the roads (trucks) to the coast (container ships). Following its spinoff from Vale in 2007, Log-In took advantage of a protectionist Brazilian law that granted preferential financing for companies that chose to build their ships in a domestic shipyard as opposed to internationally. Unfortunately, Log-In was left with significant debts when the shipyard it hired began to suffer financially and was unable to complete Log-In’s capex program. While at the brink of bankruptcy, one of the company’s largest shareholders replaced the existing CEO and began a remarkable turnaround that has solved all issues relating to the company’s liquidity. Although the company remains significantly levered, the underlying business is growing volumes at high contribution margins and is led by a talented and aligned management team that can lead to multiples of the current share price.

History and management

Log-In, originally known as Docenave, was established in 1973 in Rio de Janeiro, Brazil, as a wholly-owned subsidiary of state-controlled company Companhia Vale do Rio Doce, now publicly-traded and known simply as Vale - the world’s largest iron ore producer.

Docenave was Vale’s shipping subsidiary and was primarily used to transport ore from the Brazilian state of Santa Catarina to countries such as Japan and Germany. The development of these internal logistics later came to be shared with third parties, who used Vale’s logistics assets to handle the transportation of their own products.

In 1993, Brazil passed the Ports Law, which allowed the private sector to lease concessions for the operation of port terminals. In 1995, the privatization program began and in 1998, Docenave signed a contract to operate the container terminal at the port of Vitória in Espírito Santo state.

In 1999, Docenave began offering container shipping within Brazil, and in 2006, Vale’s ports and terminal operations were transferred to Docenave. The following year, Docenave was renamed Log-In Logistica and Vale announced that the subsidiary would be spun off as a separate company on the Brazilian exchange so that each business could better focus on its core operations. Log-In went public with a valuation of nearly $1 billion and Vale retained a 31% stake.

Upon its public listing, Log-In’s shareholders approved an investment plan of R$1.4 billion to be carried out over the following 7 years, of which R$1 billion would be allocated to the construction of 5 container ships and 2 bulk carriers. The container ships would expand the fleet for the company’s Brazilian cabotage operation (coastal shipping between ports in the same country), and the bulk carriers would serve a new contract with Alunorte, a subsidiary of Norsk Hydro – an aluminum and energy company based in Norway. The contract was a take-or-pay contract whereby Log-In would transport bauxite within Brazil for a period of 25 years.

Log-In’s competitors chose to build their ships in foreign shipyards due to the lack of capacity in Brazil. As the oil industry boomed in the 2000s, most Brazilian shipyards were at full capacity serving higher value customers such as Petrobras, Brazil’s national oil company. The downside of building ships overseas was that the company would not qualify for the benefits of the AFRMM – discussed below. Fortunately, Log-In managed to secure a Brazilian shipyard named Estaleiro Ilha (EISA) in Rio de Janeiro for the construction of its ships. The shipyard was owned by German Efromovich, also the owner of Avianca, Colombia’s national airline. Log-In borrowed money from the Brazilian development bank (BNDES) and paid EISA to build its ships.

Unfortunately, EISA ran into financial trouble and was unable to complete Log-In’s ships, leaving Log-In indebted to the BNDES and without the ships it needed to generate revenue to pay back its debt. The company took on additional debt from some private banks in Brazil and chartered other ships while its ships remained in the shipyard. The company was in a precarious financial position until a new CEO, Marco Cauduro, took the helm and began what has thus far been a remarkable turnaround.

Marco has a degree in economics from University of Sao Paulo, an MBA from MIT Sloan, and a PhD in finance from the Getulio Vargas Foundation, and is also a visiting scholar at Stanford. He was a founding partner of both Cox and Tarpon in Brazil before launching Arbela. Through Arbela, Marco was a large shareholder of Log-In but believed that the existing management was not acting with enough urgency to improve the company’s deteriorating situation. He ended up becoming the CEO of the company and has made the following improvements: 1) reduced the fixed costs of the business, 2) increased the collection of the AFRMM, 3) sold the bulk shipping division, 4) re-negotiated the debt with both BNDES and the private banks, and 5) improved the company culture and employee morale. Marco personally owns a few percent of the company, has subscribed to the company’s offerings of debentures and rights, and stands to make a significant gain if the company achieves his objectives. The largest shareholder, with a stake of 50%, is Alaska Investments. The fund primarily manages the capital of a Brazilian billionaire (Luiz Alves Paes de Barros) as well as outside capital and gained fame the past few years following its >100x return in Magazine Luiza – a growing Brazilian e-commerce company that appeared more levered than met the eye – a situation with some analogy to Log-In.

Background

Brazil’s transportation matrix is highly skewed toward the road. Approximately 66% of cargo is transported by trucks, compared to only 20% by rail and under 10% by coastal shipping (cabotage). In contrast, road transport accounts for only 8% in Russia, 32% in the US, and 32% in China, and 37% of European transport and 48% of Chinese transport occurs by cabotage/waterway. The majority of Brazil’s 10% cabotage - around 60-70% of it – is actually Petrobras oil and gas shipping and the majority of the remainder is other commodities like bauxite and iron ore. So, container shipping via cabotage remains ~2% of the entire Brazilian transportation matrix.

This seems rather unusual because Brazil has 8,000km (5,000 miles) of coastline and 80% of its population and 70% of its industrial production is located within 200km (125 miles) of the coast. However, the low contribution of coastal transportation can be explained by a few main historical reasons. First, Brazil suffered from hyperinflation in the 1980s and early 90s, which meant that goods needed to be transported as quickly as possible before prices changed and sellers lost money. Therefore, it made sense to utilize trucks instead of slower-moving ships. Second, Brazil’s ports were historically very inefficient (and to a lesser degree still are). The heavy unionization, lack of modern equipment, and significant bureaucracy caused significant delays at the port – leaving shippers to prefer road transport.

In 1999, Log-In and its competitors (discussed below) identified an opportunity to begin offering container transportation in coastal shipping along the coast of South America. Since then, volumes have grown tremendously. Between 2007 and 2017, Log-In’s coastal shipping volumes have grown at a compound annual rate of 15%. Cabotage has grown 12% per year and feeder volumes have grown 34% per year. If we consider 2007 to 2015, the year Brazil’s terrible recession started, Log-In’s total coastal volumes grew at 16% annualized, with cabotage growing at 18% and feeder at 27% (while Mercosul volumes – shipping between Brazil and Argentina/Uruguay declined).

Despite this 4-fold increase in volumes in the past 10 years, cabotage still remains a very small part of the transportation matrix. Studies by the Brazilian Institute of Logistics and Supply Chain (ILOS) have concluded that for every container being shipped by cabotage, another 3-6.5 exist on the road that can be swapped to cabotage. These volumes exclude trucking volumes that ought to be on the road, such as those being transported within the same state, cargo going to different states but less than 1,000km apart, and cargo going more than 400km inside the country. The same studies from ILOS have shown that for every 1% increase in GDP, transportation grows 1.5% and cabotage grows 3.5%.

Log-In’s coastal shipping customers come from a wide range of industries: food and beverages (Sadia, Ambev), metallurgy (Gerdau, CSN), automotive (Pirelli), chemicals (Braskem, Monsanto), electronics (LG, Sony), pulp and paper (Suzano, Arauco), hygiene and cleaning (Unilever, Colgate-Palmolive), and construction (mcm, Ferreira Costa).

Regulation

Brazilian maritime law dictates that goods shipped between ports in the country must be transported on ships that are either built, owned, and operated by Brazilian companies. This is a protectionist policy similar to the US Jones Act that benefits the domestic shipbuilding industry. An exception to the rule is that vessels can be purchased from overseas and nationalized (by paying a fee of 30-40% of the shipbuilding costs). The vessel can then obtain a Brazilian flag and must be operated by a Brazilian crew on board.

These Brazilian flagged vessels that operate in cabotage – from Brazilian port to port – benefit from a law called AFRMM, or Additional Freight for the Renewal of the Merchant Marine. This was a law promulgated by the Brazilian government to encourage the Brazilian shipbuilding and ship repair industry. Later on, the government also viewed the policy as one that would increase coastal transportation, particularly to the lower-income north of Brazil. The revenue generated from cabotage creates a 10% tax that is paid by the shipper to the Brazilian government, which then remits it back to the shipping company. Coastal shipping involving the north are exempt from the tax, but the government uses the taxes generated from other shipping routes (for example, long haul shipping has a 25% tax) to compensate the shipping company.

Thus, a Brazilian company can generate AFRMM – approximating 10% of its revenues from cabotage – either by building a ship in Brazil or by building a ship overseas nationalizing the vessel and obtaining a Brazilian flag. Having a Brazilian or nationalized vessel also allows a shipping company to utilize bareboat charters to operate in coastal shipping.

The AFRMM must be spent in a Brazilian shipyard either for the building or repair of a ship, or for the service of debt obtained for such reasons. The advantage of building a ship in Brazil as opposed to nationalizing a vessel also involved the funding. Initially, when Log-In approached EISA to build its ships, it operated under the following assumptions:

Cost to commission and build a new ship in Brazil = R$160 million

BNDES/FMM financing (90% of total) = R$144 million

Initial cash outlay (10% of total) = R$16 million

Docking (every 5 years) = R$10 million

Annual revenue per vessel = R$160-180 million

Annual AFRMM generated per vessel = $R16-18 million

Based on the economics above, it is clear to understand the advantage of building a ship in a Brazilian shipyard as opposed to abroad – and the reason why Log-In sought to utilize EISA for its fleet while other Brazilian shipping companies struggled to find capacity. The financing was offered at subsidized rates by the BNDES and FMM (Merchant Marine Fund). Over a twenty-year period, the typical ship would generate R$320-360 million of AFRMM revenue in contrast to a total cost of around R$300 million (R$160m for the ship, R$40m for the docking maintenance, and the remainder for interest payments). In other words, Log-In planned to build its ships for free – and absent the Brazilian recession and EISA bankruptcy, it likely would have. Instead, Log-In had to resort to buying a ship in China which is expected to be delivered next year. The company will have the added costs of nationalizing the ship and will not receive the generous financing offered to ships built in Brazil.

Competition

Coastal shipping

Today, Log-In is composed of two divisions: coastal shipping and port/terminal operations. The shipping division is composed of: a) cabotage – shipping between Brazilian ports, b) Mercosur – shipping among Brazil, Argentina, and Uruguay, and c) feeder – transporting of goods to Brazilian ports after arriving from long haul international shipments. Cabotage is priced in reals, whereas Mercosul and feeder revenues are generated in US dollars given their international customers. Log-In’s primary dollar-based costs are fuel, container, and charter expense – and is slightly long dollars.

Log-In faces two types of competition in coastal shipping: trucks (the dominant, alternative mode of transport) and other shipping companies. The advantages of cabotage over trucks are manifold. First is cost. At distances exceeding 1,500 km, the cost is 10-15% lower than road. At distances greater than 2,000 km, the cost advantage can reach 30-40%. These cost savings only consider the perspective of the customer, but there is also a cost saving to the government in terms of reduced stress on already bad infrastructure and roads. The second advantage of cabotage is safety. Whereas Brazil suffers from high rates of truck hijacking, this is not an issue in the sea. Third are the environmental benefits. Trucks emit more than 101 grams of CO2 for each ton per kilometer (TKU), whereas cabotage emits under 14 grams of CO2 per TKU, less than 1/7^th the amount.

Brazil’s dependence on trucking was in full display earlier in 2018 when truckers across the country went on strike and paralyzed the roads in response to an increase of the diesel price by Petrobras/Temer. The economy was crippled by the action (lack of food and gasoline across the country) and demonstrated the need for a reduced reliance on the road mode of transportation. This occurred while the economy is weak; when the economy heats up, the increase in transportation places great stress and traffic on the Brazilian roads.

At the same time, coastal shipping has several disadvantages compared to trucks. First is the elevated transit time (depending on the route, trucks can deliver in half or two-thirds the time). Second is the continued weak infrastructure in the ports and the lack of infrastructure that bridges different modes of transport together. Goods can indeed be transported by ship, but they will eventually need to connect to rail or trucks for last mile delivery. Third is the specific frequency of ship routes, which may not align with a customer’s schedule.

The other form of competition is other shipping companies. Log-In has two foreign-owned competitors in coastal shipping, particularly in the cabotage and Mercosur segments. These two competitors are Aliança and Mercosul Line. Aliança – the leading player - was acquired by Hamburg Sud in 1998, and in 2017, Maersk acquired Hamburg Sud. At the time, Maersk also owned Mercosul Line, the 2^nd largest coastal shipping company in Brazil. Following its acquisition of Hamburg Sud, it was forced to divest of either Aliança or Mercosul Line and clearly chose to divest of Mercosul Line given that it was the smaller company. Mercosul Line was then acquired by CMA CGM for $238 million USD. Log-In Logistica is therefore (and has been for some time now) the only remaining independent Brazilian coastal shipping company.

The total capacity in the container coastal shipping market is 60,600 TEU. Aliança operates 9 ships and a total capacity of 35,300 TEU. Log-In operates 6 ships and a total capacity of 15,300 TEU. Mercosul Line operates 4 ships with capacity of 10,000 TEU. However, these figures are not directly comparable because Aliança (Maersk) and Mercosul (CMA CGM) utilize a portion of their capacity exclusively for themselves in the feeder market (transferring cargo from their long-haul ships onto smaller ships and then distributing among other ports). Therefore, Log-In’s independence means it is the de facto choice for feeder operations for the remaining international shipping companies arriving into Brazil (MSC, Cosco, Hapag Lloyd, et al) and is therefore in an advantaged position. As container ships continue to increase in size, and many ports struggle to handle this increase (requiring additional dredging and deeper draughts), feeder transportation demand is likely to increase as well.

Between 2011 and 2014, a new company called Maestra entered the cabotage space. Its shareholders were primarily Triunfo (an infrastructure business in Brazil) and NYK Line – the Japanese shipping company. Due to being sub-scale, the company liquidated after only three years of operation. Maestra remains the only “new” entrant over the past decades, and no new entrant is envisaged given the weak Brazilian economy and lack of demand for additional capacity.

Log-In offers three cabotage services for its customers: Amazonas, South Atlantic, and Manaus. The routes go between the north and south of Brazil, making different stops along the way (the South Atlantic service also stops in Buenos Aires). Log-In also offers two feeder routes, the Shuttle Service and the Shuttle Rio, both in the south of Brazil. To better compete against Aliança’s capacity, Log-In and Mercosul have a vessel sharing agreement whereby each is entitled to capacity on the other’s ship.

Ports and terminals

Log-In’s other main asset is Terminal de Vila Velha (TVV), where it operates the only container terminal in Espírito Santo state. Log-In had a 25-year concession expiring in 2023, but it has been renewed until 2048 contingent upon a small re-investment required by Log-In. The total concession period can reach up to 70 years and therefore Log-In can request an additional 20 years after 2048. In 2017, TVV handled >150k containers and generated >40m BRL of earnings before tax, half of the cash flow generated in 2014 before Brazil’s recession. When the real weakens, imports decline, which results in reduced fees generated from storage. Log-In also owns a couple terminals that generate approximately 10m BRL annual cash flow for the company.

Growth

In the short-run, Brazilian transportation volumes are correlated to the strength of the economy. Over a long period of time, coastal shipping will likely continue to take share from the roads. As previously mentioned, industry experts believe that for every container of cabotage on the coast, there are another 3-6.5 on the roads that it makes economic sense to convert to the coast. This growth will require little re-investment in the short term because of the spare capacity on Log-In’s ships.

Capital allocation

Log-In generates substantial free cash flow, but the entirety of it goes to service debt given the company’s heavily-levered capital structure. The most extensive capital expenditure is a purchase of a new ship from China, which will be nationalized and brought to Brazil. Along with a bareboat charter, it will likely replace two of the company’s ships which are under time charter.

Valuation

Share price = 4.20

Shares outstanding = 36m

Warrants outstanding (in-the-money) = 21.5m

Diluted shares outstanding = 58m

Diluted market cap = 240m

Cash/warrants = 101

AFRMM receivable = 64

BNDES debt = 788

Bank debt = 477

Net debt = 1,100

Enterprise value = 1,344

Although Log-In has significant debts, I believe the leverage is more manageable than it appears. For instance, net of the AFRMM receivable, Log-In owes just over 700m BRL to the BNDES but this debt matures through 2034 with average annual amortization under 50m BRL. Currently, the company is operating 6 ships, of which only 4 are receiving AFRMM. Starting in 2019, Log-In will generate AFRMM with all its ships. Even if the Brazilian economy remains in its current malaise, this will yield approximately 40m BRL annually. If cabotage volumes normalize to historic levels and/or the Brazilian economy improves, AFRMM generated will also increase closer to the annual repayment owed to the BNDES. Therefore, as long as there is no change in regulation regarding the AFRMM, the debt to the BNDES appears quite manageable and we can exclude the majority of it from the EV calculation, along with the corresponding annual AFRMM earnings. There is also the option for the company to securitize/factor the AFRMM receivable at a discount if necessary to anticipate the cash.

The true remaining net debt is therefore around 375m and is owed to a syndicate of the Brazilian private banks (Banco do Brasil, Santander, et al). There are a number of actions that can reduce this debt, in particular a sale or collateralization of Log-In’s port asset at TVV and terminals (similar to the recent sale of the TERCAM terminal to Santander). Cash flow generation is currently below normal given the weak Brazilian currency which reduces imports (that utilize high margin storage before they are picked up or transshipped), but 2017 EBITDA was over 40m BRL at the port with very little maintenance requirement. This is a concession Log-In has until 2048 (and with possible renewal to 2068) and therefore is easily worth between 10-15x subdued earnings – 300-450m BRL. If necessary, this asset can be sold to extinguish the private debt. In addition, the terminals generate around 10m of cash flow each year.

Excluding the AFRMM and the port, Log-In would be focused exclusively on the core business of coastal shipping. Despite the subdued Brazilian economic environment, coastal shipping has generated close to 80m of EBITDA in the last twelve months and 60m of FCF after maintenance capex. Given the growth in volumes as more transportation moves to the coast and the high contribution margin of each incremental container (~55%), this figure is likely to be materially higher in 5-10 years.

The final point to be made is that Log-In will potentially be an attractive acquisition target. The company has had many suitors in the past but they have been put off by the significant debt (a couple years ago it peaked at nearly 2 billion BRL before the current management disposed of the bulk transport contract and improved the business). The company is an attractive target for a host of foreign shipping companies that rely on Log-In for feeder services and separately wish to also participate in the growing South American coastal trade (cabotage) with a Brazilian-owned company (whether a company like CMA CGM with existing operations or a company like MSC without operations). As the business continues to improve and the leverage decreases, an acquisition of the company may become a reality.

Given the leverage, it is difficult to pinpoint a price target but I believe it is multiples of the current price given the analysis above. With the AFRMM netted against the BNDES debt, and a potential sale of the port to extinguish the remaining debts (if necessary), only little growth is required for Log-In to be left with a coastal shipping business and a few terminals in total generating more than 100m of free cash flow. The company has attractive assets that are finally being managed by a competent and aligned management team that can realize their value.

Risks

The greatest risk for Log-In is the company’s financial leverage combined with its operating leverage. While I clearly believe it is manageable and less dangerous than it appears, as discussed above, this is a clear risk and it is possible the equity could become worthless if Brazil undergoes another terrible recession and revenue decreases. 

Shipping is inherently a highly competitive business. Pricing pressure or incremental capacity from competitors is a risk. It appears that the 3 players operating in the industry are doing so more rationally following the Brazilian crisis and their new foreign owners (for 2 of them).

Any change to the AFRMM regulation could be unfavorable for the company. Cabotage laws inherently protect domestic shipping industries but some countries have begun to relax them (e.g., India).

The development of nearby ports could weaken the profitability of TVV, despite that it is the only container port operating in Espírito Santo state.

Catalyst

Continued secular growth in coastal shipping (from trucks)

Reduction of debt via asset sale