“Even with new contracts not sure how they can recover from here. The news continues to disappoint on the downside once more for stakeholders who have been most patient.”
With respect, aramalap, I think your analysis has missed the mark here.
While some may be disappointed by the prima facie adverse earnings momentum, I think there is nothing disappointing at all about the thing that is far more important to the share price performance, namely the reduction in the Enterprise Value via the process of deleveraging the balance sheet/
Indulge me for a minute to share my thoughts, if it pleases you:
The overarching reasons – more than any others – why this company has destroyed so much shareholder value, are twofold:
Over-capitalisation of the asset base due to a reckless acquisition strategy in the mid-2000s, and over-investment in capability subsequent to that, and
The fixed cost base, which has not matched the reduction in asset utilisation
If I may, I’ll discuss each of these separately, and provide my limited insights into how – just as they damaged the business value until now – their reversal will bring the market value of the company a lot closer to its intrinsic value.
OVER-CAPITALISATION
Management is at great pains to point out that the carrying value of the crane fleet is reliable, having been - inter alia - been stress tested by the company's bankers during the debt renegotiation exercise that was concluded successfully in December last year.
For my part, I think that if the lenders are happy to lend against the value of the fleet, then that's a reasonable enough, independent endorsement as one can expect to receive.
(That said, however, I think that we should forget about BOL being a wholesale liquidation play, as some posters are suggesting by wishful reference to the NTA of the company. The reason I say BOL is not a liquidation story is because, not only is the liquidation on a piecemeal basis of 400 cranes and 250 travel towers totally impractical, it is also not the articulated strategy by Boom's management, who clearly want to better commercialise the capital base of the company.)
Looking at the numbers:
In 2004, Boom’s national crane fleet numbered 265 in size, serviced by 400 employees and supported by 35 depots.
By 2008, following $200m of acquisitions (funded almost to the dollar by equity raisings) and capital investment totalling about $80m, the company operated over 600 cranes, staff numbers had swollen to 1,435 and the company operated 62 depots.
At the peak of the mining construction cycle in 2008, Boom was generating around $400m pa in revenues, of which around $70m pa was dropping through to the OCF line.
The trouble is, during these halcyon days, BOL continued re-investing aggressively, by around $40m pa into expanding the crane fleet and associated infrastructure:
In 2009 some scaling back started to occur, with 580 cranes, 1,275 employees and 52 depots. 2010, too, saw some reduction in capacity, to 530 cranes, 1,200 employees and 50 depots.
But the biggest reduction in capability occurred over the course of FY2013, when the company started that financial year at 490 cranes, 1,150 employees and 45 depots.
Since then the pace of reduction has accelerated, to the current situation of under 400 cranes, 930 employees and 40 depots.
Why is this significant?
Well, it has meant that accounting standards, as they are obliged to be applied by the company and its auditors, do not reflect the practical reality of what is happening on the ground. Put simply, depreciation is a fixed charge, irrespective whether the capital plant and equipment is working hard, or is idling in a depot somewhere.
In other words, depreciation I the same whether the gear is being thumped by very strong demand conditions, or whether it stands wrapped in tarpaulins in a warehouse somewhere.
Sure, over the course of a full boom-to-bust business cycle, cumulative depreciation will probably “average” out appropriately, but during the boom it tends to under-estimate what is happening in terms of run-down of plant condition (and therefore overstates earnings, I suggest) and – conversely – during the bust times (like now) the depreciation expense tends to understate underlying profitability).
You might say, "well, so what?"
The reason this is a significant issue is that when operating profit (EBIT) is compressed (like it is in the current half, which is at an all-time low since the 2003 IPO of the company), depreciation becomes a big number relative to EBIT; D&A for the current half will be around $14m, while EBIT is under $3.8m per today’s update.
So you can see the acute operating leverage in the P&L.
But clearly, a big source of this operating leverage results not so much from cash operating costs, as it does to an accounting construct in the form of depreciation charge.
It is this effect, I suspect, that generates the “disappointment”, as it might be perceived by some.
However, I argue strongly that this is a distraction from the investment thesis for BOL, which as I said is one of deleveraging (i.e., what is happening to the balance sheet, specifically based on the cash flows generated by the business).
So let’s take a look at this, and let’s focus on the past 12 to 18 months, chosen because represents the toughest period in the company’s history:
During that time period, cumulative underlying EBIT was a mere $20m (JH13 = $6.0m, DH13 = $9.9m and JH14 = $3.9m). Not very much to support and Enterprise Value of $150m, you might be tempted to argue.
But the cash flow statement tells a totally different story: Contrasted against this paltry EBIT performance, cumulative Operating Cash Flow will have exceeded $50m (JH13 = $25.0m, DH13 = $11.4m and JH14 = $15.0m [approximately, back-solved to get to 30 June 22014 net debt of $89.5m as reported by the company]).
And remember that this Operating Cash Flow included the adverse impact of cash outgoings totalling some $8m which relate to restructuring exercises over the past 18 months.
So really, we are talking about adjusted Operating Cash Flows closer to $60m over the this period (which, as a reminder, has been acutely tough for the company).
Out of this, the company put around $35m back into the business in terms of capital expenditures. Offsetting this, however, has been asset sales totalling around $22m.
And because the company has not paid dividends over this time, the surplus capital has been applied to reducing borrowings.
As a result – and here is THE most important investment attribute, in my view – Net Debt has fallen from $127.8m as at 31 December 2012, to $89.5m @ 30 June 2014.
So, that’s a $38m drop in debt over that time (and would have been closer to $45m if the cash restructuring costs are added back). (And remember, the reason I’ve chosen that particular timeframe is because that has been when the company’s business has been very weak, making the deleveraging achievement that much more commendable)
All that remains now is for us to out this into some sort of valuation context:
The company’s market cap is $62m, and Net Debt is $90m, yielding an Enterprise Value of a little over $150m.
And yet the company is – at the worst time in its history – reducing its Net Debt (therefore its EV) at the rate of around $45m per 18 months, or $30m per annum.
That says that the Surplus Cash generated each year is around one-fifth of the value of the Enterprise.
In other words, in theory, as a buyer of the business today, the payback period is 5 years. (And recall, that is based on the company’s surplus capital generating capacity assuming the current deep cycle trough conditions don’t improve over the entire five-year period)
That, I believe, is what is known in the investing trade as an adequate margin of error.
Operating Cash Flow (OCF) has never been Boom’s problem: over-investment have and ill-disciplined acquisition strategy have been the culprits.
SLOW-TO-FLEX FIXED COST BASE
While strategically, the company’s management failed shareholders by acquiring excessively and over-investing in the business (presumably on the basis of a demand outlook that was clearly wrong), operationally there has been a major oversight: namely, the inability to avoid locking in an inflexible fixed cost base (notably uncompetitive employee expenses through Enterprise Bargaining Agreements that reflected an acute shortage of labour at the peak of the mining boom).
While Total Revenues are down significantly since the peak of the cycle (BOL will probably report FY14 Revenue of $260m, down from over $400m at the peak of the cycle), Revenue per Crane (an inexact metric, I concede, and one that is more indicative than prescriptive) is around $680,000 (cf. $700,000 at the cycle peak, so not that statistically significant).
By comparison, Employee Costs per Crane (again, not prescriptive, merely indicative given inherent inaccuracies) have risen dramatically over the cycle, to be over double their level of a decade ago:
Employee unit costs have risen much faster than inflation with Employee Expenses in FY13 being almost 50% higher than they were in 2004
Employee Expenses Per Employee: ($’000) 2004: 102 2005: 100 2006: 99 2007: 94 (looks like the businesses they acquired in preceding years had lower-paid employees) 2008: 103 (...which they soon brought into line with Boom levels of remuneration, it seems) 2009: 112 2010: 112 2011: 126 2012: 136 2013: 149
Manning levels are still excessive compared to history, with the Number of Employees per Crane today being significant
Number of Employees Per Crane: 2004: 1.14 2005: 1.72 2006: 2.07 2007: 2.31 2008: 2.39 2009: 2.28 2010: 2.23 2011: 2.30 2012: 2.28 2013: 2.34
The outworking of all of the above on the financial performance of the company is that Employee Expenses as a percentage of Revenue has risen from the mid-30% levels in the mid-2000s, to 48% today
Clearly, the problem lies not what Boom is invoicing its clients (pricing appears to be holding up OK, as illustrated above), but in the management of the company’s fixed costs, notably employee costs.
In other words, its not an external problem beyond management's control; its a problem within the business, one which management has a mandate to fix.
Put another way, if management can get Employee Costs-to-Revenue down – not even all the way down to 35% again, but merely back to 40% – then even on the current depressed levels of Revenue, the EBIT uplift would be some $20m pa, which is more than a doubling of the current run rate of $14m!
That would place BOL on around $34m in EBIT (or $60m in EBITDA).
On an EV/EBITDA multiple of just 4x, that would result in an Enterprise Value of $240m. By June 2015, Net Debt should be close to $70m, so the market cap would $140m.
On a per share basis, that’s around 36cps, representing a near three-bagger from here.
SUMMARY
Yes, Boom is not a good quality business at all (in fact, truth be told, it’s a poor business) and ordinarily it is not a company I would ever own.
However, based on my modelling and the stress-testing that I have done on the balance sheet and on the cash flows, I think that all the bad news is priced into the stock at current levels.
While execution risks remain, at least management has articulated a strategy to restore intrinsic value (there is clear evidence that they are already getting runs on the board with Point 1 [De-Capitalisation] discussed above, and they have started to articulate action around Point 2 [The Employee Cost base])
I believe the Risk-Return equation is highly favourable.
Accordingly, I started buying the stock earlier this year at 17c, and I have continued buying it all the way down to 12c.
Even without any rebound in business conditions, if management continue remotely on the current path, I think this will be a plus-30c stock within a reasonable investment timeframe (12 to 18 months).
If demand for their products and services recovers, then I foresee 50c as a distinct possibility.
Adam
PS. For readers looking for added assurance, there are a few precedent situations that are almost identical to this one, which had precisely the same deleveraging investment thesis a year or so back and which have performed very well, namely PMP, TPI and COF.
BOL Price at posting:
13.5¢ Sentiment: Buy Disclosure: Held
(20min delay)
