A few weeks
ago two companies crossed my desk that happen operate in similar segments thus
taking a hint (from what obviously is a) divine signal I decided to look into
them a bit more.
Zicom Group
The company is
an industrial conglomerate (headquartered in Singapore), founded in 1978 and
listed in Australia. Core segments (currently) are (i) offshore marine, oil and
gas machinery (ii) construction equipment (iii) precision engineering and (iv)
industrial and mobile hydraulics (if this doesn’t get you excited I don’t know
what will). To note the businesses will be housed in two segments, likely by
the next half, into (i) and (iii), which will also house new technology / engineering
investments (more below). Zicom is 36% owned by Giok Lak Sim (chairman and
group managing director) whose two children are also directors in the business.
To get this out of the way upfront the
company is a microcap c. US$46m market cap and US$40m EV and in a good month
about a US$1m worth of shares trade.
There are a
couple of reasons why this could be an interesting situation.
Committed management. While Zicom is a
controlled company, the CEO is remarkably forthcoming in his annual letters and other
communication (most
recent example here). He has been buying shares since 2008 in the open
market and has also acquired shares instead of his cash bonus. In addition, his
salary has been frozen since 2007. I could go on for a while but I find it
positively surprising in the context of most Asian, controlled companies.
New business. Since 2010 the company
has invested in what it calls disruptive technologies in the field of
electronics and medical technology (VC type investments generally related to
its precision engineering portfolio). The company invested over S$15m ($12m) equity
in four businesses (Orion Systems Integration, Biobot Surgical, Curiox
Biosystems and iPtec). While such investments can go either way the company is
saying that most of these are on the cusp of commercialisation which you can
essentially view as a free call option (i.e. not reflected in the valuation). As
noted above the business will collapse into two segments, which will help
reflect the performance of these new investments.
Valuation. The company is relatively cheap
on a statistical basis and trades at 0.6x book (vs 0.8x historical), 5x EBITDA (vs 3-4x historical), 5x free cash
flow (vs 9x historical) and 14x PE (vs 7x historical). The shares yield around
4% and the dividend is paid out of conduit foreign income, which is not subject
to Australian withholding tax. In addition, the balance sheet is strong with S$22m cash and gross debt of S$15m.
Now what can go wrong. The core segment
is offshore marine, oil and gas machinery (it makes winches for rigs and
supply vessels) and while sales and orderbook have picked up since last year
this is quite cyclical (with normally a 1-2 year lag), however management is positive
on the outlook. But this should be considered: while offshore exploration
picked up since the financial crisis so did Zicom's sales and orderbook (though
remains cyclical) but given where oil price is currently and possibly where it is headed
2015 E&P capex is at risk as well as Zicom's business, which is perhaps not yet discounted (though you
could argue that at 0.6x book it is). Base case thesis on the stock seems to be a late,
cylical upturn in their O&G segment, however I’d be cautious.
In addition
to the above the following could be negative as well: (i) VC investments flop
(ii) bad corporate governance (so far no evidence) (iii) continued weakness in
construction segment (has been weak as of late), which has exposure to the
Australian market and (iv) technicality if you are running a large fund but the
stock is quite illiquid.
Apart from a
spike in 2011 the share price hasn’t moved materially over the last five years.
Profit warnings have also preceded their last three earnings release so I’d say
the market was quite pessimistic about the stock. This has been
recognised by mgmt and as noted in the chairman’s letter they intend to do something
about it so there appears to be a catalyst (let’s see their approach).
Depending on
your stomach for volatility on the oil and gas front I think this is a very
interesting business, with good and aligned management in place and potential
upside from their new investments.
Orion Marine
Orion is a
slightly different animal. It is approx. $300m market cap, civil marine
construction company that is listed in the US and operates mostly in North
America and the Caribbean. The company was founded in 1994 as a construction
project management business and expanded into its current shape organically and
via acquisitions (most recently a $9m purchase of an Alaskan company).
Orion
provides marine construction services (to marine transportation facilities,
pipelines, bridges etc), dredging (essentially maintaining waterways/shorelines
by removing or adding soil) and other specialty services (demolition,
surveying, underwater inspection etc).
In 2013 the
company generated sales of $355m (mostly by bidding for various contracts) of
which 60% was from the private sector and 40% from various government
entities (federal, state and local). Key markets/customers are: ports, marine
infrastructure, oil and gas, defence/homeland security etc. As it’s a
contracting company backlog is key, which as of end 2013 was $247m ($242m as of
Q3’14).
As you’d have
guessed it by now Orion’s performance is tied to the general economic cycle but
with a lag (just like Zicom so the business is very cyclical). For instance, in
2009 revenues reached $293m with gross and EBITDA margins of 21% and 17%
respectively. By 2011/12 the margins were down to 4%/1% and 5%/3%. 2013 seems
to have marked a turning point as margins have improved to 9%/6% and on TTM
basis 10%/8%. Historically, average margins are 14%/11% (gross and EBITDA, respectively) so the company is
trending towards those levels. Key drivers for the decline was drop in
demand and also pricing pressure on contracts. So as you can see the business
is choppy.
I’ve been
looking at this stock many ways but the key story seems to be the recovery in marine
infrastructure construction in the US. Just to highlight a few potential
avenues for capex growth in this segment: (i) private sector: energy sector
growing, expanding and refurbishing waterside infrastructure (e.g. gas related
projects – ammonia, LNG, chemicals etc) not just in ports but inland waterways
as well (ii) local port authorities growing capex (port deepening etc) for
increased cargo volume and larger vessels primarily due to the Panama canal
expansion and (iii) government funded programmes to improve, maintain and
restore the coast (think damages of recent hurricanes or that accident in the GoM
in 2010).
I’d say
barriers to entry are medium. You need specialised equipment and trained
people (nothing one cannot replicate given the resources) but gaining access to
government funded projects (especially on the defense side) require all sorts
of clearing thus these relationships are very valuable. On the other hand given
that around 40% of revenues are from the government when funding hits a dry
spell it can get pretty painful.
Due to the
cyclicality it’s hard to value this stock and figure out what are the recurring numbers but an EV/Sales approach could give an indication of what the market implies.
If you look since 2008 the peak has been 1.4x (2009; it’s actually been higher but
only for short periods so 1.3x-1.4x more reasonable), which dropped to 0.4x
(2012; again 0.4x only for short periods and 0.5x is probably a better
indicator). It’s currently trading around 0.7x. So those are the ranges.
In 2013 the
company generated $355m in sales and this year they are on track to do $385m
(mgmt noted Q4 should be on par with Q3). Using 2014 sales and most recent net
debt as a base at 1.3x it’s an $18/share stock and at 0.5x it’s worth around $7.
Given where we are in the cycle I think 1x eventually is not ridiculous (i.e.
lights at the end of the tunnel but not fully out yet), which would imply
around $14 (vs current $11).
Commodity
prices drive oil and gas capex and while Orion remains bullish on the outlook
of private sector projects in the near term I’d tread carefully here (at least
in the very near term). As a result of the cyclicality using say the average
revenue since 2008 is perhaps more defensive. The same multiples on those numbers
imply a range of $6 to $15, and $12 using a 1x multiple (i.e. fully valued)
though it could get interesting in the $8-9 range. I think on the long-term
horizon this is a very interesting story to watch.
To note
Arnold van den Berg, the founder of Century Management, whom I admire greatly,
is a large shareholder in the company (around 9% stake) and his thesis is very
similar (i.e. marine infrastructure boom in the US of which Orion would be a
beneficiary). In a recent interview with Graham
and Doddsville he noted that he’d be a buyer should the stock dip to around
the $9 levels.
