Frank Voisin is the author of the popular value focused website Frankly Speaking, found at Frankvoisin.com
Great Lakes Dredge & Dock Corporation (NASDAQ:GLDD) is the largest provider of dredging services in the United States. Dredging involves the enhancement or preservation of navigability of waterways, or the protection of shorelines. The company has been providing these services for more than 120 years. The company also operates in the demolition market, with recent expansion into the marine demolition niche as related to bridges and other structures over water.
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The company currently has a market cap of $450 million, plus net debt of $142 million for an EV of $592 million. What interested my in the company was not its free cash flows or earnings (average of $40 million and $22 million respectively over the last three years, suggesting that the company isn’t cheap on this basis), but rather the assets. Recall again that the company is very old. Many of its assets were purchased decades ago and have been largely depreciated. Normally this would be concerning because one would think that the equipment would need to be replaced. Here’s what the company has to say about this (emphasis mine):
The average age of our more significant vessels as of December 31, 2011, by equipment type, is as follows:
Type of Equipment Quantity Average Age
Hydraulic Dredges 20 35 Hopper Dredges 8 30 Mechanical Dredges 5 36 Unloaders 2 34 Drillboats 2 35 Material and Other Barges 146 31 Total 183 32
Remaining economic life has not been presented because it is not reasonably quantifiable because, to the extent that market conditions warrant the expenditures, we can prolong the vessels’ lives indefinitely.
So the company has old assets that it has been able to maintain (and believes it can continue to maintain indefinitely – I confirmed that its competitors make the same claim). The reason this is important is that, when a company buys a capital asset like this equipment it records it at the original purchase price. Each year, the company depreciates this historical value, and capitalizes certain repairs. So for long-lived assets, the recorded value begins to become less reflective of the purchase price (which itself is a poor proxy for current market price or replacement cost), and more reflective of the capitalized portion of maintaining those assets. Let’s look at the company’s disclosure on depreciation:
Property and Equipment—Capital additions, improvements, and major renewals are classified as property and equipment and are carried at depreciated cost. Maintenance and repairs that do not significantly extend the useful lives of the assets or enhance the capabilities of such assets are charged to expenses as incurred. Depreciation is recorded over the estimated useful lives of property and equipment using the straight-line method and the mid-year depreciation convention. The estimated useful lives by class of assets are:
Class Useful Life
Buildings and improvements 10 Furniture and fixtures 5-10 Vehicles, dozers, and other light operating equipment and systems 3-5 Heavy operating equipment (dredges and barges) 10-30
Note here that the maximum useful life of the company’s heavy operating equipment is 30 years, but the average age of this equipment is 32 years. The conclusion we can draw is that the bulk of the historical purchase price of the company’s operating equipment has been depreciated. Remaining on the balance sheet is largely the capitalized maintenance expenditures that have occurred in the interim. And in case you thought the operating equipment is only a small portion of the company’s assets, we see in Footnote 4 of the 10-K that, of the company’s $530.6 million of gross PP&E (before depreciation), operating equipment is $519 million or 98%! The carrying value (net of depreciation) is $310.5 million.
The point I am driving at is that the company purchased equipment at one point, almost fully depreciated that original purchase price and then subsequently depreciated a significant amount of the cost of maintaining that equipment. The result is that a casual observer of the company would think that its equipment is worth just $310.5 million, when in reality this bears no resemblance to the replacement cost of these assets.
So what is the replacement cost of these assets? Thankfully, the company helps us out with this:
The Company estimates the replacement cost of the Company’s fleet to be in excess of $1.5 billion in the current market.
Well, this is certainly a surprise! $1.5 billion is 5x greater than what the company lists as its net PP&E (or 3x gross PP&E) and 2.5x greater than the company’s EV. Furthermore, the company should be a beneficiary in the near term of increasing demand in the United States to expand and otherwise invest in improving American ports, as the widening of the Panama Canal will put greater pressure on the American intermodal transport industry.
What do you think of GLDD?
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