Friday, March 30, 2012

A watershed moment for Conrad Industries (CNRD)

CNRD is a shipbuilder which makes and repairs small to medium size boats (barges, tugs, ferries) operating at the Gulf of Mexico. It's not listed and is traded over the counter (OTC). It has a market cap of $106m and is controlled by the Conrad family. 

A reasonably run business in an industry-wide recession?

I initially invested in CNRD about a year ago. At the time, the CNRD's business environment was very gloom because of the Deep Horizon oil spill incident. CNRD's business was heavily dependent on the oil/gas exploration activities in the region. My original investment thesis was: exploration activities were destined to recover, it was just a matter of time; the headwind CRND facing was temporary. And there was evidence that the management was prudent: they had been gradually replacing their revenues from the energy sector with revenue from the public sector and the commercial sector. This is I wrote in my then private investment journal that I shared with a couple of close friends:
CNRD doesn't have much structural competitive advantage. What we have is a reasonably run business which is mispriced.  In 2010, ROE is 12%, op margin is 11%. (6 years averages are 24% and 12%) It looks like the management has been keeping the operation pretty efficient even in the bad years with price pressure from over capacity in the industry in the region.
I estimated CNRD's pre-tax earning power was about $17m in a more normal business environment and its intrinsic value would be about $19-20 per share. And I told myself I would sell it once it reached that price range.

Yesterday, CNRD released its 2011 annual report. Headline net profit was $19m, almost double the figure in 2010. Its share price briefly shot past $19 in the first trading hour. So now I need to decide what I want to do about my holding.

Or is it a growing business?

Events didn't unfold as expected, but in a good way. My original investment thesis hasn't played out as expected yet. Exploration activities in the region are still very muted. However, The performance of CNRD's management has far exceeded my expectation. They were growing revenue while completely moving away from the energy sector.

The more I look at it, the more I think CNRD is a high quality growing business which excels in its operation. It has been traded at its book value for some time. It should deserve much higher valuation. Look at its average ROE again. It's 24%. So we are talking about buying a business at 1x BV which is internally compounding at 24%. But that still doesn't fully justify CNRD's profitability. CNRD virtually doesn't use any debt and it  has ~$7 cash per share on the book. Both penalize CNRD's headline ROE. In other words, CNRD's real ROE is actually much higher. While CNRD has never paid any dividend, it has spent $3.6m in 2011 to buy back shares. That's equivalent to a 3.4% yield.

What to do now? Now comes the watershed moment.

CNRD has decided to spent $20.8m for 2012 to expand its shipyard. (See page 3 of the annual report.) Considered that it spent only $49m in total in capital expenditures in the last 11 years, this is a giant expansion program. If I consider CNRD an average business recovering from an industry-wide recession, I won't be happy with such expansion. I'd rather getting some kind of special dividends. However, if I consider CNRD a growing company and that they can main their mid-twenty ROE on this new investment, this is an excellent news. Many high quality businesses with high ROE's have hard time to reinvest capital back into the business. (Just ask Buffett about See's Candy or observe how Microsoft has struggled to put its pile of cash into good use.)

I'm leaning towards to the latter. The question I have to ask myself is: Do I trust them they can compound the $20m better than me? The current management has been prudent in their capital allocation and operation. It's highly likely their decision on the expansion is opportunistic. The expansion includes buying a piece of land right next to one of their existing shipyard. How often can you buy your neighbour's house? Also, don't forget the ROE we have been talking about includes this $20m in the denominator. Regardless what they are doing to the cash (e.g. flush it down the toilet), it shouldn't damage its ROE a bit.

On the top of that, I still believe it's a matter of time the exploration activities will eventually resume. At the moment, CNRD is at $16.8. It's still 15% below my original no-growth EPV of $20.

By the way, the senior Conrad is now 96. I am wondering what will change when he finally passes the full control of the company to his son who is currently the co-CEO.... (If I haven't mistaken the history, the son was originally brought in at CNRD's most difficulty moment in 2004 to turnaround the business. And he did.)

p.s. One has to be aware of the risk that US shipbuilder industry is protected by Jones Act (1920) that boats going from US port to US port have to be owned by US companies and built in US. This is protectionism. There are arguments that companies choose to import stuff from overseas instead of cheaper local alternatives because of the artificial high local shipment costs caused by the Jones Act. What's strange is, this Jones Act has survived for 90 years and through many rounds of deregulations (e.g. rails and air). It's still here. It looks like it's unlikely it'll change. But politicians brought it up once again in 2010 after the oil spill. There is still a risk. What I can't be sure is how much shipbuilding and repair work will lose to overseas competitors if the Act is abolished. Apparently, proximity is a factor that counteracts this threat. e.g. Oil companies in Gulf doesn't engage shipyards in Seattle (west coast) to do their repairing.

(Disclosure: Long CNRD)

UPDATE: Followup post can be found here


  1. Thank you for a well written and interesting post. I do not feel I have any read on this type of business, still interesting to read anyway.

  2. Hello, how do you think CNRD barge business will be affected by the drought, i.e. Mississippi River "Trade Dries Up Along with Mississippi" WSJ?