Hidden Value Stocks is a Hedge Fund Alpha edition that gathers respected names in the hedge fund industry discussing their investment approach and stock pitches. In the Q3 2020 edition, the guest was Charles Lemonides from ValueWorks LLC who presented his investment thesis for the Tidewater Inc.
Company Background
ValueWorks is a company started in 2001 by Charles Lemonides aiming to deliver a reasonable rate of return by using his value investing discipline. The firm runs three portfolios:
- Capital appreciation portfolio with equity exposure in a value discipline.
- A more balanced portfolio overlays a fixed-income component.
- A risky part of the portfolio utilizes a degree of leverage and short exposure.
As a value investing firm, the cornerstone of its approach is viewing a specific security as a claim against assets. And when buying they are trying to get the assets at a discount price. When identifying a potential discount they are not looking at a specific market segment, particular benchmark, or metrics involved.
That way they would be limiting their investing reach. ValueWorks is essentially attempting to avoid buying mediocre companies at low prices, opting for high-quality businesses at compelling prices.
Investment Process
Understanding how much an asset is worth is the central part of the investment process. The company prefers to construct a concentrated portfolio of 15 to 25 holdings with a long-term horizon. According to Lemonides, it is difficult to identify a higher number of fundamentally different companies that are worth investing in the specific time frame.
A number between 15 and 20 holdings is optimal since increasing the number of investments would not significantly decrease volatility. The largest issue that shook the ValueWorks portfolios was a wide market collapse that led to cheap stocks even further losing their value.
As a value investor, his biggest fear is buying at a solid discount while the security loses even more value over time. This issue is not a sector-related issue, but rather a subjective judgment of whether a specific security gains or loses value over time.
The firm avoided several sectors including airlines and tobacco but the reason was not depreciation, but rather not being able to identify who would invest in these assets before them.
Tidewater Pitch
When assessing Tidewater (NYSE:TDW) at the given time it sounded like an outright bad investment. Since 2014 and the oil crash it struggled and at the same time the company was finishing an ambitious new-build program.
Tidewater was just one amongst a number of energy companies that had a switch in their stance from confident and aggressive, to a financially burdened landscape. What drew attention to ValueWorks was the investment that the firm already made in the long-lived assets that were getting cheaper and cheaper.
TDW owns one of the largest fleets in the world that work in support of offshore energy production. Also, they made significant steps to improve their fleet, making it the top of the line in their type of operations.
Regarding investments, the company infused its fleet with between $4 and $6 billion, while there are 40 million shares trading at $7 per share at the time of this interview. The equity cap was under $300 million, while the assets combined with cash could almost match the liabilities.
If an investor decides to invest into the company he gets an asset with a long track record for less than $300 million, and equipment that was supposed to be worth $5 billion five years ago. This can be defined as the best asset bought at the best price.
Asset Worth And Company Valuation
The company had in cash a total of $223 million, and at the same time, the debt was at $281 million. The equity was traded at $280 million. For that valuation, the investor gets 192 vehicles that compose their fleet.
Since the price of every vehicle to be built is about $4 million, we get to the figure of more than $750 million. However, their value dropped resulting in defensible value for the fleet in the range between $1.25 and $2.5 billion.
The range is wide but it comes from a different set of factors. If a seller would want to sell the entire fleet he would probably be unable to find the buyer. In case every vehicle is sold separately, it would take more time, but in case that the reasonable value is set for these vehicles it is possible to earn a value that is in the middle of that range.
From these figures, it is possible to estimate the intrinsic value of the company anywhere between $1.25 and $2.5 billion. Coming from this the intrinsic share price is between $32 and $65.
It must be taken into account that the stock price at the time of the interview was $7, while in 2018 it reached $30. Returning to this value is not the best scenario for Lemonides, since it is expected that energy prices will bounce back to old levels. This would trigger a rise in revenue to $500 million raising the stock value to over $100.
At the time of the interview, Tidewater acquired Gulfmark, a crude oil transportation company. From ValueWork's perspective that brought two positive aspects: they built their fleet in an economic manner, and also, by buying a competitor, they narrowed down the competitive landscape. Better valuation should come as a result of a more compact competitive pond.
Risks
The last decade was a disappointing one for TDW which experienced a serious drop in value. The problem is that hydrocarbons are being replaced by renewable alternatives.
The company entered this deal with risks in mind, however, it followed a century-old practice, that the demand for oil always rises. Betting that the oil would be pushed out of the market was always a bad one. The history of the asset and its importance is what is keeping the company confident that TDW will turn around.
They do not want to downplay the importance of renewables, but at ValueWorks they do not see an option when this type of energy will replace traditional sources any time soon.
The problems with liquidity are minor, and despite the company borrowing a significant amount of capital, they are still managing to cover its cash at any moment. To remain in safe waters the company should avoid buying assets with cash to avoid the burden of overleveraged.
Management Potential
The company went through Chapter 11 reorganization in 2017 after a series of aggressive buybacks in 2015 and 2016. From a company's perspective, the management has the right mindset to pull the company through the bad cycle.
Investment Outcome
The company reported their investment in TDW in Q1 2021 13F when they disclosed buying 335 thousand shares at $8.64. They currently own 245 thousand shares with a share value that skyrocketed to ~$74. When looking at the investment price, the stock value increased almost 10x.
Since Q3 2023 the company has been reducing its share in TDW, slowly trimming it to 245 thousand shares. It is still one of their largest holdings (currently third in size with 7.25% allocation) with a value of $23.34 million.
The latest analysis conducted by Simply Wall St showed that investors earned a 557% gain in the last three years. The share value dropped by about 20% in the last quarter, but despite these developments, investing in TDW proved to be highly lucrative. Even after a bit of a struggle, the share is showing signs of growth from the beginning of September, pointing out that TDW can still offer much to its shareholders.
TDW provided its shareholders with 16% total returns, which is a bit lower than the market managed to return. However, long-term returns at 37% per year in the last five years are a much better indicator.
What is also encouraging for the shareholders is that TDW returns managed to beat analysis prediction by 2.7% hitting $339 million. This was followed by increased earnings per share which came at $0.94 (6.8% more than expected).
The stock value estimates have a wide range between the most bullish $138 and the highest bearish $75. When a value range is this high it shows a difference in opinions, but the stock is still possible to forecast to some degree.
TDW in their latest report presented encouraging economic parameters. Revenue hit $339.2 million which is an increase of $18.1 million or 5.6% from the last quarter report. EBITDA rose by $0.8 million to $139.7 million, while net cash provided by operating activities also rose by $23.9 million to reach $76.8 million.
The company is in the process of repurchasing its shares. At the beginning of May 2024, they bought 176 thousand shares for $16.9 million ($95.66 average price per share). Also, the board approved another $13.9 million for the purposes of repurchasing shares, reaching a total figure of $47.7 million.
When looking at the ValueWorks investment figures we can see that the current stock price is 540% higher than an average buying price. In the last three years, ValueWorks bought TDW shares at ~$12 while the current price is ~$74.
These figures proved that ValueWorks made a good assessment. The thesis they created showed that the business was in a ditch, but after a bad cycle, it would rebound. The company betted that the stock value would go above the $100 mark and it did in May 2024.
The share did lose some of its value, but the management is highly confident in its operations. The drop could be just a short-term value depreciation due to several macro factors that made an impact on the oil market.
As a verdict we can say that the company made a great deal, knowing that the oil market is impossible to keep down. It rebounded and brought massive gains to those who were willing to make a daring bet.