Gulf Island Fabrication (GIFI) shares have performed poorly since I last wrote about the company in October. Shares are down 45% in the last six months and 70% over the last year. At the time of this writing, the company trades at almost half the value of its net current assets. The market has chosen to heavily discount GIFI’s shares despite $70 million of cash on the balance sheet and zero long-term debt. I find this particularly puzzling because there have been some positive organizational developments at the company in the last six months, most notably the appointment of a new CEO. The previous CEO, Kirk Meche, was replaced by Richard Heo in November and Mr. Heo has already begun a company-wide shakeup. Heo has scheduled the closure of the underutilized Jennings shipyard, consolidated divisions within the company, and laid out a plan to move into onshore oil and gas fabrication projects. These changes haven’t yet resulted in operational profitability, but the value of the company’s assets remains intact and having a turnaround plan in place creates a potential upside catalyst that could materialize in the next six to twelve months.
A Turnaround Plan has Emerged
Mr. Heo has taken a number of large steps in his first six months as CEO. Most impressive to me has been admitting that the company’s bidding process has been a failure and that most of the company’s backlog will not generate profits. On his first conference call as CEO, Heo stated that he is already taking action to address the problem:
“First, we will be more disciplined in pursuing and evaluating prospects. We cannot and will not bid every opportunity that we see in the market. Our resources will be focused on profitable opportunities in which we offer a competitive and strong value proposition to our customers. I can tell you, we have already no bid prospects that we don’t believe are real or projects that have too much underlying risk for the contract price.
For those projects we choose to pursue, we are placing increased rigor around the development of our bid estimates, including a full assessment of the execution plan and the associated risks and opportunities inherent in the projects as well as the appropriate pricing of such risks. For example, we are pushing back on terms and conditions that do not reflect our acceptable level of risk. In many of these circumstances, we are receiving commercial considerations.“
(Source: Q4 2019 Earnings Call)
GIFI’s history of underbidding for contracts has resulted in negative gross margins for many consecutive quarters. Although Heo’s acknowledgement of these failings resulted in nearly $31 million of non-cash impairment charges in Q4 2019, I think it was an important step towards building trust with shareholders and demonstrates he understands the company’s core problem. $8 million of the write-down came from scheduling the underutilized Jennings shipyard for closure in Q3 of 2020, another important step to improve the bottom line. I think it is telling that non-cash impairments were only $1.2 million in Q1 of 2020, demonstrating that the rot has been cleared out and that future write-downs will be minimal.
The second major decision was to consolidate the company’s Services and Fabrication divisions. This section of the business focused on fabricating components for offshore oil wells and providing technical operating expertise for the well operators. Heo has stated that the new combined division will shift its focus to new fabrication opportunities for onshore oil and gas customers. Heo stated:
“In the case of our fabrication and services division, we will continue to provide fabrication and associated services to our traditional offshore markets but are significantly increasing our business development efforts on the fabrication of modules, piping systems and other structures for onshore refining, petrochemical, LNG and industrial facilities. There is a significant amount of capital projects within a 300-mile radius of Houma anticipated in the next three to five years and we are determined, and we will be well-positioned, to get our share of this market opportunity.“
(Source: Q4 2019 Earnings Call)
Three to five years is a long time to wait for investors that have seen the value of their shares decrease by 78% over the previous five years, but the consolidation of the two divisions should help lower costs in the short term and open up a new market of customers that are less vulnerable to oil price shocks.
GIFI’s Operations Are Still in Rough Shape
I want to be clear, GIFI is not a great business that I would be excited to own for the long term. The company hasn’t reported meaningful net income or positive cash flow since 2014. The CEO has admitted that the backlog is worthless and will take over a year to work through. If GIFI sticks to its new commitment to be more judicious in their bidding process, it seems inevitable that the company’s top-line numbers will drop in the short term. Transitioning to supporting the onshore oil and gas industry has future potential, but it is difficult to enter a new industry and there are likely to be some missteps along the way. Even if the transition is successful, GIFI will be highly exposed to the domestic oil and gas industry, which remains under pressure. GIFI has been deemed ‘essential’ and thus allowed to operate despite Coronavirus mitigation measures, but the company could still be negatively affected if the virus continues to reduce economic demand for oil or if the company were to experience an outbreak in one of their facilities. Heo stated the concern about the oil markets this way:
“Despite the progress on our initiatives, completion of key projects as forecasted and new project awards primarily from the Navy, recent events have created significant challenges to an already difficult market environment. During the first quarter, there has been historic declines in crude oil prices due to a decrease in demand resulting from the economic impact of COVID-19. This has been exasperated by a market share dispute between the world’s large oil producers. As a result of the current market environment, 2020 will be a challenging year for our newly integrated fabrication and services division.
Let me provide some examples of how COVID-19 and the decline in crude oil price has impacted our business since March. A $10 million fabrication project in our backlog was suspended and we experienced an immediate decrease in our onshore maintenance and offshore services activity. Further, in regard to our sales pipeline, some of our customers have announced significant reductions in capital spending and others have announced the suspension of projects. Specifically, we had two eminent awards totaling $30 million in which we were in final negotiations that were put on hold, and we believe we will see a significant reduction in onshore maintenance and offshore services activity for the balance of the year.“
(Source: Q1 2020 Earnings Call)
So, if GIFI still has a lot of problems, why I am I bullish on the company? It all comes down to the price of GIFI’s shares. GIFI is trading at a $45 million market cap at the time of this writing. The company has $70 million in cash and cash equivalents and total current assets of $160 million against $92 million of total liabilities. An investor is getting company shares at a 60% discount to net current assets and an additional $70 million in PP&E for free. The PP&E numbers are already conservative based on asset sales in the last three years, but even a haircut of 60% would still cover GIFI’s entire market cap. Throw in new management and a turnaround plan as potential upside catalysts and I don’t see a reason that this company shouldn’t trade around $8 a share within the next year. I acknowledge that I have been completely wrong about this company’s share price for over a year now, but I am willing to own shares at this level despite the market’s opinion that the company is worthless.
Disclosure: I am/we are long GIFI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article should not be taken as financial advice, it is only an expression of my own opinions as an individual investor
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