2023-10-11 08:49:26 ET
Summary
- Operating losses in majority of past 10 years indicate a flawed strategy or poor execution.
- Balance sheet concerns are not fully addressed by recent debt refinancing.
- Valuation is not cheap enough to compensate for an above-average risk profile.
- The turnaround strategy lacks clarity.
I believe that the current stock valuation of Orion has a lot of optimism factored into it, with the market capitalisation standing at $168.61 million. The analysts' estimated EPS for the fiscal period ending in December 2024 is $0.27, translating to a forward PE of 19.44.
In my opinion, this stock is already fully valued even if it delivers on the optimism that is currently embedded in the stock price, capping its potential for further increase in the share price.
Should the management fall short of delivering in the coming quarters, which is what I am expecting then stock price could very well revisit its 52-week low of $2.10.
Recent performance and going concern issues
ORN disclosed a 7.5% decrease in revenue year-over-year in the first half of 2023, amounting to $341.7 million, a downturn pressured by unfavorable weather conditions, project hold-ups, and the decision to exit unprofitable markets. The operating loss expanded to $8.6 million from $5.7 million the previous year, while the net loss grew to $12.9 million, up from last year's $7.9 million loss.
As of March 2023, the company expressed concerns regarding its going concern status due to an outstanding balance on its credit facility set to mature on 31 July 2023. However, in May 2023, ORN secured a new 3-year $103 million senior secured credit facility to restructure its balance sheet, successfully averting a credit event.
This new credit agreement encompasses a $65.0 million asset-based revolving credit facility and a $38.0 million fixed asset term loan. Revolving credit facility carries an interest rate of the 30-day SOFR plus 5.5%, and Term loan has an interest rate of the 30-day SOFR plus 8.0%, both with a SOFR floor of 4.0%.
Consequently, the company is set to incur double-digit interest rates on its debt.
The company has also been monetizing some of its assets via sale and leaseback arrangements. While such transactions do provide short-term liquidity, they also bind the company to lease commitments moving forward, thereby increasing the overall cost base.
Prolonged execution issues
Orion's lackluster performance on the bottom-line is noticeable. Given its inconsistent history of profitability, with no net profits over the past decade, foreseeing sufficient and sustained profitability to validate its valuation is challenging. The reported operating losses signify either a flawed business strategy or an inability to execute projects profitably, illustrating Orion's ongoing struggle to translate revenue growth into enduring profitability.
Multi-Year Overview of Income Statement, Highlighting Key Financial Metrics from 2013 to Present (Seeking Alpha)
Moreover, as of the end of Q2 2023, Orion reported a backlog of $818.7 million, marking a 36% increase from $603.2 million at the end of Q2 2022. The backlog in the higher-margin Marine segment soared by 119% year-over-year to $614.9 million. On the other hand, the Concrete backlog stood at $203.8 million, a decline of 37%, attributed to competitive pressures and withdrawal from the Texas markets. Whether the company can turn this revenue backlog into profits remains uncertain.
Based on the history of poor performance and lack of clarity on the turnaround strategy I remain unconvinced that there is going to be a quick turnaround in the business fortune and its ability to make profits on a sustainable basis to justify the current valuation.
Industry structure and challenges
Orion predominantly secures its contracts via a rigorous competitive bidding process, and typically operates within relatively brief project cycles, often concluding in under a year. Being a modestly-sized construction firm heavily reliant on governmental projects, it encounters a spectrum of risks emblematic of this sector, coupled with an array of execution challenges that have noticeably impacted its recent performance outcomes.
Contract Revenue Mix (FORM 10-Q)
From my perspective, most government contracts are given out through tough competitive bidding, which usually leads to thin profit margins, leaving little room for mistakes in cost estimates. To carry out these contracts profitably, a high level of operational excellence is needed, a standard that Orion has sadly struggled to meet consistently. The detailed aspects of managing costs, making sure projects are completed on time, and skillfully handling the bureaucratic details tied to government-contracted work require a sharp operational skill, something that seems to have been challenging for Orion, showing in its not-so-great financial results.
Management change
Orion Group's underwent a major management change with the previous CEO Mark Stauffer who stepped down as President and CEO, and as a member of the Board in April 2022 and appointment of new CEO Travis Boone in September 2022.
A new CFO was also appointed in September 2022 replacing previous CFO Robert Tabb who left the company in October 2021.
New Management Team (ORN-Investor-Presentation-2Q23)
The new management has been at the helm for slightly over a year now, so the grace period is nearing its end, with investors likely anticipating improved financial outcomes.
While the management has shared some aspects of their turnaround strategy through investor presentations , I find these details to be somewhat sparse and not very reassuring, leaving me skeptical about the presence of a solid strategy to revitalize the business.
ORN-Investor-Presentation-2Q23
ORN-Investor-Presentation-2Q23
Valuation
Whilst Seeking Alpha methodology is currently assigning ORN a A- rating on valuation, this rating seems to be based on the comparison of EV & price against Sales.
In my view, this is not an appropriate matrix to value a company that has consistently failed to convert sales into profits. I believe that the more appropriate valuation methodology is to compare EBIT and EBITDA against the Enterprise value, and on that matrix the share price is significantly overvalued as compared to their 5 year average and also the sector median.
I think that EV/EBITDA ((FWD)) is the best valuation methodology for the company and if we use the sector median of 10.75 times it gives an EV of $210.7M. Removing the Total Debt $102.5M, provides us with a market cap of $108.2M which equals to a per share value of $3.33.
However, I don't think that ORN deserves to be valued at the sector median and so applying a 20% discount to sector median the company should be valued at 8.6 times which give it an EV of $168.56M and a market cap of $66.06M which equals to a per share value of $2.03.
My reasoning for EV/EBITDA ((FWD)) being considered one of the best valuation methodologies for Orion Group Holdings is because it provides a clear and insightful reflection of the company's operational efficiency and core profitability. By focusing on forward earnings, this metric takes into account the company's future operational performance, making it more forward-looking than the simple historical EV/EBITDA ratio. Furthermore, for a company like Orion Group Holdings, which has significant lease commitments and debt levels, this ratio serves as a more comprehensive measure than P/E or P/B, as it factors in both debt and equity financing.
Conclusion
Orion Group's construction business involves above-average uncertainty and volatility. The turnaround strategy lacks clarity while financial resources are stretched thin. Until Orion demonstrates sustainable profitable growth, the risk-reward does not favor long-term investors.
In conclusion, Orion Group Holdings operates in attractive infrastructure end-markets but has struggled to convert opportunity into profitable growth. Orion's credit profile has improved after the recent refinancing but remains pressured. Achieving sustainable cash generation is key towards unlocking ORN's latent valuation potential. However, execution risks remain an overhang until project delivery inconsistencies are addressed.
In my opinion, this stock is already fully valued even if it delivers on the optimism that is currently embedded in the stock price, capping its potential for further increase in the share price. Should the management fall short of delivering in the coming quarters, the stock price could very well revisit its 52-week low of $2.10.
For further details see:
Orion: Prolonged Execution Issues, Turnaround Strategy Lacks Clarity