Description

World Fuel Services (INT) is the largest marketer of bunker fuels to the marine transport industry and a large supplier to the aviation industry. Each segment accounts for about 50% of INT’s gross profits, respectively. Through its global network of 23 offices in 13 countries, INT handles approximately 12% of all marine bunker fuels sold in the world. However, INT takes no price risk or inventory risk in its model. It simply serves as a broker or reseller of the fuels to its customers. On the aviation side, INT procures fuels for second and third tier and corporate jet customers. Importantly, they do not supply the likes of American, United, etc. Since the company never takes possession of the fuel, it has low working capital requirements and very little capex. The biggest asset on the balance sheet is A/R. The stock is trading at only 11x forward eps, while it is sitting on net cash of $27.5 million ($2.60 per share). The company doesn't have any comps, but as a logistics provider, it doesn't seem unreasonable to put it up against the asset-light freight forwarders, which are trading in the mid-20s times eps. Even using the low end of the range for that group, at 20x, the stock would be valued at $40, 79% price appreciation potential.

On the marine side, fuel costs tend to be 30-40% of the operating costs of INT’s customers, so cost savings can be an important driver in choosing who to procure through. The company's competitive advantage is knowledge of the markets and being able to aggregate purchases on behalf of customers to garner cost savings. INT’s biggest risk is the credit of its customers. Think of them as a big trading desk. However, the marine side has not experienced any credit events in recent history and appears to be under tight credit controls. They give very good disclosure quarterly about bad debt provisions and write-offs for both aviation and marine.

The company did take a credit hit on the aviation side in March 2000. Since then, INT has a new management and has refocused its efforts to emphasize higher tier aviation customers at the expense of volumes and has since experienced no meaningful writeoffs while profitability has improved dramatically. Volumes in aviation recently ramped up with new deals to procure for Jet Blue as well as a joint venture with Jeppesen, a division of Boeing.

INT should continue to grow its earnings at a double digit clip as marine customers gradually migrate from the broker model, where INT takes a fixed commission, I estimate around $0.70 per ton, to the reseller model, where INT acts as an aggregator of fuels for multiple customers, buying and subsequently reselling in bulk. In the reseller model, I estimate margins have averaged between $3.50 and $6.00 per ton. Resold volumes were 49% in Q1 versus only 38% two years ago. Meanwhile, overall volumes should generally track international trade levels or greater as INT continues to gain market share. The biggest challenge to achieving the higher margins of the reseller model is educating customers as to its benefits. As customers buy-in and convert from simple brokered trades, margins should expand meaningfully. I estimate that every 1% increase in the percent of the volumes shifted from brokered to resold adds about $0.05 to earnings. The leverage is tremendous. It is also important to point out that the company has net cash on hand of $27.5 million. The company is currently digesting some recent acquisitions and I do not expect further acquisitions for at least a couple of quarters. The company may buy back stock with the cash, or they may continue to build cash for future acquisitions. If congress passes some form of dividend tax relief, the Board may bump up the dividend. Either way, insiders own about 12% of the shares outstanding so I expect them to be very shareholder friendly.

In the most recent quarter, marine margins exploded with the uncertainty in the shipping markets. As with trading desks, the less the customer transparency, the better the trading desk will do. I estimate resold margins expanded to around $6.50 per ton, up from under $4.00 in Q4. Even assuming margins begin reverting back to normal in the second quarter with the end of the war, the company should be able to post around $2.00 eps this year. This should translate into around $27 million of operating cash flow. Since the business requires almost no capex (I estimate about $3 million a year) INT should be able to generate free cash flow around $24 million ($2.25 per share) in 2003. As a point of reference, they generated $7.3 million in free cash flow in 2002 after spending $5.5 million on acquisitions. Adding that back, they would have generated $12.8 million free cash flow last year.

Catalyst

If management continues to execute on its plan to increase margins through higher reselling, INT could grow at earnings by at least a mid-teens percent over the next few years. Moreover, the company has a bullet-proof balance sheet which could be used for further accretive events such as share buybacks or acquisitions. At a 20x earnings multiple on 2003 estimates, INT should trade at close to $40 per share.