Great Lakes Dredge & Dock: Insiders See Value In This ~$4 Infrastructure Play

Great Lakes Dredge & Dock, which has not rallied like most infrastructure stocks due to internal issues, has brought in new management, and looks poised for a turnaround in 2017.

There are myriad reasons the company looks like it will see brighter horizons over the coming 12 months.

These include: a return to profitability at key part of its business, activist investors, and a new focus on bidding on the right projects.

Insiders continue to make small purchases in the stock, giving an extra measure of confidence in this turnaround.

Company Overview:

Founded in 1890, Great Lakes Dredge & Dock Company (NASDAQ:GLDD) is the largest provider of dredging services in the United States, accounting for approximately half of the domestic dredging bid market share. Its business consists of two operating segments: dredging and environmental & infrastructure (E&I), with dredging responsible for ~83% of the 2016 total revenues. The dredging division performs four primary types of work: capital (port expansion projects); coastal protection; maintenance (re-deepening waterways and harbors); and river & lakes. Capital projects were 44% of 2016 dredging revenues with about a 4-to-1 domestic to foreign ratio; coastal protection was 34%; maintenance, 14%; and river & lakes, 8%. The E&I segment provides construction, repair, and/or stabilization of environmental barriers. Great Lakes’ E&I business has been supplemented by two acquisitions: Terra Corporation ($26 million) in December 2012 and Magnus Corporation ($40 million) in November 2014. Gross profits, as a percentage of contract revenues for Great Lakes, have been consistent at just above 11% each of the last three years.

For the dredging business, the company employs three types of machinery: mechanical dredges (5); hydraulic dredges (18); and hopper dredges (5); which are complemented by large barges or “scows” (12). The company is near completion on the construction of an Articulated Tug & Barge (ATB) trailing suction hopper dredge (named Ellis Island). For the E&I business, the Great Lakes uses a variety of excavators, earth-moving equipment, and slurry batch plants.

The company enjoys some barrier to entry dynamics as a result of the Jones Act, which requires that work such as that performed by Great Lakes be conducted by American entities.

The Bad News:

Absolutely and relatively, Great Lakes’ recent stock price performance has been abysmal. Shares of GLDD are down over 47% since the end of 2014, while its peer group is up ~25% during the same period. This underachievement is not unmerited and due to several factors.

1. Terrible integration of the Terra and Magnus acquisitions. The E&I division has been a money-loser ever since the acquisition of Terra. Losses peaked in 2015 at $41.1 million and were $19.4 million in 2016.
2. International business took a big hit in 2016. The international segment of the dredging business is lumpy, subject to large, single customer contracts, and is concentrated in the Middle East. When business is slow, the company’s five overseas-dedicated dredges are underutilized and the top line suffers. Revenue from foreign capital projects plummeted 57.5% from $139.9 million in 2015 to $59.4 million in 2016 due to the absence of the Suez Canal project, which generated significant revenues and margins. This was the driving force behind the 6.4% drop in overall dredging revenues during 2016.
3. The black hole that is the ATB hopper dredge construction. The company entered into a contract to build a massive (433 feet long and 92 feet wide) ATB Hopper Dredge in early 2014. The cost was estimated at $96.6 million and the initial construction time was 32 months. It now appears as if the final cost will be ~$159 million, not to mention that it is behind schedule. Cost overruns on the Ellis Island are equal to 23% of the current market cap of Great Lakes.
4. A recent leadership shakeup has left the company without a CEO. On December 27, 2016, Great Lakes announced the retirement of CEO Johnathan Berger and the hiring of new CEO Lasse Patterson. However, Mr. Patterson is a Norwegian citizen, and must attain U.S. citizenship to head-up Great Lakes as per the Jones Act. Mr. Berger departed on January 3rd, leaving CFO Mark Marinko to temporarily assume CEO responsibilities. It is hoped that Patterson will obtain citizenship in early 2Q17. Also, amongst other changes at the board level, Chairman of the Board, General Mike Walsh, stepped down at the end of 2016 and was replaced by Robert Uhler.
5. The Domestic Dredging Bid Market Dried Up in 2016. The market for Great Lakes’ core domestic dredging business experienced a ~25% drop in 2016, largely a result of only two projects exceeding $75 million – neither of which was won by Great Lakes – versus 2015 when five such projects went out for bid. As a result, total project backlog at the company is down nearly 33% (2016 vs. 2015) to $505.3 million.

The Good News:

Despite all of the difficulties experienced last year, 2017 looks to be a turnaround year for Great Lakes and this potential turnaround does not seem to be reflected in the stock price as of yet.

1. E&I expected to return to profitability. During 2016, Great Lakes was able to divest its Terra Contracting Services division, which was a drag on earnings. The company also suggested that it will be more selective in the bidding process for E&I projects due to an anticipated robust bidding environment. As a result of these developments, expect the E&I division to return to profitability in 2017.
2. The Ellis Island should be operational in 2Q17. Although, over budget and late, the ATB Hooper dredge should be generating revenues for the company in 2Q17, making the transition from a ‘draw on’ to an ‘earner of’ capital. ~$142 million of the ~$159 million price tag has already been paid. This state-of-the-art vessel will provide Great Lakes with a competitive advantage as it will be the low-cost producer, owing to its lower fuel and personnel requirements along with economies of scale. In fact, a recently won $88 million contract for coastal restoration work in the Gulf of Mexico appears to be the Ellis Island’s first job. Interim CEO Marinko expects the vessel to add at least $20 million of incremental EBITDA to the company. With the completion of construction, capital expenditures should drop significantly considering that the Ellis Island accounted for $53.9 million of the $83 million in capital expenditures during 2016.
3. The Panama Canal Expansion should result in more U.S. port dredging projects. Port deepening work is likely to be required on many Gulf of Mexico and East Coast ports as the Panama Canal recently added larger locks to accommodate the new generation (post-Panamax) container ships. Great Lakes will be a natural beneficiary of this dynamic.
4. Government Tailwinds: Even if one were to ignore President Trump’s pledge to upgrade the country’s infrastructure, the government has a lot of plans and plenty of funding sources. The RESTORE Act requires that 80% of the $20.8 billion BP (NYSE:BP) settlement money be deposited into a coastal restoration works fund, a portion of which will go towards dredging. The Water Resources Reform Bill, passed in 2016, authorizes $16 billion of infrastructure improvements. These government funding sources are important because 64% of Great Lakes’ dredging revenues in each of the last two years were generated from contracts with federal agencies, either directly or indirectly.
5. Activist Investors: Seeing the undervalued assets of Great Lakes, Privet Fund, Clinton Group, and Kenny International have made their grievances known to management. This activism has already resulted in the addition of Privet founder Ryan Levenson to the board. Two others with marine infrastructure and construction industry experience joined the board in January. These changes are certainly no guarantee of success, but a new CEO, new Chairman of the Board, and active investor participation signal a greater focus on shareholder value.
6. Insider Buying: In addition to taking the reins as Chairman of the Board, Mr. Uhler has purchased GLDD stock three times since November 7, totaling 17,220 shares. More impressive, however, is the fact that 40 insider transactions have taken place in the last 12 months, totaling 483,561 shares with not one sell. The biggest transaction to date occurred on the last day in February, when a director purchased 110,000 shares of GLDD. Shares have been purchased by nine different directors and officers in the past three months. Considering the stock has been under $5 per share during this time period, it would stand to reason that board and c-level personnel see a lot of upside from the current $4.50 stock price.
7. Double Bottom: From a technical standpoint, shares of GLDD appeared to have put in a double bottom, bouncing off of the $3 level in late January 2016 and early November 2016.

Balance Sheet & Analyst Commentary:

The company has been actively covered by only one analyst on the Street in recent months and he rates the stock a hold. His revenue estimate for 2017 is $803 million (vs. $767.6 million in 2016 and $856.9 million in 2015). His earnings forecast is $0.14 per share (vs. ($0.13) in 2016 and ($0.10) in 2015). Given the asset-centric nature of the business, depreciation and amortization play large role in earnings; therefore, EBITDA is a better measuring stick for Great Lakes. Adjusted EBITDA was $72.0 million (or $1.18 per share) in 2016 vs. $83.0 million (or $1.36 per share) in 2015. If EBITDA were to approach $90 million in 2017, remember Interim CEO Marinko expects Ellis Island to generate at least $20 million in additional EBITDA annually, that would mean shares are currently trading at 3x 2017 EBITDA.

As of December 31, 2016, cash on the balance sheet was only $11.1 million. However, the company recently entered into a new $250 million revolving credit facility, of which $104.1 million was drawn to retire the prior revolving facility and a term loan facility. Maximum borrowing capacity is determined by a formula, resulting in an additional $47.5 million of current availability. Total long-term debt was $390.4 million at year-end 2016 vs. $413.0 million of property and equipment. The company has a current market capitalization of approximately $275 million.

Outlook:

With the Ellis Island ATB Hopper coming online in 2Q17, plenty of federal money committed to dredging, and a profitable E&I unit for the first time in five years, expect Great Lakes to generate significant free cash flow in 2017 and beyond. Investor activism and new management will see to it that this money is put to work with share price appreciation in mind. Strong insider participation signals a belief that shares of GLDD are poised for significant appreciation in 2017.

Source: Seeking Alpha