Ocean Wilsons Holdings Limited — Update 16 December 2016

Ocean Wilsons is a Bermudian investment holding company whose main assets are a 58.25% interest in Wilson Sons and an international investment portfolio, both run with a long-term view. Wilson Sons is a public Brazilian port, maritime and logistics company. On a look-through basis, including Wilson Sons’ market value, the NAV split is c 64:36 between Wilson Sons 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 Wilson Sons revenue and profits. The directly oil-exposed activities, Brasco and the offshore vessels joint venture accounted for c 16% of pro forma revenues and 19% of pro forma EBITDA in Q316. Wilson Sons reports in US dollars and earns around 50% of its revenues in that currency. As a Brazilian company, its costs are mostly in Brazilian reals (BRL). 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 grew at a compound rate of 7.9% between 2008 and 2015.

Hanseatic Asset Management manages Ocean Wilson’s investment 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 categories: (1) core regional funds that form the core of the portfolio; (2) a long-term growth category with investments in biotechnology and technology, for example; and (3) a diversifying category that will provide an element of protection to the portfolio as the business cycle matures.

In this section we focus on the Wilson Sons’ third-quarter results and the announcement of the 25-year extension of the Salvador container terminal concession. The Ocean Wilsons investment portfolio, including cash under management, was stable compared with the half-year end with a value of US$237.1m at the end of October (compared with US$234.1m at the end of June).

While the economic background in Brazil remained challenging, Wilson Sons’ Q3 results showed resilience with revenues (pro forma including a 50% share of the offshore vessels joint venture) and EBITDA up modestly compared with Q315. Greater stability in the US$/Brazilian real exchange rate over the quarter meant that negative FX-related items were less than US$1m, much lower than in Q315. Key numbers from the Q3 results were as follows (including the offshore vessel joint venture on a pro forma basis where relevant).

Exhibit 1 summarises segmental revenue, EBITDA and EBITDA margin trends and, looking at the sequential comparison between the second and third quarters this year, there was a 23% increase in EBITDA led by increases in container terminals and towage with the latter benefiting from efforts to reduce costs and the acquisition of six tugboats that had previously been leased. The offshore support vessel activity also showed an improvement reflecting the start of operations for the largest vessel in the fleet, Larus, partly offset by two vessels being offhire.

Capital spending in the third quarter at US$17.3m was lower both sequentially (Q2 US$39.6m), because of the incidence of costs relating to new crane investments for the container terminals, and compared with Q315 (US$33.3m) reflecting fewer tugboats and platform support vessels under construction. Wilson Sons has previously estimated capital spending of US$127m for FY16 and US$80m for FY18, including expenditure by the offshore joint venture. Expenditure on the expansion of the Salvador terminal (see below) is not expected to begin in earnest until FY18.

On 16 November Wilson Sons announced the signing of a lease agreement with the Brazilian government that extends the term of the concession for the Salvador terminal by 25 years to 13 March 2050. As a condition of the extension Wilson Sons will carry out minimum expansion and maintenance spending at the terminal with a minimum expansion budget (at end 2013 values) of BRL398m, which translates into c US$115m at the current exchange rate.

The first phase of the expansion is expected to start nine months after the signing of the lease amendment and to be completed in the second half of 2019 at a cost of c US$74m. This phase of the investment will provide a 423m extension to the quay giving a total length of 800m and allowing the terminal to accommodate the increasingly large vessels that are an industry feature and reduce vessel waiting times. The second phase need not be completed until 2030 and will add backyard capacity at a cost of c US$8m while phase three (required by 2034) adds further backyard capacity for an additional c US$33m leaving the terminal with capacity of 925,000 TEUs (twenty foot equivalent units) compared with the current c 430,000 and Q316 usage running at annual rate of around 350,000 TEU.

The lease renewal is an important confirmation of the long-term retention of and development of the terminal. The phasing of expansion has the potential to allow capacity to expand in line with market demand both in terms of ship size and overall capacity.

The trading background for Wilson Sons in Brazil has remained subdued with negative economic growth reflected in lower domestic activity, although earlier currency weakness has aided exports, supporting broadly flat overall volumes for the company’s container terminals year to date. The impeachment of Dilma Rousseff earlier in the year and succession of acting president Michel Temer provided a catalyst for a significant rally in the currency and equity markets (see Exhibits 2 and 3). However, this is a forward-looking reaction and the macroeconomic and political background remain uncertain. Politically, president Temer has to implement proposed reforms to contain government spending and has meanwhile been accused by the opposition of assisting an ally in a property deal, adding to the challenges the administration faces. This, mixed economic data and the result of the US election (prompting a repatriation of funds from emerging markets to the US) all contributed to a relatively modest correction in both the currency and equity market recently.

Economically, data remain weak, although there are some signs of the recession easing and, looking ahead, the IMF Outlook published in October forecast a return to economic growth next year (c 0.5%) and medium-term growth in the range of 1.5-2.0% (Exhibit 4). Trade growth, led by exports with average growth of 3.7% 2017-21, is expected to outpace economic growth (Exhibit 5).

Given this uncertain background and the expectation of a slow recovery in oil-related activity, Wilson Sons has been maintaining close control over costs with restructuring measures already taken, as noted above, in the logistics, shipyard and Brasco businesses. The benefits of this should be evident in future quarters. The market background for the offshore support vessel joint venture, WSUT, remains dull but it does benefit from long-term contracts with 10 of the 21 (soon 22) vessels having contracts extending into 2019 or beyond. In the near term there are two vessels off-hire on the spot market to be joined by another new vessel this month. In the medium and long term the opening of development of Brazil’s pre-salt reserves to international companies should be helpful while the current global glut of offshore support vessels would tighten if there were a sufficient strengthening in oil price to generate renewed growth in exploration activity. For the main container terminal and towage businesses, the expected longer-term growth in trade (Exhibit 5) together with further containerisation and development of cabotage (shipping between ports in Brazil) are positive features.

For the Ocean Wilsons investment portfolio the manager has previously talked about near-term uncertainties but has not adopted an overly cautious stance. The global diversification of investments should help mitigate market volatility to some extent while the long-term approach mirrors the management style at Wilson Sons while providing some balance to the specific exposures of the operating subsidiary.

Exhibit 6 summarises changes in our estimates following the Q3 results. Reflecting performance year to date and assuming the exchange rate remains broadly stable, our revenue estimates have been increased by between 8% and 9% while pre-tax profits forecasts are increased by 4.5% and nearly 2% for this year and next. Higher assumptions for the non-controlling interest line leave EPS estimates lower.

The financial position at Wilson Sons at end September showed only modest changes when compared with the half-year stage. Net debt stood at US$270.9m compared with US$279.8m at end June. The average interest cost is only 3.1% and 86% of the debt is long-term. In addition the offshore vessels joint venture had net debt of US$257.2m versus US$259.6m. Including the joint venture on a 50% pro forma basis, the trailing 12-month debt to EBITDA multiple stood at 2.7x.

Details of our financial forecasts for Ocean Wilsons are shown in the financial summary (Exhibit 9) with the debt structure set out in Exhibit 10. As the operating business within the group, Wilson Sons is the primary influence on cash flows and debt. The ability of the towage and offshore vessels activities to access long-term, low-cost finance from the Brazilian government via the Fundo da Marinha Mercante explains the relatively high level of debt to equity when the share of joint venture debt is included (debt/ equity 74% for FY15, for example). Capital spending this year has been boosted by spending on port handling equipment and the six tugs that were previously rented in the towage business. Otherwise capital spending has been running well below the peak level of over US$200m seen in 2011, averaging c US$100m between 2012 and 2015. Overall movements in net debt over the same period have shown a modest reduction, excluding foreign exchange movements. Wilson Sons expects the level of capital spending to be lower in FY17 and, on our estimates, there should be a reduction in net debt. We have factored in an increase in capital spending for 2018 as spending gets underway on the first phase of the Salvador container terminal expansion. Similar or slightly lower spending may be seen in 2019, following which we would expect capex to fall back to lower levels, all else being equal.

We have updated our look-through discount calculation for Ocean Wilsons. This includes Wilson Sons at market value and the Ocean Wilsons investment portfolio (OWIL) at the end-October valuation given in the trading update. As shown in Exhibit 7 this gives a discount of 32%, similar to the level shown in our last note published in September. This still appears wide given the resilience demonstrated by Wilson Sons and the globally diverse nature of the investment portfolio.

Next (Exhibit 8), we show a peer comparison for Wilson Sons that includes a selection of Brazilian and international port and shipping companies. Here Wilson Sons stands towards the lower end of the range for consensus earnings and EBITDA multiples and is in line with the average book multiple, albeit within quite a wide range.