|Shares Out. (in M):||55||P/E||7.5||0|
|Market Cap (in $M):||720||P/FCF||0||0|
|Net Debt (in $M):||540||EBIT||0||0|
Navigator Holdings (NVGS)
Market Cap: $730 million
Business: Owner/operator of 28 LPG transport vessels
1. Superior industry: Navigator Holdings operates in a stable niche within the shipping industry.
2. Strong management: The CEO is one of the industry’s most accomplished capital allocators
3. Financial strength: The Company has significant liquidation value, and debts are largely tied to mortgages on individual vessels.
4. Growth: Demand for LPG transportation will likely rise over time as American gas export terminals start coming online in 2016
5. Value: Navigator Holdings trades under assessed net asset value while generating returns in excess of cost-of-capital.
Part 1: Overview
The White Rabbit put on his spectacles. “Where shall I begin, please your Majesty?” he asked
“Begin at the beginning,” the King said gravely, “and go on till you come to the end: then stop.”
– Alice in Wonderland
Navigator Holdings (NVGS) is an owner and operator of mid-sized LPG carriers.
The company was founded in 2000 to take delivery of five Maersk LPG vessels. Current-CEO David Butters joined the company in 2008 after a long career at Lehman Brothers, and has grown the fleet from 8 in 2008 to 28 vessels as of September 2015. Currently, the company’s fleet includes 28 LPG carriers, with 4 ethane carriers and 4 LPG carriers on order.
LPG (also known as propane and butane) and ethane are produced as byproducts of the oil and gas refining industry. American wet shale gas, for instance, typically consists of 18% LPG. The process of compressing natural gas for export (known as LNG) also generates ~8% LPG as a byproduct.
LPG is a relatively clean-burning fuel used primarily in cooking and heating, while ethane finds its use in petrochemicals and power generation. These gasses should not be confused with LNG, which is primarily used for power generation.
Part 2: A shipping company as a value investment?
"How do you know I’m mad?” said Alice
“You must be,” said the Cat, “or you wouldn’t have come here.”
– Alice in Wonderland
Mid-sized Liquefied Petroleum Gas (LPG) carriers are truly misunderstood creatures. Unlike the majority of the shipping industry, LPG shipping is a relatively stable business that requires highly specialized equipment.
LPG is produced as a byproduct of the oil and gas business; since most refineries have little use for the feedstock, they rely on shippers such as Navigator to help transport the gas to willing buyers. Furthermore, LPG naturally “boils” away over time even under the best storage conditions. Oil and gas refiners are thus forced to either quickly use the gas or transport it elsewhere, else see their money quite literally vanish up in smoke over time. Thus, the supply and demand for LPG shipping has been remarkably stable.
As a quirk of history, the LPG shipping industry also has an unusual feature that it tends to operate on shorter-term contracts. This makes the business less attractive for new entrants who might otherwise use long-term contracts to secure mortgages for new ships.
Technology also play a major role. Navigator focuses on the more complex mid-sized LPG transport vessels (known as handy-sized vessels). These vessels have compression plants built in, which allows them to cater to LPG producers without access to deep-water ports or LPG compression plants.
Finally, safety is of utmost importance, and few shipbuilders have the technical capabilities to build these highly specialized vessels.
These four points makes Navigator Holdings stand a world apart from the highly commoditized drybulk shipping industry. This is important to keep in mind when reading the next section on industry dynamics.
Part 3: Industry
The handysize LPG industry is relatively consolidated. According to the company, Navigator Gas is now the largest player with 28 owned vessels of the 95 in operation globally. Second-largest player Ultragas has 9 vessels, and third-largest Naftomar has 8. Unlike their larger counterparts, handysize vessels are able to dock in smaller ports across the European North Sea and US Gulf Coast without the need for deep-water ports. The ships are also equipped to compress gas on-board, allowing them the flexibility to serve customers without LPG compression plants.
The industry’s consolidated base and advanced technical capabilities mean that daily shipping rates have remained quite stable over time. Navigator’s Time Charter Equivalent rate (TCE) in 2005 was $24,500/day. This figure rose to $29,700 in 2008 before falling to $23,600 in 2010. (This compares to the fall in the Baltic Dry Index of ~$9,000 in 2008 to ~$3,000 in 2010).
Today, Navigator’s TCE is slightly above $30,000.
Handysize rates will likely remain stable over the medium-term. Ships take up to four years to deliver, so the probability of shipping oversupply is vanishingly small through at least 2017. Given the indiscretionary nature of LPG production, the generation of LPG (and thus the demand for LPG exports) is also likely to remain quite stable in the medium-term.
The first wave of US LNG export facilities is scheduled to come online in 2016 and McKinsey Energy Insights predicts that US exports will ramp up to 14 bcfd by 2030. While high-profile companies like Cheniere Energy (CHE) and others have taken on this much-touted idea of exporting cheap US natural gas, the dowdier LPG exporters will also likely gain.
Management and Governance
“I could tell you my adventures–beginning from this morning,’ said Alice a little timidly: ‘but it’s no use going back to yesterday, because I was a different person then.”
Fortunately, Navigator Holdings is led by CEO Mr. David Butters, a 37-year veteran of Lehman Brothers and chairman of GulfMark Offshore. He has been instrumental in consolidating the industry and keeping the company focused on the highest-return segments of the LPG shipping business. Mr. Butters also owns roughly $30 million worth of equity, or 3.5% of outstanding shares.
As plainly clear from interviews and off-the-cuff remarks, the soft-spoken Mr. Butters thinks more like an investor than an operator. Investment decisions are made with specific metrics and hurdle rates, and the company has been focused on the ownership of high-quality assets, while outsourcing the operations and management to third-parties. Link to his interview with Jim Cramer available at the end of this article.
From a corporate governance standpoint, Navigator raises no significant red flags, i.e. boards terms are one-year long, the company only has one share-class, and the company’s financial statements don’t defy common sense.
It is important to note, however, that David Butters acts as both CEO and Chairman. At 75 years old, he does pose a key-man risk.
Part 5: Valuation
"Take care of the sense, and the sounds will take care of themselves. "
– Alice in Wonderland
Cash flow return on investment is key in any business, and Navigator does very well in this regard. According to Credit Suisse, the company generated 8.2% cash flow return on investment in 2014. Liquidity risk is also minimized: each ship is funded under a separate LLC structure and loans are secured by first-priority mortgages on individual ships.
So can the company continue to make profitable investments? Most likely.
Taking some relatively conservative assumptions:
1. Initial investment (PV): assume that future vessels cost $44 million to purchase
2. Annual gross cash flow (PMT): assume TCU rates of $32,500/day, a utilization rate of 95% and a very conservative contribution of 49.0% of net revenues. This leads to $5.53 million gross cash flow per vessel
3. Years of useful life (N): assume 29 years with zero salvage value
Using a financial calculator, one would find that these assumptions generates an IRR (I/Y) of 12%, a sufficient return on capital as long as TCU rates and utilization hold up. These figures are highly abstracted (one can imagine some value for a 29-year-old LPG carrier), but serves to provide a sense of the margin of safety in the value of new LPG ships.
The company also has significant resale values on its vessels. Navigator uses straight-line depreciation, and its sale of the Navigator Mariner for $32.6 million in 2Q15 was comfortably over its carrying value of $31.4 million.
All said, a value investor should be willing to pay perhaps a 10-20% premium to the company’s net asset value, given that the company generates positive real value on its assets. Growth investors might look to the potential for ethane exports, as well as a potential supply glut of exportable LPG as American LNG compression plants come online in 2016, but value provides a decent floor to where prices should stand.
This equates to a “fair value” of roughly $17.0 to $18.5. On the downside (as discussed later), investors might expect perhaps a 5% risk of default and 20-25% risk of business deterioration through end of 2017. On the upside, perhaps a 25-30% probability that LPG/ethane export demand rises faster than supply, and a 3-5% chance that the investment community goes through a mania of investing in US natural gas exporters and takes NVGS shares along for the ride.
Why is the market wrong?
“It was much pleasanter at home,” thought poor Alice, “when one(‘s share price) wasn't always growing larger and smaller, and being ordered about by mice and rabbits”.
Investors tend to be a fickle bunch, but often for the wrong reasons. In Navigator’s case, the company is can be easily associated with the broader shipping industry (low barriers to entry, high cash-flow variability) or midstream energy companies (non-recurring capex, but highly dependent on geography…pipes are hard to move). Even though Navigator sits in a stable niche, share prices have been understandably volatile over the past year.
Yet, the recent sell-off in all shipping and midstream energy assets has thrown the baby out with the bathwater. Navigator’s share price has fallen from a high of 2.30x tangible book value in September 2014 to just 0.93x today. This equates to 7.63x NTM price/earnings and 5.20x NTM price/cash-flow (as defined by Capital IQ). All the while, average sell-side estimates for the company’s FY16 earnings per share has been lowered by just 16% from $2.4 in Dec 2014 to $2.0 as of Oct 2015. One might even speculate that the rise of ETF trading has increased price-correlation between industries with similar-sounding classifications (LPG and LNG do sound awfully similar).
So those who use drybulk as a proxy for LPG shipping do so at their own risk. Banter from the 2Q15 earnings call between the CEO and analysts put it best.
Fotis Giannakoulis, Morgan Stanley – Analyst
“I understand that there might be some owners that they might have financial difficulties from other sectors, particularly the drybulk sector. Do you see any opportunities of taking advantage of this weakness that might be in the overall shipping sector and buying some assets at attractive prices right now?”
David Butters, CEO
“Look, I'm not interested in the business of shipping as shipping… I don't really give a damn on what's happening in the drybulk, I don't care about the LGCs (Large Gas Carriers), I don't care about car carriers. I care about the structural changes and the enormous, unique opportunity that we have and that we're exploiting. We were one of the first of the movers in this whole space and we have that advantage of the first mover and we're going to stay in this very specialized business and exploit it to maximum abilities to us that we have and the capabilities of our talent that we have around this table.”
Note that this focus on a highly specialized niche has served the Company well. Navigator’s net asset value has continued to march upwards every single year since its listing in 2005. Tangible book value now stands at $15.44, up from $14.56 at YE2014, and $13.03 YE2013. In short, Navigator is no ordinary shipping company.
“Alice: How long is forever?
White Rabbit: Sometimes, just one second.”
-Alice in Wonderland, Tim Burton
It is difficult to predict the mood of the general market. Nevertheless, the underlying value of Navigator will likely continue to rise in the medium-term. As American natural gas export terminals start coming online through 2016, the amount of LPG and ethane production will also have to rise. While this may not catalyze a “re-rating” of Navigator Holdings, it opens a large market opportunity for the company to exploit. In 2016/17, the company will also receive delivery of 4 ethane and 4 semi-refrigerated LPG carriers, increasing their fleet capacity by 37%; Navigator is a company well-placed to take advantage of this opening market.
As a warning, however, there is little reason to assume handysize shipping will remain in investment nirvana forever. Unless shipping companies have lasting competitive advantages (i.e. customer lock-in or proprietary technology), new competitors could eventually go out and purchase additional ships. Indeed, there are currently around 33 handysize LPG vessels on order according to Steensland, a ship broking company.
Declines in TCU rates will also have immediate impacts to the resale value of Navigator’s vessels at the same time as reducing cash-flow. An investor in Navigator must remain vigilant that the supply of new LPG vessels matches the growth rate of LPG exports.
Competition in the handysize LPG industry is relatively benign thanks to 1) industry consolidation, 2) technical complexity and 3) the industry standard of shorter-term leases. Navigator Holdings trades under book value, while generating returns in excess of cost of capital. Growth in the US LNG export market will increase the amount of LPG produced as a byproduct, and this gas will have to find a home somewhere in the world.
CNBC Interview: https://www.youtube.com/watch?v=r-UOn4TpeQU