Horizon Kinetics is lead by Murray Stahl (Trades, Portfolio) and Steven Bregman. These are some of the gurus who had a profound impact on the way I think about investing. You won’t be surprised I’m following their quarterly reports eagerly!
They are currently on the bearish side among value investors I follow. They are holding quite a bit of cash across the various strategies they manage. In this first quarter 2018 quarterly letter, they are again tackling some of the problems associated with the indexation trend. In addition, they discuss some of their stock picks, and I wanted to take one and highlight it: Subsea 7 (OSL:SUBC, Financial). Not least because I witnessed the beauty below while touring the Rotterdam port last summer:
As you may have guessed from the pic of the Borealis, Subsea 7 is an offshore services firm.
Because these services are primarily in demand with deep-water oil and gas drilling, which isn’t exactly booming. When oil is below $60, Subsea 7 stock hasn’t been the hottest thing over the past couple of years. Horizon makes several compelling points to why it should be (quoted text is from the Horizon Kinetics quarterly):
"The company is 21%”owned by Siem Industries, which is operated by its founder and Chairman Kristian Siem, known as the Warren Buffett (Trades, Portfolio) of Norway for his long record of astute deep value investing across the marine commercial sector. He is the chairman of Subsea 7 and controls nearly 80% of Siem Industries."
Kristian Siem apparently achieved something like 30% annualized returns in the shipping industry, according to MarketWatch. He is also profiled in Dynasties of the Sea.Ă‚
"Subsea 7 has $2.2 billion of current assets, of which $1.1 billion is cash. Against this, short-term liabilities are $1.3 billion, and non-current debt and other liabilities are only $0.5 billion. In other words, cash and current assets exceed all liabilities."
In such a cyclical business, a strong balance sheet is a huge asset, and if one can attain attractive returns while keeping a clean balance sheet, that is an attractive risk/reward.
"The company is also quite profitable, even in this severe operating environment that has seen scores of bankruptcies, and cash earnings were positive in each year of this downturn. Last year, the company earned $455 million, and it trades at 10.6x this trailing figure. More important than reported net income, it produced $730 million of free cash flow – earnings after accounting for depreciation expense and capital expenditures."
Given the extremely depressed levels of captial expenditures I've observed across the offshore industry by energy companies, it would be very surprising if we wouldn't see substantial growth at some point. With oil around $70, offshore is starting to look better. Capex is ticking up but because futures are still pointing towards lower oil prices, a real push into capex remains delayed.
"The shares trade at only 6.6x free cash flow. In fact, not only has Subsea 7 not needed to raise capital, it has consistently repurchased its shares throughout this period. It bought back 3.8% of its shares last year, and almost 17% since 2012. Book value per share rose by over 7% last year. It has also been able to use its balance sheet strength to improve its market position as the industry struggled, having made a number of acquisitions in recent years. And it has also been investing in its renewable energy segment – think offshore wind turbines and their engineering requirements. That business line was virtually nonexistent in 2014, but contributed $958 million in revenues in 2017, and is growing very rapidly."
The offshore wind business is indeed growing extremely rapidly. Parks are now going up with virtually no subsidy. One of the problems faced by offshore operators is that turbines are constantly increasing in size. This means ships have to increase in size as well, but that means a ship that just broke a record in size can be completely outdated in just a couple of years.
At some point it is going to plateau though. Many countries are very excited about wind turbines and heavily investing in huge parks at sea. Once those MWs start getting fed into the grid, they will be less and less enthusiastical about increasing the percentage of power that should be derived from wind. Wind is an important component but not a complete solution in the energy transition.
"Subsea 7 shares trade at 0.8x book value. The S&P 500 (SPY) trades at 3.2x book value and 23x earnings.The significance of a balance sheet and income statement such as those just described, and a share price below tangible, book-basis liquidation value, and of a company that has already been tested by a severe market downturn, there is no substantive business failure risk. Armed with that knowledge, one can hold, in essence, a permanent call option on a recovery in that sector, by which time the return could easily be multiples of the purchase price. And that could happen irrespective of the price behavior of the S&P 500."
What more encouragement to foray outside of the S&P 500 for once? Tthis is an extremely compelling and interesting idea by Horizon Kinetics. I like to buy deep value plays where the equity is backed by real assets and there is a chairman present who is a skilled capital allocator, which is very important if you invest in a cash flow positive company, but you may need to wait a few years before the market will re-rate your investment. There is a lot of money that needs to be invested in the interim, and there are a lot of people out there who would happily squander it on something that doesn't drive shareholder value.
Disclosure: Author owns no shares.
