Description
Summary
With competitive moats the size of Lake Superior, we see opportunities for Rand Logistics (a water-borne commodity carrier on the Great Lakes) to both expand the profitability of its existing business and potentially acquire capacity from its few competitors. All of this for the low price of 4.0x forward EBITDA.
Industry Summary
The Great Lakes are dotted with ports on the US and Canadian shores. There are 15 rather large ports and between 50 and 60 smaller ports. Most of the shipping at these ports involves commodities such as iron ore, coal and limestone.
Demand
Shipping volumes on the Great Lakes vary from year to year and from commodity to commodity. Generally, steel related volumes have come down over time as the blast furnaces in the region have declined somewhat. While overall volumes have shown some cyclicality over the last 6 years, on the whole they have remained relatively stable.
|
US-Flag Cargo (mil. net tons)
|
|
|
Commodity
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
|
Iron Ore
|
48.2
|
43.0
|
51.2
|
46.6
|
49.0
|
47.2
|
|
Coal
|
21.7
|
21.9
|
24.4
|
27.2
|
25.3
|
25.2
|
|
Limestone
|
26.6
|
24.2
|
29.9
|
27.9
|
29.5
|
26.0
|
|
Cement
|
3.8
|
3.9
|
4.0
|
3.9
|
4.0
|
3.6
|
|
Salt
|
0.6
|
0.9
|
1.0
|
1.2
|
1.1
|
1.2
|
|
Sand
|
0.2
|
0.5
|
0.5
|
0.5
|
0.4
|
0.4
|
|
Grain
|
0.3
|
0.3
|
0.4
|
0.4
|
0.4
|
0.4
|
|
Total
|
101.5
|
94.7
|
111.3
|
107.7
|
109.7
|
104.0
|
|
Canadian-Flag Cargo (mil. net tonnes)
|
|
|
Commodity
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
|
Iron Ore
|
15.5
|
15.1
|
16.4
|
15.8
|
16.0
|
16.6
|
|
Coal
|
17.4
|
15.5
|
13.1
|
13.5
|
13.7
|
12.1
|
|
Limestone
|
8.1
|
8.0
|
9.8
|
9.2
|
8.9
|
7.3
|
|
Cement
|
1.4
|
1.4
|
1.4
|
1.0
|
0.7
|
1.0
|
|
Salt
|
5.2
|
7.2
|
8.1
|
7.7
|
7.4
|
7.0
|
|
Grain
|
6.0
|
6.4
|
6.4
|
6.1
|
6.0
|
5.9
|
|
Other
|
12.6
|
11.2
|
11.6
|
11.8
|
11.9
|
11.1
|
|
Total
|
66.2
|
64.8
|
66.8
|
65.1
|
64.6
|
61.0
|
Supply
Carrying these commodities are 47 US-flagged vessels and 58 Canadian-flagged vessels. While the larger ports can receive cargos from the industry’s larger 1,000 ft. ships, many of the smaller ports can only be serviced by smaller River-Class vessels. The US fleet includes 10 River-Class vessels and the Canadian fleet includes 8 River-Class vessels.
The majority of the vessels on the Great Lakes are self-unloaders. These vessels have a boom arm that connects to a series of conveyors. This equipment allows a ship to load and unload much more efficiently and with no on-shore crew. Many customers around the Lakes have designed their operations to not utilize on-shore staff and therefore rely on self-unloading capabilities.
Over the last 10 years, the region has seen a significant decline in River-Class self-unloader capacity, as older vessels have been retired and the cost of manufacturing a new vessel have been prohibitively expensive. For example, in 1995 the US fleet had 16 vessels with approximately 35m tons of annual capacity versus today’s 10 vessels with about 22.5m tons of capacity. The Canadian fleet has seen similar levels of capacity exit the market.
Rand Summary
Rand is unique because it has both a US and a Canadian subsidiary, with 12 owned vessels between them. Rand’s US fleet consists of 5 River-Class self-unloading vessels (50% of the US industry’s River-Class vessels). Its Canadian fleet consists of 4 River-Class self-unloading vessels (50% of the Canadian industry’s River-Class vessels) and 3 Conventional Bulk carriers. Rand also charters a 13th bulk carrier to flexibly handle customer demand, but they do not profit from this vessel.
Reasons Rand’s Business is Attractive:
Supply Constraints
1. Regulation: The Jones Act in the United States restricts foreign-owned, -crewed, or –constructed vessels from shipping between two US-based ports. The Coasting Trade Act (in Canada) similarly restricts shipping between Canadian ports. These acts provide a barrier against cheaper foreign carriers encroaching on Rand’s shipping routes.
2. Ship manufacturing costs: The cost of manufacturing a new ship in the US (or Canada) is prohibitively expensive. Management estimates it would cost roughly $70m to build a suitable new ship. Contract rates do not make this an economic proposition.
3. Other domestic players: Repurposing a vessel from another region for use in the Great Lakes is not very feasible. First, the vessel would have to be Jones Act compliant. There are a fair number of qualifying vessels extant. However, to enter the Great Lakes, the vessel would also need to fit through the St. Lawrence Seaway. Most of the available vessels are wider than the St Lawrence Seaway’s 78 ft. locks. These two constraints leave a qualifying pool of potential new entrants of 2-3 ships. Unfortunately for new entrants, their vessels would also need to be self-unloaders to fit the shipping practices on the Lakes. For these few available ships, it would take $25m-$30m of capex to refurbish and convert them into self-unloaders. Contract rates do not make this attractive.
Scale
1. Scheduling: Most routes are not back and forth between two points. A given ship is likely to pick up for one customer at point A, drop off at point B, pick up a new customers load at point C, drop off at point D, etc. Fleets must be sufficiently large to properly optimize scheduling and minimize the amount of time a ship sails empty.
2. Customer requirements: The threat of a competitor cherry-picking a single lucrative route (a la JetBlue’s point-to-point model) is minimized, because customers require that a carrier be willing to serve all of its routes. For example, a customer may require pick up from one point with delivery to 14 different ports over the course of a season. A carrier cannot carve off just the routes which are convenient.
Contracts
1. Customer contracts: More than 95% of Rand’s customer contracts are long-term in nature (usually 3-5 years). This is attractive for the customers because they can lock in scarce water-borne capacity. Rate increases are steady, contractually increasing in the high single digits per year, on average. We estimate that demand for Rand’s services is 140% of Rand’s capacity. Rand oversells to 130%-140% of its capacity. Therefore, even if customers reduce their activity, there is a cushion before the reduced activity translates into a reduction in realized volumes for Rand. There are not any major contracts up for renewal in F’10.
2. Labor: Rand’s Canadian fleet is not unionized. Its US fleet is unionized (42% of Rand’s total employees), by the Masters, Mates and Pilots union (MMP), which has historically been more amenable to working with management than some competitors’ unions. Because of the MMP’s flexibility, Rand has been able to crew its ships with the legal Coast Guard minimum, as opposed to competitors’ artificial union-mandated minimum. This (combined with rigorous crew training) has led to what Rand believes to be a $500k per year per vessel cost advantage (comparing Rand’s crew vs. other unions). Rand’s agreement with the MMP has 3 years remaining.
Competition
1. American Steamship Corp. (ASC) is uneconomic: ASC’s River-Class vessels are a small part of ASC, which itself is a small non-core part of GATX. ASC has the same union on its larger vessels as it does on its River-Class vessels. Unfortunately for ASC, the union agreements have left the River-Class vessels at an economic disadvantage, as they are overstaffed. However, if ASC tried to make changes on the River-Class vessels, they would endanger the more-profitable larger vessels’ operations. The union has significant power in that a strike would lay up all of their larger vessels. IF ASC tried to throw out the union, they would have a difficult time re-manning the vessels, as the supply of qualified captains and engineers is very low. As a result, ASC has recently chosen to simply lay up most of its River-Class vessels.
2. Seaway Marine Transport (SMT) will need capex: Sometime in the next 10 years, SMT’s River-Class vessels are likely to need significant refurbishment to repair the damage caused by their exposure to the corrosive saltwater of the St. Lawrence Seaway (which Rand avoids). This capex is not imminent, but over time it could have ramifications for industry capacity as SMT determines whether huge capex makes economic sense.
3. Small competitors lack scale: Rand’s small competitors lack the capital to expand and do not have the flexibility in their capacity to protect against unexpected down-time or loss of contracts.
Customer Base:
- Varied drivers of volume: Rand has diversified its customer base such that there are multiple drivers of overall volumes:
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Commodity
|
% Rand Rev.
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Driver
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Sample Customers
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Stone
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39%
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Infrastructure, Steel
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Lafarge, Carmeuse
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Grain
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25%
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Food / Brewing
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Anheuser-Busch, Casco
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Ore
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13%
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Steel
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Algoma Steel
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|
Coal
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11%
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Power plant/Industrial
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Georgia Pacific
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Salt
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9%
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Weather
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Morton Salt
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|
Other
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3%
|
|
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Management
1. Operating management: Scott Bravener, the operating subsidiary’s CEO, is extremely knowledgeable about shipping on the Great Lakes, having been around the business since he was a teenager. In addition to managing the overall operations, he is also the active captain of the Cuyahoga. Our own discussions with Bravener left us with the impression that he is a hands-on, disciplined manager.
Catalysts
Increased profitability
- Contracts: The aforementioned contractual revenue increase should lead to a natural mid to high single digit annual revenue increase for the foreseeable future. Rand has not had significant difficulty renewing contracts with favorable rate increases, as water-borne hauling is cheaper and more efficient than other modes of transportation. Expenses are rather stable, with roughly 2% contracted Labor increases, insurance up within a range and fuel costs passed through to customers. Net, we expect the bulk of the revenue increases to drop straight to EBITDA. We expect this to add $3.6m to F’10 EBITDA.
- Increased sailing days: In Q4 of F’08, the Saginaw was fitted with an engine upgrade, converting its old inefficient steam engine to a faster heavy fuel engine. Capital costs were in the neighborhood of $13m, but delays also meant that the Saginaw lost nearly an entire fiscal quarter (or 1/3 of the shipping season) of utilization. The ship is now faster, cheaper to maintain and requires fewer crew to operate. These benefits should be fully realized in F’10 (calendar ’09 shipping season), as the Saginaw will be available for the full season. There were also just over 50 lost sailing days in F’09 as several vessels in the US fleet were delayed by winter repairs. In addition to the same-ship level benefits, there will be a small incremental boost in the network benefits to the entire fleet by having the additional capacity available. We estimate these lost days should add $1.5m of EBITDA to F’10
Acquisitions
- Competitor ripe to exit?: We believe that ASC’s River-Class vessels are uneconomic with the current union in place. However, ASC will have difficulty changing these agreements without it having ill-effects on its relationship with crews on the rest of ASC’s larger-vessel fleet. If Rand were to purchase some of these vessels, it could re-flag the ships and fulfill Canadian demand with more economic crews and customer contracts.
- Small players on borrowed time?: We also believe that some of the smaller players may be more vulnerable to an economic downturn, more sensitive to credit conditions and have a significant percentage of their personal wealth tied up in their small fleets. If these operators hit rough times, Rand would be a natural buyer of these assets. If the Rand were to decide the vessels were not attractive and the operators decided to simply lay up the vessels, then the lower industry capacity would only make Rand’s existing assets more attractive.
Reporting
- Rand’s reporting has been complicated: In F’08 Rand had a strike, multiple game-changing acquisitions and the end to a complicated set of Variable Interest Entity accounting treatments. F’09 is the first year that even comes close to a normal looking set of financials. We believe that as F’10 begins in the spring of ’09, Rand’s results will be more readily understood by investors when making YoY comparisons.
Infrastructure
- Stimulus program: While still taking shape, the proposed Obama stimulus program is expected to have some component of traditional infrastructure spending. This would likely provide some benefit to Rand’s Stone and Steel related businesses. Rand’s benefit is not quantifiable at this point, but it could provide some offset to any macro-related weakness in volumes that might otherwise occur.
Financials
Model
The sailing season is generally 275 days (+/- depending on weather conditions and vessel downtime). Total baseline available sailing days for Rand’s fleet would be 12 vessels * 275 days = 3,300. For the most part, this covers the period from April 1 to December 31, but most years there are vessels that continue sailing into January or start sailing the new season in late March. For example, this year the majority of the vessels are already in port for the winter, but a handful are still sailing. We expect actual sailing days in F’09 to be 3,151. This is based on actual sailing days in Q1 and Q2 of 955 and 1092 (respectively) plus our estimate of 1104 days in Q3 and Q4 combined.
Management discusses revenue and profitability of the business on a per vessel per sailing day basis. Revenue guidance for F’09 is for ~$27k per vessel per day (excluding fuel pass-throughs, charter expenses and fees). Q1’09 and Q2’09 revenue per vessel per day averaged $28.6k and $29.6k, respectively. The back half of F’09 should be lower based on currency translation and seasonality.
We expect Vessel EBITDA (analogous to a retailer’s 4-wall profit) to be $9.9k/per vessel per day. This compares to prior year Vessel EBITDA per day of roughly $6.5k in F’08 and $5.3k in F’07. Improvements have come from capital projects, training, contracted rate increases and network effects from having a large fleet. Q1’09 and Q2’09 vessel EBITDA per day averaged $10.9k and $14.1k, respectively. Again, back half seasonality and currency translation should bring this in line with our estimate of $9.9k.
G&A includes about $2.3m of corporate and public-company expenses and $7.3m of operating G&A related to the US and Canadian operating locations.
We expect Rand to generate $31.1m of total Vessel EBITDA in F’09, and after subtracting $9.6m of G&A, we expect F’09 EBITDA to be $21.5m.
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Simplified Model (F'09)
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|
(in $000s, except Days)
|
|
|
Sailing Days
|
3,151
|
|
Vessel EBITDA/Day
|
9.9
|
|
Vessel EBITDA
|
31,100
|
|
G&A
|
9,600
|
|
EBITDA
|
21,500
|
Note that management’s guidance has included high-end EBITDA guidance of $19.5m., though in public presentations they have said they are “highly likely” to meet or exceed the high-end guidance. YTD EBITDA is roughly $21.5m. The revenue and profit generation of Q3 (end of the sailing season) should theoretically net out with an almost purely expense generating Q4 when there is very little sailing.
For F’10, we estimate baseline sailing days to be 3,300 (275 days * 12 vessels). The increase from F’09 will be largely from the Saginaw’s extra 83 days and the lack of lost days from the US fleet startup. Combined, these should add roughly $1.5m of EBITDA.
We expect contracted rates to increase by 6%, but we expect roughly 200 bps of this growth to be eaten up with contracted expense increases. Net, we expect 400 bps of this revenue growth to drop straight to Vessel EBITDA. This should add ~$3.6m of Vessel EBITDA. Therefore, Vessel EBITDA per day should organically increase as follows:
($27k Vessel Rev./day * (6% contract increase – 2% exp. increase)) = ~$1.1k of Vessel EBITDA/day
We expect G&A to remain flat, though we note this can move based on $USD/$CAD exchange rates. Of the $7.3m of operating G&A, 60%-65% of this is spent in $CAD.
|
Simplified Model (F'10)
|
|
(in $000s, except Days)
|
|
|
Sailing Days
|
3,300
|
|
Vessel EBITDA/Day
|
10.9
|
|
Vessel EBITDA
|
36,135
|
|
G&A
|
9,600
|
|
EBITDA
|
26,535
|
Capital Requirements
1. Working Capital: Working Capital needs are extremely seasonal. Bank debt rises during the season and can vary substantially depending on fuel prices. A/R builds during the season, but by the end of Q4 it is usually negligible. Because customers are very dependent on Rand’s capacity, Rand is only vulnerable to slow-paying at the end of the season. Thus far, despite the current economic environment, Rand says they have not seen any material changes or delays in customer payments.
2. Winter Work/Drydock: Maintenance work per vessel averages ~$600k/year, usually with ~50% expensed and ~50% capitalized. Management is careful to avoid saltwater exposure to help keep maintenance work lower. Each vessel must be drydocked every 5-6 years to undergo a thorough governmental inspection and maintenance overhaul. Each drydock averages ~$750k/vessel. Timing is staggered, with only 1 vessel scheduled to drydock in F’09. We estimate total capex for F’09 to be $7m and similar levels on a go-forward basis. We note that the covenants restrict capex to less than $8m per year, except under specific conditions.
3. Projects: Management is always looking for opportunities to improve its vessels. Past projects have included upgrades to the self-unloading apparatus (which sped up turnaround time while loading/unloading) and the aforementioned Saginaw engine upgrade. Management believes that all of the recent projects have had an ROI of at least 15%. Another engine upgrade project could be done in the next couple of years, but there are not currently plans for any major projects in F’10.
Debt
1. Levels: At Q3 ’09, Rand had ~$67.5m of debt (excluding the bank debt, which we assume will be paid off upon A/R collection at the end of the season). Cash on hand is currently $8.3m, though we expect this to be slightly higher by year end (again, as A/R is collected). Debt is denominated in both $USD and $CAD to create a natural hedge in the capital structure. We expect net debt at the end of F’09 to be ~$56.9m.
2. Covenants: Financial covenants include a fixed charge coverage ratio; minimum EBITDA; Max. Senior Funded Debt/EBITDA; Max. Capex; and Min. Appraised Value/Term loan. Rand is well within all covenants.
3. Lenders: The main lenders (in descending order of commitment) are GE Capital, National City and KBC bank. While we would prefer to not have the company’s top lender in the news (as they may tend to be less flexible in the event of stress), management says that the lenders are very happy with the collateral and the performance of the business.
Valuation
1. Taxes: Rand had a combined US and Canadian NOL of ~$62m at F’08 (tax-affected $20.1m). We believe this will shield taxes for perhaps the next 7-10 years, with our best estimate of NPV at $12m-$14m.
2. EV/EBITDA: After the expiration (and cashless exercise at 20:1) of 5.2m warrants in Oct. 2008, Rand is left with 12.7m shares of common stock and preferred stock convertible into 2.4m shares of common, for a total of 15.1m shares. Assuming a stock price of $4.05, net debt at EoY F’09 of $56.9m (after prescribed debt payments) and an NOL worth $13m, we calculate the EV at $105.1m. Based on our estimate for F’10 EBITDA of $26.5m, RLOG is trading at just 4.0x EV/EBITDA.
|
F'09 End-of-Year Ent. Value
|
|
(in $000s, except shares in 000s)
|
|
Common Shares
|
12,436
|
|
Former Warrants
|
276
|
|
Conv. Pref.
|
2,419
|
|
Total Shares
|
15,132
|
|
Price
|
$ 4.05
|
|
Market Value
|
61,284
|
|
|
|
Bank Debt
|
-
|
|
Current of LTD
|
4,580
|
|
LTD
|
61,777
|
|
Cash
|
(9,500)
|
|
Net Debt
|
56,857
|
|
|
|
PV of NOL
|
(13,000)
|
|
Enterprise Value
|
105,141
|
Risks
Macro deterioration
1. Overselling: While Rand’s customers have several drivers of volume, economic activity will have some bearing on overall customer activity. However, demand on the Great Lakes outstrips shipping supply by as much as 40% in some cases. Rand oversells its capacity. As customers decrease their activity levels, there is an inherent cushion for Rand (i.e. the demand that goes away is demand that Rand would have had difficulty meeting anyway). Rand also uses the 13th vessel, a non-revenue generating charter, to cover customer volume on some of its most cyclically exposed steel related business. As this volume recedes, Rand simply takes volume away from the charter, providing a further cushion to profit generating volumes.
2. Customer Inventory: More likely to cause a problem would be a slow start to the season in the event that customers do not draw down winter inventory fast enough.
Sailing Days
1. Weather: Rand’s sailing days can be reduced due to a longer than expected winter. Profitability can be affected if storms or wind force ships to operate at slower speeds during the season. Further, water levels can have an effect on operating speeds and the tonnage a ship can carry. Management’s expectations allow for some variability here. Water levels in 2008 were roughly average
2. Human or mechanical error: Accidents or breakdowns can remove a ships capacity until repairs are made. This not only removes the affected ship, but also weighs on the overall fleet’s efficiency by unexpectedly reducing its flexibility.
Currency
- Currency moves are a concern. We usually assume that currency moves eventually net out and are therefore not usually overly concerned with translation effects. However, since a portion of Rand’s business relies on export/import flows between Canada and the US, significant currency moves can make trans-border shipments more or less viable than domestic sources of a given commodity. This could have effects on volumes that move beyond simple financial statement translation issues.
Illiquid stock
- Low Volume: The stock does not trade a lot. Occasionally blocks become available.
Catalyst
1. Improved profitability due to increased sailing days and contracted price increases
2. Potential acquisitions
3. Cleaner financial reporting makes operating performance more transparent
4. Wildcard: Infrastructure stimulus package