Description

There’s a whole lot to love about Trailer Bridge, a small jewel of a value investment, and one drawback. The company is the low cost provider in a protected market, with consistent price increases and a relatively fixed cost base, trading below 9x 05 FCF, and less than 7x 06 FCF (by my estimates, after netting out cash). The company has idle assets which may start to be deployed soon, and the most persistent insider buying pattern by a CEO that I’ve ever seen. Add to that some catalysts that should occur in the next couple of quarters and you have a very compelling investment opportunity. So what was that drawback thing? Liquidity. Insiders own the majority of the shares, and at these low prices, you’re not prying them loose. It is possible to locate shares, however and even this issue should start to rectify itself somewhat over the coming months, as I’ll outline below. With the stock at $9, I believe that there is 70%+ upside based on current operations, and the kicker of a greater upside option if certain idle assets are employed in the future.

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Usual disclaimer: We own this stock, but may buy or sell at any time, without notice. This is not a recommendation to buy or sell the stock.
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This is a follow up to several previous write-ups of TRBR on VIC – by Jon64 in 2001 and 2003, and rosie918 last December. The stock is up a lot since jon64 first brought it to our attention, but I believe that there is a lot more to come.

For background, the 10-K is pretty detailed and informative, and the previous writeups do an excellent job of laying out the industry basics and company history, so I’ll just give a very quick recap:

Trailer Bridge is a Jones Act shipper operating in the Puerto Rico market. The Jones Act requires in essence that all vessels operating between two US ports be US built, owned and crewed (the original idea being to maintain a merchant navy for times of war). The main markets are Alaska, Hawaii/Guam, and Puerto Rico. For PR and HI, pretty much all hard goods that have to be imported from the US are coming on a Jones Act ship.

The cost of newbuild US cargo vessels has risen to the point where current rates generally don’t justify the construction of a new ship, and as a result most vessels are quite old (29-37 years in the PR market) . Trailer Bridge is one of four operators in the Puerto Rico market, and unusually it operates ocean going barges (as does one of its competitors, Crowley Lines). The barges are slower, but much cheaper to build and operate than self propelled ships (operated by SeaStar and Horizon in the PR market). They are also much more fuel efficient and cheaper to maintain. TRBR’s fleet is the youngest in PR, with 5 barges 7 years old and 2 that are 21 years old.

The PR market was plagued by overcapacity and price cutting until the fifth operator (Navieras) went bust and the ships were scrapped. Since then, rates have been marching steadily upwards. Fuel costs are passed through via surcharges, and having just emerged from a vicious price war, competition is extremely rational. Rates are still 15%+ below 1995 levels, but rising steadily as all players focus on profits over volumes (which tend to be fixed in the market overall, growing at about GDP)
TRBR has taken advantage of this situation to fix its balance sheet, buy out some high cost leases and preferred stock, and replace high cost tractors. The result has been a huge jump in EBITDA and cash flows over the last year. Take a glance at this for healthy growth in profits ($millions):

Year 2000 2001 2002 2003 2004 2005E 2006E
REVENUE 91.7 82.1 76.0 86.4 98.8 104.9 110.8
EBITDA 0.4 (16.3) (0.8) 0.8 11.7 22.3 25.4

To further illustrate, check out the 2Q EBITDA for the last 3 years:
2Q03: 0.93
2Q04: 2.56
2Q05: 6.43
That’s an attractive progression in the numbers, needless to say.

Part of the improvement from 04 to 05 stems from the reduction in rented equipment (due to the lease buyout above) – about $7.2MM/year, or $1.8MM/Quarter. The rest, more or less, is increased rates and volumes, over a cost base that is fairly fixed. There are some small changes in salaries and benefits, and quarterly variances in O&M, but there is a LOT of operating leverage here.

EBITDA is all very well, I hear you say, but what about real cash flows? There’s good news there too. First off, the company expenses all of its drydocking costs and includes those in its EBITDA calculation, (as opposed to Horizon for example, which capitalizes and then amortizes them). Maintenance capex is minimal, about $0.5MM per year according to the management team. The tugs are rented, and the barges have a very long life (30 years+). On top of that, only 4 of the 7 barges are currently used in the PR service. The other 3 are either laid up, or chartered part of the time (charter revenue has been about $0.2-$0.4/quarter and EBITDA has been less, with costs to activate the barges for charter, though it should increase in the future).

Interest costs relate to $23MM Title XI debt on the barges and an $85MM 9.25% high yield issue that the company did last year to buy out the leases and preferred. Net interest expense runs about $10.5MM/year.

The company has about $80MM of PP&E, and D&A runs a bit over $4MM/year. TRBR also has about $20MM of tax assets. Between depreciation and the tax shield, there’s no taxes to be paid until 2009 by my calculations.

Actual capex has run a bit higher than the $0.5MM number. The reason for this is that TRBR replace some very old high maintenance tractors in the last few Qs. TRBR can’t pay down its 9.25% high yield until 2008, so it’s using its cash to reduce operating costs, (and the returns are attractive). We expect some open market debt purchases as cash builds further.

Valuation:
TRBR’s market cap is 12.3 million FD shares at $8.73 = $108 million
Total Debt is $109 million
Cash is $12 million
Tax assets $20 million, my PV = 15 million at 10%
So EV = 108+109-12-15 = $190 million

Recurring free cash flow:
First, strip out the tax shields and subtract them from the market cap, along with the cash (Adj. Mkt Cap = 108-12-15 = $80million), and look at adjusted market cap to recurring free cash flow. The EBITDA numbers below are my estimates, but they really only show a continuation of the current rate increases, at a slightly lower rate, and lowering Q3 and Q4 volumes against strong 2004 numbers. I think they are fairly conservative. (YTD 2005 EBITDA is 11mm, Q4 is seasonally the best quarter and Q1 the weakest).

Year 2005 2006
EBITDA 22.3 25.4
D&A 4.0 4.0
Interest 10.5 10.5
Taxable 7.8 10.9
Taxes (35%) 2.8 3.8
Net Income 5.0 7.0

D&A 4.0 4.0
Maint Capex (0.5) (0.5)
Recurring FCF 8.5 10.5

Adj Mkt Cap/FCF 9.4x 7.6x
EV/(EBITDA-Capex) 8.7x 7.6x

For those of you who prefer to leave the tax assets in there, and adjust the market cap for the cash only, market cap would be 108-12 = 96

FCF 11.3 14.3
P/FCF 8.5x 6.7x

Sorry to belabor the point – it’s cheap, and getting cheaper as rates rise and cash builds. In addition, there’s no reason that further slow rate increases, small volume increases and resulting EBITDA and FCF shouldn’t continue to increase beyond 2006 (remember rates are still below 1995 levels). In addition, management said in the last conference call that they were considering an opportunity to put one of their idle barges into active service, possibly in 2006. I wouldn’t think that this will be competing in the PR market (the management are very clear about the need not to cause a rate war, as are their competitors). This could produce incremental EBITDA of $2-$3 million/year, conservatively. It’s not in my estimates, and the idea is only being considered, but I doubt those barges stay idle forever. While you don’t want to destabilize your own market, there are other Jones Act markets to enter, and PR competitors occasionally need overflow capacity. In addition, after November 15, 2008 the company can pay down that expensive high yield debt.

To my eyes, the stock is easily worth 15x 2006 recurring FCF/share (ie no tax credits).
That would give you
15x 10.5 = $157 + $12 cash +$15 tax assets = $184 / 12.3
= $14.95 / share, or 70% upside from here.

You get the ~20% FCF growth, and the upside on idle assets being deployed

Insider Buying:
It’s always nice to see management eat their own cooking so to speak, and I’ve never seen anything like the CEO, John McCown’s taste for his own stock. Literally EVERY month going back years (except April 2004, for some odd reason), sometimes 2 or 3 times a month, he buys shares in the open market with his own money. It’s usually 100-500 shares, but there’s some 1,000 and 1,500 share purchases too. Then in July he exercised 314,000 options for a total cost of almost $300k out of his pocket. Didn’t sell any shares to cover the costs, either. And don’t worry about diluting the other shareholders – these shares came from the estate of the founder, so no change to the sharecount. He (and his family) own a bit over 940k shares now. I’d say his interests are pretty aligned. Bill Gottimer, the Secretary and General Counsel, isn’t averse to spending his own money on shares either. It’s good when the folks inside agree with you.

Liquidity:
The liquidity of TRBR shares is the main issue. The owners are mostly insiders, including the estate of the founder, Malcolm McLean, which held 44.7% of the shares outstanding. The good news is that the estate has delivered those shares to the McLean family, apart from 628,000 held to back options held by the CEO, who will exercise his over the next two years. The family members are not inclined to sell at these prices, or so it seems, but at least the shares are now finally in their hands should they be so inclined.

The stock tends to trade very little below $8, but as the price spikes toward $10 (usually at conference calls), liquidity improves noticeably. There are sellers, but they’re not willing to give the shares away at firesale prices. At $10, the shares are still cheap.


Risks:
Repeal of the Jones Act. Highly unlikely - hasn’t happened in 85 years. Especially unlikely in a time of war.

New competitor in the PR market. Highly unlikely. There is still excess capacity (remember that TRBR has 3 spare barges). A new self propelled ship costs about $125 million – if you can get one at a US yard. In addition, you have to get dock space in San Juan, and there’s not much of that (if any). The rates don’t justify new build, and the market clearly doesn’t support any more players (witness poor Navieras).

Irrational competitor. Everyone just got over the last price war. In addition, competitor Horizon Lines just IPO’d and needs to delever. TRBR is the lowest cost player. Rates are going up, not down.

Fuel costs: TRBR is the most fuel efficient (new tugs vs old ships). All carriers pass through fuel surcharges.

Slowdown in the economy. Could affect business, there can be lumpiness quarter to quarter also. However, virtually all of the imported essentials of life in PR get there by sea, and over time it grows along with GDP.

Catalyst

1. Q3 and Q4 numbers, demonstrating continued rate increases and operating leverage. Q305 completes 4 quarters since the step function in EBITDA that occurred with the restructurings and lease buyouts Q404. Q3 LTM EBITDA will be $20MM, and FY2005 $22.5, up almost 100% from FY2004. Cash is building, and so the EV/EBITDA is falling. FCF is increasing.
2. IPO of Horizon lines (HRZ). Goldman and UBS just brought HRZ public, and they will initiate coverage on it, the only other pure-play Jones Act shipper, and a comp to TRBR.
3. Deployment of one of the 3 idled barges. This is something I expect management to talk about more in the next few quarters.
4. Potential entry into new Jones Act markets. Probably a few years away, but a way to deploy some of the excess capacity.