Distressed Equities 2: Fishing for undervalued stocks!

 Today, I'll be looking for value in SEACOR Marine Holdings (NYSE: SMHI) and Genco Shipping Limited (NYSE: GNK).

Their 10 yr bonds (the day their full principal has to be repaid) is due on 15th May 2030,

Business Model

For SEACOR, their revenue is derived mainly from supplying fast support to crews working on oil drilling operations across the Atlantic Sea. For Genco, their revenue ... In contrast to Genco Shipping, SEACOR's revenue is exposed heavily to oil drilling operations, and as a result, its stock price is exposed to shocks in oil price volatility. This can be seen in their Fast Support Vehicles (FSV), where utilization rates dropped from 67% to 52%

During this quarter (Q1 2021) their cash position improved significantly, standing at 68 million compared to last quarter of 32 million. This is primarily due to the sale of their business Windcat Workboat Holdings Ltd, which brought in an additional 22.8 million. Despite that, they seem to drop 10 billion in net cash every quarter.

Source: https://seacormarine.com/

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Approaches to valuing negative earning companies

So how exactly do you value companies that have negative cashflows or earnings? Many of the commonly relied on metrics such as PE ratios or EPS can't be relied on. While the approach to valuing negative earning companies are more difficult, there is still inherent value in young growth companies, hence it is important to use the right approaches. Here is a typical outlook on prospective young growth companies.

In the early stages, companies are faced with heavy startup costs usually associated with building up a company. Initially, these costs will eat into their revenues giving them negative cash flows, but as time progress, these companies enjoy the benefits of economics of scale of generated revenue streams, while depreciating their original invested capital.

Depressing Outlook

Since their earnings are negative, we can't really rely on the income statements or any shortcuts such as Operating Margins, to help give us a clear picture of its intrinsic value in the future. So, we must look into the cash flows of this firm. From the past 4 quarters, we can see that they burn through roughly 10 million per quarter. In terms of survivability, I predict based off of their current situation that they can operate for 5 more quarters worry free. I say 'worry free' with air quotes, what I REALLY mean is that their company is failing. Why the hell are they still issuing such high compensation to their board of directors? We can tell by September 30, 2020 that the firm had issued 755 thousand shares to their directors. And on average, each director doesn't hold their shares for very long (source: pending investigation). To make matters worse, they aren't making any reinvestments to their firm. Compared to Genco Shipping, SEACOR is actually offloading their Windcat vessels and business. Sure, that cuts down on operating costs substantially, but its not like any other parts of their business was running efficiently anyways. Sure, direct vessel profits had an operating margin of 12% for the year 2020 (1.3/11.2 Million), but they kept losing money from their property, compounded with the problem of depreciating usefulness. (note Property Depreciation for Q120 - Q121)

Examining their fund raising methods

When looking for growth value in a stock, you must take care that the data you sourced are of quality and free of any errors. So before I turn to compute Earnings Per Share (EPS) or turn to look at the company's Earnings Before Interest, Taxes (EBIT), I examine whether the companies are running efficiently are ask myself whether these companies can cut down on these problems to stimulate higher growth.

Reinvestment: Genco's procurement of new vessels

Often, a good intuitive indicator of the insider management view on the 'longevity' of their company is by looking in reinvestment rates. In our scenario, the reinvestment can be found in business acquisitions of adding new ships to their fleets. Similar to R&D in a tech company, where money is pumped back into companies for to generate new tech and acquire patents for products. Vessel acquisitions, is where money is spent for these companies to acquire new ships in order to continue operating business and cut down on operating costs (think fuel and oil). Simply put, capital expenditures (CapEx) is as critical to Maritime Transportation Companies as R&D is as critical to Tech firms. 

Announcement of Upcoming Dividends

One thing we take into consideration when calculating intrinsic value is dividends. Following the latest quarterly report, Genco Shipping Limited has announced that they would issue dividends.

Source: Genco Shipping 10-k Investor Relations

The dividends for the next quarter can be anticipated to be 0.05 per share. (Source: Guidance Report) We should take this factor into consideration when calculating our intrinsic value as it is an expense on our cash flows.

Analysis of Trends

We should begin by building a picture of what their earnings and expenditures look like, here is data from 2016 to 2020, detailing their trends of Revenue, SG&A, COGS, and Net Income.

Source: 10-K Genco Shipping Limited SEC data

Here, we can observe that net income improved substaintially compared to previous years. Although averages are not good indicators of future efficency, they can give us a rough estimate of what expenditures to expect for the next couple months.

The Forecast Begins

Now with the formalities out of the way, we can begin to forecast their growth (if any) for the next couple of years. Firstly, for the second quarter of 2021, I believe they will incur a total COGS of 76,109. I forecast for the year 2021, items 6-10 will inccur a 10% reduction, with an overall COGS reduction of 8% YoY. However, their General & Administrative and Managment fees, items 9 and 10 respectively, will grow in line with Revenue of 1 percent. 

The assumptions will be listed below:

(Lease R +1%, Spot R +2%, Total SG&A -10%, Total COGS -7%)

These previous stated assumptions will carry across the second and third quarters. Moving onto the year 2022, I maintain that their firm will struggle to gain footing for a while with Revenue at 355,560 and total Operating Expense at 456,630. This continues until 2026 (or Phase 1, if you would), where the firm becomes profitable (meaning their net income is non negative for the first time). Here, the firm's revenue continues to grow at 1 percent, while facing decreasings overall costs. Before, the firm was losing money and was not taxed, here we will assume they begin take a tax rate of 18%, the industry average. Moving onto the year 2030 (Phase 1.5), their SG&A and COGS stops decreasing and starts increasing at 1% in line with the revenue growth. In year 2022 (Phase 2) the firm reaches peak growth, and in the following year (Phase 3) the firm reaches stable conditions. With estimate their revenue will grow at a rate of 0.5%, with their SG&A and COGS growing at 1 percent and taxes at 10%. These forecast variable will continue to be used in perpetuity. 

Discount Rate

The most crucial part of the forecast model involves the discount rate. Discount rate is the interest rate you require for stock investments in order to account for its riskiness inherent in the concept of the time value of money. Since their financing of the 2 new vessels includes both debt and equity, I will be using Weighted Average Cost of Capital (WACC). To find the discount rate, you must find cost of equity, the cost of debt, and their relative proportions to their sums. The WACC is found to be 5.36%.

Source: 10-Q 2021 Genco Shipping Limited

Using the WACC (5.36%) as the discount rate, we arrive at the net present value of 915 million, deducting their current net cash of 269 million we get a terminal value of 646 million, or 15.42 dollars per share. 

Source: Author's Estimates

We see that the value we have arrived at is not far from their current value, and altough their growth is promising, I wouldn't buy into neither Genco at such a high price.

Concluding Thoughts

It would take 'half a miracle' to wrestle this company's profitability out of its current spiral. Genco Shipping on the other hand is a much better choice for long term prospects. This can be argued on three basis: (1) its operating efficiency, (2) its reinvestment rate, (3) its upcoming dividends. However, I sense heavy insider trading activity against this stock so I wouldn't bet against it. Secondly, I would not purchase Genco Shipping's company right now. As of 05-June-2021, their stock stands at 15.74. Our valuation model provides use with 17.26. I do not deem that there is a sufficent margin of safety. 

The model is free to download, and provides only raw data. For futher information & enquiries please call +852 9181-8099 or email me at dompatrick2021@gmail.com.  Download Model

Distressed Equities 1: A Valuation on Private Prisons!

In the last couple of weeks, we have seen two REIT stocks at their 52 week low. The first company leading the market cap for private prison was GEO Group Inc, a  real estate investment trust that invests in private prisons and mental health rehabiliation centers across North America, Australia, South Africa, and the United Kingdom. Following close after, is CoreCivic, a company that runs private prisons and correctional facilities across primarily in the United States. Prior to the 2nd qurter of 2021, CoreCivi was the second largest private corrections facility in the US.

The Story of GEO Group

GEO Group is one of the two REIT's heavily invested in private prisons. Both GEO and CXW suffers from decreasing contract renewal from the states, and limited access to borrowing. GEO Group had annouced on April 7th that they will suspend their dividends to pay off thier existing debt. For 2021, GEO plans to repay a minium of $125-$150M in net debt over the course of the year, while the decision is resonably made, it was done late compared to CoreCivic it their cutting of dividends in early August 2020.

Data by ThinkorSwim

GEO Group has four business segments: GEO Secure Services (formerly named U.S. Corrections & Detention), GEO Care, International Services, and Facility Construction and Design. GEO Secure Services focuses on running and leasing detention centers. The GEO Care segment brings in revenue from is community-based service business, youth services, eletronic monitoring and other supervision services. The Internatioanl Services manages rehabiliation facilities across Australia, South Africa and the United Kingdom. Finally, the Facility Construction & Design gets revenue from management contracts from both local and federal agencies for its design and constructions of facilities.

Criticisms of the Industry

Even prior to the election to Joe Biden, we can observe that United States have slowly diverged from privatised prisions into alternative punishments into ... In fact, both GEO Group and CoreCivic have long faced controversy on spending millions on lobbying legislators, and thier use of  prison labor. These companies has been critized by Scott Stringer, the 44th New York City Comptroller, as part of a "financially risky and morally bankrupt" industry. As such, I will value these comapnies accordingly to public sentiment.

Photo by Randall Enos via Cagle

Historical View of their Performance

From the end period of Q1 2021 to Q2 2021, the market cap of GEO Group Inc had gone from 1.04 billion to 693 million. For CoreCivic, it went from 801 million to 920 million (...and change). These represent 12.11 percent decrease and 14.78 percent increase respectively. My job now, as a value investor, is to determine wether the paris will continue on their trend on diverging prices, with CoreCivic leading the private prison industry, or can GEO Group Inc prove to be a tangible investment. 

===== UnderConstruction =====

Before using our historical data of cash flows to compute the value of the two companies. There are first several macro questions we must consider.

1. Overall decline of the industry

2. Riskiness of Cash Flows

3. Obligation to Debtors

My Deep Dive into Financials

Prima facie, the value of GEO group seems to weigh more than CoreCivic, I have based this claim based on the overview of several metrics. 

GEO vs CoreCivic

1. P/E Ratio     5.95 vs 18.56        for relative valuation lower P/E is indicates better value

2. P/BV ratio   0.74 vs 0.72        lower P/BV is better in terms of accounting value

3. P/FCF          2.018 vs 3.716           lower P/FCF indicates one is undervalued

However, we can devle even deeper into the financial health. Specifically, lets take a look at their debt, which Dane Bowler has claimed will be the undoing of GEO Group. While is is true that GEO Group faces higher debt obligations of 2.73 billion, compared to 1.79 billion of CoreCivic and their Debt-to-Equity Ratio 3.189 compared to 1.285. The return on equity of GEO Group Inc is, for the most current quarter, is 11.91%, comapred to CoreCivic's 3.91%. The delta for thier ROE have been moving relatively constaly, and there is nothing to indicate, as far as operating efficecny, that CoreCivic would grow to have a higher Return on Equity compared to GEO Group. Both companies have annouced that the State does not plan to renew their contracts for their correctional facilities.  source, source. Given the inevitable decline of the industry, their earnings will rely soley on the continuing operations of their facilities.

GEO vs CoreCivic

1. Debt-to-Equity Ratio     3.189 vs 1.258        lower better

2. Return on Equity   11.91% vs 3.91%        higher better

I think, given the current measures GEO Group's managment have taken to address its debt issues, shows good promise that they will transition into taken on less debt in the future to finance their growth.

Valuation

I used a DCF model to value GEO.  Key inputs to estimate NPV(Net Present Value) are operating margin, return on invested capital, discount rate, cost of capital. NPV is calculated =NPV(discount rate, series of cash flow).

My value per share is about 8.74, close to 52% higher than the current share price. My key assumptions as follows.

Revenue Growth

In my model, I used a prediction  of 1 percent revenue growth in perpetuity.

Net Operating Margin

I won't bother breaking down the NOI margin sector-by-sector, rather I opted to go for an overall estatimate. Given in the last eight quarters, their 10, 11, 9, 12 percent respectively. I will assume their overall operating margin will continue to hold constant at an average of 10 percent. I set the model to reflect this feature and forecast what might happen in the next four quarters.

Effective Tax Rate

To calculate FCFF, a tax rate should be estimated. The simple-average tax rate for the past 4 years was 12%. I used an estimate of 10%. I used this tax rate to compute the after-tax Net Income and the cost of debt and capital. GEO's historical sales-to-capital ratio is

Discount Rate

For the discount rate, I used their 10 year bond. 5%.

Conclusion

GEO group, relative to CoreCivic, is oversold. The dividend cut does not justify its 27.31% drop. Further, at the current price of 8.42, CoreCivic is overvalued. Buy GEO and short CXW.

Disclaimer: Not Financial Advice

In life and in death, glory to Wall Street Bets.

Shout out to my bois on WSB. Possible squeeze window.

Data provided by Fintel

Terms and Definitions (For those 'Not in the Know') :

Price-to-Free Cash Flow   lower better; a higher P/FCF ratio might indicate that a firm is trading at a high price but is not generating enough cash flows to support the multiple

Debt-to-Equity Ratio        lower better; a higher ratio suggest higher risk that the company is financing its growht with debt; and signals that the comapny is in financial distress and unable to pay debtors

Return on Equity               higher better; a higher ROE suggest that the company is increasing a profit generation without needing much capital