ASC - Ardmore Shipping: Amazing Business Prospects

Summary

• Ardmore Shipping owns and operates chemical tankers in worldwide trade.
• The company’s asset/liability ratio is larger than one, so I would say that the company stands in good shape.
• In my view, the current valuation does not include a significant stock price appreciation potential. I would try to buy more shares at less than $8.
• Management noted strong momentum and impressive performance. In my view, if the company continues to deliver great numbers, stock demand may trend even higher.

Ardmore Shipping Corporation ( ASC ) recently delivered outstanding quarterly figures thanks to an increase in asset values and strong market conditions. In my view, further fuel efficiency and emissions reduction strategies could bring significant revenue growth and FCF margins. With that, my discounted cash flow models didn't result in a significant upside potential. I believe that the maximum fair value for Ardmore could be around $14 per share, and, in the worst cases scenario, the stock price could fall to $8 per share. In sum, I will not be buying stock at the current stock price.

Ardmore Shipping

Ardmore Shipping owns and operates chemical tankers in worldwide trade. The company claims to have high quality vessels, average age close to 8.2 years, fuel-efficient fleet, and currently increasing scale and improving flexibility.

I believe that the information reported in the most recent quarterly report is a good reason to study Ardmore. Management noted strong momentum and impressive performance. In my view, if the company continues to deliver great numbers, stock demand may trend even higher, even considering that the stock is already pricey.

Product and chemical tanker markets continuing at historically high levels with many factors now contributing to ongoing momentum. Source: Quarterly Presentation July 2022

Even if we don't like the current stock price, strong market conditions are driving the company's profitability up. Management is delivering very impressive figures with double digit sales growth.

Asset values also rising as buyers now factoring in strong market conditions to value estimates, most recently the sale of a 2016-built MR at $34.5 million, up 26% from $27.5 million at the beginning of the year. Source: Quarterly Presentation July 2022

It is also worth noting that many banks decided to refinance some of the company's portfolio as the company is doing really well. In my view, more investors may be willing to have a look at the company's balance sheet right now.

Recently completed a refinancing of virtually all of our debt with core lending banks, reducing our higher-cost lease portfolio from 14 ships down to two, and have also engaged in limited usage of the ATM over the past quarter to further build financial strength. Source: Quarterly Presentation July 2022

Financial Analysts Expect Declining Sales Growth In 2023 And 2024

Financial analysts forecast 2024 net sales of $177 million, EBITDA of $90.4 million, and an EBITDA margin of 51%. In addition, the EBIT will likely be $24.9 million, with an operating margin of 14%.

Estimates also include 2024 net income of $50.3 million, which may be appreciated after many years of negative results. Finally, financial analysts are also expecting 2024 free cash flow of $56.4 million and a FCF/sales of 31.9%. Note that I did use some of them in my financial models.

Balance Sheet: Good Financial Shape With Little Debt

On June 30, 2022, the company reported cash and cash equivalents of $45 million and advances and deposits of $11 million. Vessels held for sale stand at $26 million, and total current assets are equal to $164.426 million. Vessels and vessel equipment is worth $544 million. Total non-current assets are worth $568 million, and the total assets stand at $733 million. The company's asset/liability ratio is larger than one, so I would say that the company stands in good shape.

The total amount of current liabilities is small, so I wouldn't expect any liquidity crisis any time soon. Accounts payable was $6 million with accrued expenses and other liabilities of $13 million in addition to deferred revenue of $1.455 million. The current portion of long term debt was $15 million, with the current portion of finance lease obligations worth $24 million and the current portion of operating lease obligations being $2.293 million. Finally, management noted total current liabilities of $64 million.

On the other hand, the non-current portion of long term debt was $118 million, in addition to the non-current portion of finance lease obligations of $173 million. Finally, other non-current liabilities are equal to $943 million with total liabilities worth $359 million.

For June 30, 2022, in addition to the senior debt of $106 million, the company reported revolving credit facilities of $26,491 million, and total net debt was $286 million.

My Base Case Scenario Implied A Valuation Of $11.24 Per Share

Under normal conditions, I would expect sales growth close to 5.32% because the global transportation fuel market is expected to grow at this rate:

The Global Transportation Fuel Market grew USD 1,763.64 billion by 2027, at a CAGR of 5.32%. Source: The Global Transportation Fuel Market

Under this base case scenario, I assumed that the company's fuel efficiency and emissions reduction strategies will enhance both FCF margins and sales growth. Besides, I believe that the company's Eco-design and Eco-mod vessels will likely draw the attention of more investors. Stock demand could also increase. As a result, the company's cost of equity would likely remain moderate.

We believe we are at the forefront of fuel efficiency and emissions reduction trends and are well positioned to capitalize on these developments with our fleet of Eco-design and Eco-mod vessels. Our acquisition strategy includes to continue to build our fleet with Eco-design newbuildings or Eco-design second-hand vessels and with modern second-hand vessels that can be upgraded to Eco-mod. Source: 20-F

Now, if we also assume conservative EBITDA margin close to 57%, FCF margin around 24%, and an exit multiple close to 5.6x, the implied enterprise value would be $734 million. The implied price would be $11.24, which is close to the most recent market price. Under this model, I would say that the company is correctly priced.

I Believe That There Is Downside Risk, And The Upside Potential Is Not That Significant

I tried to design several discounted cash flow scenarios to understand whether buying more shares in the stock would make sense right now. Under my worst case, I obtained a valuation that is lower than the current stock price.

I assumed that one of the largest customers of Ardmore would not work as much with the company. In the past, the company had two clients that accounted for more than 10% of consolidated revenue of the company for the year ended December 31, 2021. It is a major risk in my view:

We have derived, and we may continue to derive, a significant portion of our revenues and cash flow from a limited number of customers. BP accounted for 10% or more of our consolidated revenue for the year ended December 31, 2021. Vitol Group accounted for 10% or more of our consolidated revenue for the year ended December 31, 2020. Source: 20-F

I also believe that Ardmore could suffer a significant decrease in FCF margins as a result of salary increases or new negotiations of collective bargaining agreements. The company noted these risks in the annual report. In the worst case scenario, I believe that if some equity researchers do deliver information about these risks, and an eventual decrease in margin occurs, the stock price could decrease significantly.

A significant portion of the seafarers that crew our vessels are employed under collective bargaining agreements. If not resolved in a timely and cost-effective manner, industrial action or other labor unrest could prevent or hinder our operations from being carried out as we expect and could have a material adverse effect on our business, results of operations and financial condition. Source: 20-F

With the previous bearish assumptions, I also used a discount of 5%, sales growth decline of -5% from 2025 to 2028, and a FCF margin around 25%. The exit multiple stands at 5.5x, which implied net debt close to $285 million and a fair price of $8.05 per share. Note that the downside risk, right now, appears significant. Right now, the stock is trading at $11-$13. I don't say that Ardmore will not creep up to $15 or even $20. I just say that future free cash flow would likely not be enough to justify such valuations.

My Best Case Scenario Would Imply A Valuation Of $14.5 Per Share

I believe that the company's balance sheet would allow management to acquire second-hand vessels, which may enhance revenue growth. Economies of scale would also improve the company's FCF/Sales. Let's note that the acquisition of second-hand vessels appears to be among the company's strategies. Purchase of new vessels and ordering new ones could also be a possibility for Ardmore:

Our business strategy includes additional growth through the acquisition of new and second-hand vessels.

We expect to purchase and order additional vessels from time to time. Source: 20-F

Under this optimistic case scenario, with a WACC of 5.05%, sales growth close to 6.5%, and FCF margin close to 25%, the NPV of future FCF would be close to $420 million. If we also use an exit multiple of 6.25x, the equity valuation would reach close to $575 million, and the fair price would remain at $14.5 per share.

Conclusion

Ardmore is a fantastic business model with an outstanding portfolio of fleet and talented management. I do believe that the company will deliver more revenue growth in the coming years driven by acquisition of new vessels and further fuel efficiency and emissions reduction strategies. With that, I don't believe that the current stock price represents a real opportunity. In my view, the current valuation does not include a significant stock price appreciation potential. I would try to buy more shares at less than $8.

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