KEX - Kirby: Takes On A Little Water With Sluggish Sequential Guidance (Rating Downgrade)

2023-10-30 23:55:31 ET

Summary

• Kirby's third quarter results were decent, with revenue rising 3% year over year, but there were complications from the closure of the Illinois Waterway and ongoing supply issues in DES.
• Kirby faces a mix of positives and potential threats in 2024, with limited incremental inland barge capacity and strong refinery activity offset by higher operating costs and economic uncertainty.
• I calculate a fair value in the $80's but Kirby shares have pulled back by a third or more when the Street has been worried about the economic outlook.

Tank barge operator Kirby ( KEX ) has had an okay year in 2023, with demand improving throughout the year, but the share price performance has certainly weakened of late on increased concerns about the economy in 2024 and the company’s own guidance for somewhat sluggish Q4’23 performance. Up as much as 20% in September from my prior article , Kirby has followed the same basic trajectory as transports in general, even high-quality ones like Old Dominion (ODFL), since then and now sits about 5% above the price when I last wrote about the stock.

The cyclicality of Kirby makes it a tough buy-and-hold call and it’s not at all unusual to see pullbacks of a third or more. Such a move from recent highs would take the shares back into the $50’s, and while I don’t think the economic outlook justifies such a move, Wall Street can be a “sell first, ask questions later” sort of place. I do see fair value in the $80’s, but I’m not as confident in the risk/reward right now even though there are several fundamental positives in place.

A Modest Beat In A Challenging Quarter

Kirby’s third quarter results were basically okay, and that’s with the added complications of the closure of the Illinois Waterway for four months, refinery outages, and ongoing supply issues in the Distribution & Services (or DES) business.

Revenue rose 3% year over year and fell 2% quarter over quarter in the third quarter, just beating expectations. Marine revenue declined 1% yoy and rose 1% qoq, missing modestly, with inland revenue up 2% and coastal revenue down 13%. The closure of the Illinois River drove a 14% decline in ton-miles per barge, and delays increased 24% yoy, but utilization still stayed in the high-80%’s and pricing continues to improve.

In the DES business, revenue rose 7%, with oil/gas revenue down 16% as good demand for e-frac equipment was offset by ongoing supply/component bottlenecks. Commercial/industrial revenue improved 28% yoy, and management noted strong demand for Trane ’s ( TT ) Thermo King products.

Adjusted operating income rose 59% in the quarter, with margin up 430bp to 12.2%. This was good enough for a small beat relative to Street expectations. Marine earnings rose 52% (and declined 1% sequentially), with margin up more than five points to 14.8%. Inland margins improved into the high-teens (likely around 18% versus around 11% last year), while coastal margins were slightly negative.

In the DES business, profits rose 50%, with margin up 280bp to 9.9%; the oil/gas business posted low double-digit margin, while the commercial/industrial business had a high single-digit margin.

Sluggish Guidance And A Slowing Economy … But Limited Capacity And Strong Refinery Activity

Despite adding 28 barges in the quarter and continuing to see healthy conditions in the inland market (improving spot and contract renewal prices, as well as longer contract terms), management is only looking for sequentially flat inland revenue in the fourth quarter. The main culprits here appear to be rising weather-related delay days and low water levels in the Mississippi River, which limits/slows barge traffic.

Looking into 2024, the market conditions are an interesting mix of positives and potential threats.

On the positive side, capacity remains pretty limited. There about 4,000 barges in the market (and Kirby owns more than a quarter of them) and adding new barges is difficult – there is limited drydock capacity now and prices are quite a bit higher. Along similar lines, a significant percentage of the inland fleet (around 26%) is scheduled for maintenance in 2024. Given those limitations on drydock capacity, there could be risks of meaningful maintenance backlogs and much more limited spot capacity in the market.

Also on the positive side, economic indicators have come through a little more positively than I’d expected earlier in the year. The next year is not looking like a particularly strong one for the U.S. economy, but it’s looking more like a “bump along the bottom” year than an outright recession, and that should keep refinery utilization higher than it would otherwise have been. Demand, then, should be pretty healthy in 2024 and with contract renewals still coming in with high single-digit pricing growth, I think Kirby is in good shape for next year.

On the negative side, the economy could certainly prove weaker than I expect now, and refinery utilization would almost certainly be weaker in that scenario. Weather and navigation issues (low river levels) remain ongoing challenges, and while there is federal stimulus in the pipeline to improve river navigability, those projects will take years to complete. It’s also important to note that operating costs are significantly higher now and that creates pressures on operating margin even with good demand.

The DES Outlook Is More Mixed

DES has always been a volatile, hard-to-model business, and the recent supply challenges in the oil/gas business certainly haven’t helped.

Looking at 2024, I expect the oil/gas market to remain healthy provided that the economy doesn’t slow materially beyond my expectations. Healthy oil prices, then, should continue to motivate and support production activities and demand for fracking equipment and equipment services.

The other side of the business, the commercial/industrial business, should see weaker demand. The outlook for marine power is a little softer now, and I expect the correction underway in truckload capacity to drive less demand for diesel engine overhaul parts/services. Likewise, with a weaker outlook for industrial and non-residential construction activity, I’m not as bullish on the outlook for the backup power system business.

The Outlook

Although Kirby had been on a trajectory to outperform my initial expectations for 2023, the recent challenges (delay days and issues with the Illinois and Mississippi Rivers) have brought my expectations back to basically where they were at the beginning, and I’m looking for around 10% year-over-year revenue growth. I’m expecting around 7% to 8% growth next year, and long-term annualized growth in the range of 4% to 5%.

Although operating costs in the inland barge business are a risk, I still expect margin improvement on strong pricing and utilization, and with that I expect company-wide margins to improve from around 11% for FY’23 into the 13%’s for FY’24, with EBITDA margin above 20%. Free cash flow generation this year is shaping up to be lackluster relative to historical norms (around a 5% margin), but I expect meaningful improvement next year and double-digit margin for at least two years. Over the long term, I still expect low double-digit FCF margin to support FCF growth around 100bp above revenue growth.

Between discounted cash flow and an EV/EBITDA approach, I believe Kirby is undervalued today. The former approach suggests a fair value in the high $80’s. For EV/EBITDA, I think 8.5x is a fair multiple given long-term averages (7.1x to 8.9x) and where we are in the cycle. At that 8.5x multiple, I get a fair value of around $80.

The Bottom Line

My main concern with Kirby shares now is more about trying to anticipate the market than anything fundamental with the business. The market seems to be (finally) pricing in a more negative outlook for 2024, and that’s pressuring a lot of economically-sensitive sectors and stocks. As I outlined above, I think Kirby will see relatively healthy operating conditions in 2024, but I’m not sure the upside is so compelling to fight the tape. I’d put this name high up on a watch list, though, and if the pullback continues into the $60’s, it’s worth another look.

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