Ocean Wilsons Holdings — Update 9 September 2016

OCN is a Bermudian investment holding company whose main assets are a 58.25% interest in Wilson Sons (WSON) and an international investment portfolio, both run with a long-term view. WSON is a public Brazilian port, maritime and logistics company. On a look-through basis, including Wilson Sons’ market value, the NAV split is c 65:35 between WSON and the investment portfolio.

As a port operator and offshore services provider, trends in Brazilian trade volumes and oil industry activity are important drivers of WSON revenue and profits. WSON reports in US dollars and earns around 50% of its revenues in that currency. As a Brazilian company, its costs are mostly in Brazilian reais. Currency fluctuations therefore have a more limited effect on the company’s EBITDA. Accounting for foreign exchange movements can make the reported progression of earnings appear lumpy, although the underlying businesses have been relatively stable and EBITDA has grown at a compound rate of 7.9% between 2008 and 2015.

Hanseatic Asset Management manages the Ocean Wilson Investments (OWIL) portfolio on an unconstrained global basis, aiming to achieve long-term returns while emphasising capital preservation. The manager seeks to achieve this objective by allocating between three silos: (1) core regional funds that form the core of the portfolio; (2) an eclectic sector silo that gives exposure to selected long-term growth areas such as biotechnology and technology; and (3) an eclectic diversifying silo including sectors that will provide an element of protection to the portfolio as the business cycle matures.

The first half saw a mix of trends for Wilson Sons that showed resilience in its operating performance against the background of a continuing weak domestic economy, while US dollar-reported revenues were negatively affected by a near 20% depreciation in the average Brazilian real exchange rate compared with the same period last year. However, between end December and end June the Brazilian real appreciated by more than 23%, giving rise to significant positive foreign exchange accounting items in contrast to the negative items that characterised the same period last year. Key points from the figures were as follows:

Exhibit 1 provides a summary of the first half result and an analysis of the foreign exchange items. As noted above, the year-on-year changes are heavily influenced by foreign exchange movements. At an operational level approximately half of revenues are denominated in US dollars, while only 10% of costs are in US dollars. OCN has indicated that, at the EBITDA level, the net effect of currency moves is broadly neutral.

The foreign exchange items shown in the bottom section of Exhibit 1 include: (1) gains/losses on monetary items, which comprises movements in the value of working capital items and cash and cash equivalents; (2) gains/losses in foreign currency borrowings related to US dollar-denominated debt in subsidiaries reporting in Brazilian reais; and (3) changes in deferred tax related to the changes in value of debt and fixed assets reflect the resulting increase or decrease in the value of future tax deductions. While these items increase the sensitivity of reported earnings to near-term foreign exchange volatility, as noted, the structure of costs and revenues at WSON means greater stability at the EBITDA level.

The investment manager’s report on the OWIL portfolio shows a first half reduction in value of 2.2% compared with a 3.4% gain in the absolute benchmark (US CPI Urban Consumers NSA plus 3% from 1 January 2015 and previously US dollar 12-month Libor plus 2%). European and Japanese funds were the main detractors from performance, while the North American funds made a positive contribution.

To give a broader perspective on performance OCN provides a comparison with several indices and, as shown in Exhibit 2, on a 10-year view, the performance has been close to the benchmark and ahead of the MSCI global plus frontier markets index and the other indices shown.

In Exhibit 3 we set out further divisional and quarterly detail from the results for WSON. The table underlines the relative importance of the container terminal and towage operations, which accounted for 68% of revenue and 85% of EBITDA in Q216. For container terminals, underlying volume trends in Q2 were positive for exports and cabotage (+29% and +11%, respectively, compared with Q215) offset by a decline in imports reflecting the weak economy and Brazilian real. The towage business saw a modest 3% reduction in harbour manoeuvres offset by a continuation of the trend towards larger vessels (and hence higher fees). Within towage, special operations revenue is unpredictable as it includes duties such as firefighting and in the latest quarter this element of revenue fell sharply. This and the weak Brazilian real left Q2 revenues down by nearly 10%.

Otherwise we note that the shipyards returned to profitability as prior year provisions were not repeated and the current (reduced) workload is on vessels with repeat specifications and hence generates a higher margin.

The near-term economic outlook in Brazil remains challenging, following a decline in GDP of 3.8% in 2015; the IMF, for example, forecasts a further 3.3% contraction this year. The political background is also still uncertain. However, there have been some positive signs including sequential increases in industrial production in the most recent months reported, while in its July update the IMF raised its GDP estimates for both this year and next, now looking for a modest 0.5% growth in 2017. Politically, the impeachment of Dilma Rousseff and succession of Michel Temer as president have also helped to give encouragement to markets and business confidence. This has fed into strong rallies in the currency and stock market that may prove optimistic but may also be a precursor to a period of positive economic surprises.

More specifically for WSON’s operations, the company highlights the downturn in the oil and gas industry as a negative factor for the offshore support vessels and the shipyards divisions, although the support vessels do have the benefit of long-term contracts that should provide a measure of stability. For the main container terminal and towage businesses, activity levels should improve once the economy begins to revive, while on a longer view the container terminal activity is likely to benefit from the trend to containerisation and the growth in cabotage (transport of goods between ports in Brazil).

Turning to the OWIL portfolio, the manager highlights near-term uncertainties and talks about the higher probability of markets breaking out of their recent range on the downside. Nevertheless, the fundamental economic growth outlook in Europe is not seen as damaged following the Brexit vote so an overly cautious view is not taken. The global diversification of the portfolio, long-term approach and absolute benchmark mean that the portfolio provides an interesting foil to the Brazilian operations of WSON.

Exhibit 6 summarises the changes in our estimates, primarily reflecting the first half results and currency moves. The significant currency related items that are a feature of the first half are assumed to flow through to the full year accounting for a large part of the 20% increase in the EPS estimate for 2016. For 2017 we assume these items drop out leaving a more muted earnings upgrade and a reduction from the prior year.

Our revenue and EBITDA estimates are a better indicator of underlying changes. Our total revenue estimates are virtually unchanged, while estimated EBITDA for 2016 is also effectively stable and the 2017 estimate is marginally increased (+2.6%).

Looking at the cash flow and balance sheet position, the first half saw an increase in net debt reflecting negative working capital movements, a sharp increase in capital spending reflecting the investments in container terminal equipment and six tugs and, to a lesser extent, an increase in tax paid. As a result net debt increased from the year end level of US$269m to US$297m, or from US$502m to US$543m if we include debt at the WSUT joint venture and short-term investments held in WSON and intended to fund operations in Brazil. We assume some normalisation in working capital movements and lower H2 capital spending to help net debt to fall from this level by the year end.

We start by updating a look-through discount calculation that includes WSON at market value and OWIL’s latest published value (as at end June). As shown in Exhibit 7, the discount remains wide at 33%. OCN may not be as sensitive to an eventual Brazilian recovery as some stocks given its exposure to US dollar revenues, diversified maritime services business and global investment portfolio. However, by the same token it would be better placed to weather any further setbacks in Brazil and has a long track record of operating in fluctuating economic and political circumstances. With this in mind the discount appears conservative.

Our peer comparison (Exhibit 8) includes a selection of Brazilian and international port and shipping companies. Differences in scale, liquidity and business mix qualify the comparison, but, even so, WSON appears modestly valued on earnings and EBITDA multiples, while the price to book ratio is below the average for the group.