(Article based upon prices and latest valuations as of October 28th, 2016. Financial data has been obtained from Yahoo Finance, Google Finance and from specific company websites. Navigator Holdings Ltd. was priced at $7.65/share on the close on Friday, October 28th, 2016)
Recommendation:
Buy Navigator Holdings Ltd. (NYSE:NVGS) at $7.75/share or less to secure an undervalued equity having above average growth potential in an attractive but undervalued transportation segment.
Introduction – Seeking an Investment in a “Liquefied Gas” Carrier:
If one looks broadly at shipping and ship-holding companies, they are under severe economic pressure and their market pricing reflects that reality, with many shipping equities selling at fractions of their accounting book value. Some segments of the ocean shipping industry have spent their way into trouble as their ability to generate revenue becomes highly constrained. Specifically, much lower “day rates”, resulting in significantly reduced operating cash inflow, combined with significant cash outflow demanded by contractual commitments to build expensive ships no longer needed, have resulted in highly constrained net cash flow (or negative cash flow). In turn, this has created an existential threat to these shippers due to their difficulty in keeping current on their debt and interest payments. From this, the threat of default rises and, consequently, the value of their common shares drop. This is specifically true in dry bulk shipping where rates, even if they are off the lows seen earlier in 2016, are still creating financial stress for that segment.
However, there is one segment of the shipping industry, which I felt might be an excellent area to explore even as other shipping segments are under financial pressure. The “liquefied gas” carriers appeared, as a general class, to be shipping segment that appears to be less mature and having not overbuilt to the extent of other classes of shippers (i.e., dry bulk carriers). In addition, with a view that the opportunity of transporting volatile oil and gas products is expanding to a greater degree than other shipping segments, some additional growth in vessel capacity is more justified than other, saturated segments and would absorb more readily additional capacity.
Specifically, improvements in oil and gas technology, such as horizontal drilling/highly productive drilling techniques and hydraulic fracturing deployed during the past two decades, have created a very productive energy industry in North America, generating very high volumes of low-cost oil and gas. In addition, there are other regions (e.g., the Middle East and Russia) where the productivity of oil and gas assets has and continues to provide significant supply of low-cost oil and gas. In turn, this low-cost source of oil and gas can result in low-cost sources of LNG, LPG, ethane and ethylene along with other volatile fractions. To be able to deliver these materials overseas and exploit pricing differences between the producing and consuming regions separated by oceans, one needs a “liquefied gas” carrier.
These category of carrier include ships capable of transporting liquefied natural gas, or LNG, but also include transportation of other refined products including liquefied petroleum gas, or LPG, ethane and ethylene. Even as this segment is treated here as a class, it should be noted that the ships are equipped with differing degrees of refrigeration and ability to hold pressure in order to handle the differing requirements of these various fractions. As a class, these types of vessels enable other parts of the world to benefit from the revolution in energy-producing technologies taking place in North America along with low-cost production in other regions; as a result, the need for these types of vessels is still growing and this continued growth in demand for these products can absorb some increase in capacity. Yet, with all this in place, many of these companies are selling at significant discounts to underlying value.
Having decided that this segment may be a good place to look for candidates for purchase, the available options (for the author, I use those listed on North American exchanges) were screened to see which might deliver the best value for investment. Any “buy” candidate would need to be strongly financed, showing positive operating economics and be selling at a discount to assets to motivate me to make a purchase. Navigator Holdings Ltd. met these criteria very well and, as you will read, provided me one extra reason to buy it at current prices, which prompted me to act.
One Final Note: I am not a trader, at least not a good one, so I am looking for long-term investments, not quick trades based upon reversals in “day rates”. To that end, I have focused my effort on identifying an investment:
- with a strong balance sheet that can best withstand the rate cycles,
- having strong earnings to provide additional funds to grow, and
- strong operational cash flow relative to its competitors.
Finally, I will be looking for companies having strong capital allocation skills to avoid critical investment mistakes that many participants in cyclical industries have made over the past decades. It is on this basis, as opposed to other ways to select investments, my selection is made below.
First Step – Quick Screen for Financial Strength:
I started with a basic screen for financial strength across a broad number of “liquefied gas” suppliers, the data for which I obtained from Yahoo Finance:
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As you can see, there are three shipping companies with ratios of productive assets to liabilities (excluding cash) above two. In addition, because of how the screen was set up and calculated, Cheniere Energy Partners LP Holdings (NYSEMKT:CQH) also shows strong financial strength as it has significant cash exceeding liabilities (even if it shows a weird ratio as cash is greater than liabilities), but the total assets are small relative to the cash position and I was looking for those participants who were already invested significantly in equipment. Finally, given small investment plus my bias against limited partner MLPs, I chose to drop CQH as I had three other attractive candidates from which to choose a target to evaluate. For some of the readers, it may be worthwhile to examine CQH as it does appear to be very strongly financed, but it did not fit into the model in which I wanted to invest.
Second Step -Operating Performance for the Three Candidates:
Three of the best-financed candidates having the strongest balance sheets passed through the first-level screen for additional evaluation, including two LPG carriers, (Dorian (NYSE:LPG) and Navigator Holdings) and one LNG carrier, StealthGas (NASDAQ:GASS). These candidates were selected for a second level of screening on their recent operating performance. In this way, I hoped to be able to use this second-level screen to identify the “best” candidate of the “liquefied gas” carrier candidates to do additional analysis, regardless of which of the specific carrier type that it is. Headline operating performance of the three companies is used as a screen below to identify the strongest candidate, using data (found on Google Finance) from the most recent quarter as a screen (ending June 2016).
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As one can clearly see, Navigator Holdings stands out, providing the strongest operating performance in the most recent quarter reported and is the obvious choice to take a more, in-depth look at whether it merits investment.
Navigator Holdings Balance Sheet:
The balance sheet for NVGS is provided here:
The balance sheet shows a strong ratio of assets to liabilities, with equity 2.4 times liabilities. While there is a portion of LT debt that is current (needs to be repaid or refinanced in the next year), this current portion of LT debt is just a bit than 10% of assets and should be able to be refinanced relatively easily. In addition, all assets are tangible assets. As compared to many shipping companies, NVGS has a very strong balance sheet.
Book Value versus Current Equity Market Price for NVGS:
As can be seen in the balance sheet above, book value is $16.98 versus a current market price of $7.65/share. Therefore, one is buying this very strong balance sheet at 45% of book value (i.e., a 55% discount), representing an excellent value. This price to book ratio is not that different relative to many shipping companies; yet, the balance sheet of NVGS is much stronger than many of these shipping companies, so one is securing a much more robust balance sheet at the same discount. This offers patient investors an attractive entry point for a company having strong financing; as we will see below, it also represents a low price for the operating performance as well.
Earnings Growth and Per Share for NVGS:
However, valuation and balance sheet strength is not everything and shipping companies have struggled to generate cash flow, much less be able to deliver earnings. This company was being selected from two other well-financed companies in the same area due to superior earnings delivered in the 2Q. However, has the company shown superior earnings and growth over a longer period of time?
The answer is yes. For the past three years, NVGS has delivered ever net income over the past three years (millions of dollars): $42.2 in 2013, $87.7 in 2014 and $98.1 in 2015. Earnings have more than doubled from 2013 to 2015. While many shipping companies have struggled to generate positive net income, NVGS has grown net income very aggressively, even as share count has remained constant throughout that period (i.e., it does not “buy” higher earnings simply by adding capital per se).
With “day rates” declining, earnings have also followed lower, dropping from $30,596 for quarter ending June 30, 2015, down to $27,233 for the quarter ending June 30, 2016. For the six months ending June 2016, earnings dropped to $30,515 from a net income of $50,504 of a year earlier, representing a 40% decline. Given a more difficult environment, earnings are declining. For NVGS, however, they are still positive, which is more than many shipping companies can say.
If one simply annualizes the 1H’16 earnings, one would end 2016 with earnings of ca. $60MM. With 55.44MM shares outstanding, that would result in earnings of $1.08/share. With a share price of $7.65/share, NVGS sells at a price-earnings ratio of 7.1, a very attractive buying point. This represents an attractive earnings yield of 14%, very attractive in a world with very high PE ratios and in a more difficult earnings environment.
The current pricing environment affects the entire segment (at least, LPG shippers against which NVGS competes), not just NVGS. Even as NVGS has delivered less impressive number in this more difficult environment, all of the shippers have been affected likewise.
NVGS Cash Flow Summary:
Strong earnings should result in strong operating cash flow. Indeed, cash flow from operating activities for 2013 was $80MM, for 2014 was $133.1MM and for 2015 was $149.6MM, again showing strong cash flow growth. Recently, following the declining earnings trend, the cash flow from operating activities has followed net income into decline. Operating cash flow for 1H’16 was running at about 57% for that of 1H’15, at $39.0MM versus $67.6MM.
On the other hand, investing cash flow for 1H’16 was only 71% of 1H’15, reflecting less investment in a less attractive market, reducing the incentive to invest at this point in the cycle. The good news here is that the board of NVGS is responding to a less attractive market environment, unlike some companies (in other segments, especially in dry bulk shipping) that appear to be “tone deaf” to the environment and continue to invest in unaffordable ships that no one really wants. This reduced investing cash flow of NVGS will reduce some of the pressure on the reduced operating cash, yielding an overall cash flow less negatively impacted than might have otherwise been the case.
Even with the lower cash flow, however, operating cash flow per share will still be $1.40/share; as such, the investor is paying 5.5 times the operating cash flow, resulting in a nearly 18% cash flow yield on the current market price of the security.
EBITDA is $34MM in the three months ending June 2016. Annualized, that would represent $2.44 EBITDA per share. With NVGS currently priced at $7.65/share, one can buy NVGS at 3.2 times EBITDA. Again, for a high-quality, well-financed company, that is an exceptionally low ratio representing excellent value.
The (Lack of a) Dividend:
If there is a negative associated with NVGS, then it is the lack of a dividend. I prefer investments that provide some money now (via a dividend) and more money later (from capital gains); unfortunately, that is not an advantage that NVGS offers at this point. However, this is only one consideration of many when considering an investment. My decision to invest in NVGS was based upon a greater emphasis on securing an undervalued security with growing assets on the balance sheet, offsetting the lack of a dividend and income.
One Final Point about Leadership and Ability to Allocate Capital Effectively:
The combination of the balance sheet and the operating performance led me to select NVGS. However, as I had mentioned above, there is one more aspect to this company that supports my decision, even if it is not a “hard” financial measure.
The major shareholder in Navigator Holdings Ltd. is Invesco Private Capital, with the fund owning nearly 40% (39.5%) of the common shares. IPC may or may not ring a bell, but the investor most associated with IPC is Mr. Wilbur Ross and his name should definitely ring a bell with many experienced value investors. Mr. Ross is an iconic value investor with a long history of investing in depressed industries, then selling at multiples of his investment once the industry recovers. There are few capital allocators that can match his knowledge, skill and track record of success and having Mr. Ross, or those trained by him and embracing his philosophy, is another key advantage for investing in Navigator Holdings Ltd. With Mr. Ross and his lieutenants watching the store, one can have a reasonable assurance that NVGS will not repeat the mistakes of other ship-holding companies recently that continued to invest significantly (at the very bottom of the cycle) into yet more ships not needed, not providing reinvestment economics and not affordable.
Summary Conclusions:
The “liquefied gas” shipping segment offers the opportunity to invest in a shipping segment that offers a better opportunity for long-term growth than other segments, especially dry bulk shipping, as this market does not appear to be as mature and saturated. This segment has enjoyed recent growth and can be expected to continue to grow as there exists an increasing demand to transport these important products to locations requiring greater supply at a reasonable cost.
Based upon the analysis provided above, Navigator Holdings Ltd. offers a strong balance sheet along with relatively strong operating earnings and operating cash flow as compared to peer companies in the same reporting period. Even with this relatively strong performance compared to peer companies, NVGS is selling at a significant 55% discount to book value and at low price-earnings, price-cash flow and price-EBITDA ratios. Included in this heavily discounted price is a major shareholder who is one of the best capital allocators (and distressed asset acquirers) in the past half century to manage future investment for you and makes sure that the future investment will deliver reinvestment economics.
Therefore…
Recommendation:
Buy NVGS at $7.75/share or less. Purchasing NVGS at these prices will provide patient value investors an attractively priced investment, which will deliver growth of their investment in the long term.
I have created a 10% position in NVGS (at a blended price of $7.08/share) and will look to increase that position at prices below $7.75/share as funds become available to purchase additional shares.
Disclaimer: No guarantees or representations are made. The Owl is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult an investment advisor when considering an investment.
Disclosure: I am/we are long NVGS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.