An Australian Achiever on the Cheap

The other day I decided to take a look at some Australian stocks. As luck would have it, I had only flipped through a few before landing on a company with an interesting name and line of business. A little more research revealed some eye-popping statistics.

How many companies anywhere in the world have managed this kind of performance?

5 Year Average Revenue Growth: 25.3%

5 Year Average Net Income Growth: 28.30%

5 Year Average EBIT Margin: 23.4%

5 Year Average ROE: 20.5%

5 Year Average ROIC: 16.6%

And all while paying a dividend and using modest debt.

What industry would you guess this company belongs to? Consumer electronics? Maybe a pricy teen retailer or trendy restaurant chain? Your guesses probably wouldn't include a provider of marine services to the oil & gas industry.

But that's what Mermaid Marine Australia (Australian Exchange ticker: MRM) is, and it is the largest provider in Australia. Mermaid Marine operates a fleet of 41 service vessels that support the offshore petroleum industry in Northwest Australia and Southeast Asia, as well as Africa and the Gulf of Mexico. These 41 vessels include tugboats, supply vessels, barges, accommodation ships and more. Basically, all the various vessels that keep massive offshore drilling rigs staffed, supplied and in good repair.

Mermaid also owns and operates two supply bases in Northwestern Australia. These are the wholly-owned Dampier Supply Base and the Broome Supply Base, a joint venture. These bases are strategically located next to the North West Shelf, a major oil and gas-producing region. These bases provide logistical support to ships that service the oil & gas industry, including maintenance and repairs.

Finally, Mermaid owns a slipway at its Dampier base, a facility used for docking ships for repair. The company notes that its slipway is the only such facility located in close proximity to the North West Shelf.

I've mentioned the North West Shelf a few times without explaining its significance. The NWS is Australia's most important and developed petroleum-producing region. Production has been ongoing since the 1980s, with the involvement of many of the world's foremost extraction companies.

Activity in the NWS and surrouding areas is strong and is expected to remain so. Tony Howarth, chairman of Mermaid, made these comments in the 2013 annual report.

"Activity in the Australian oil and gas sector remains strong with four major LNG projects currently under construction in the North West of Western Australia with a combined capital cost of $125 billion. Exploration activity is also buoyant with nine oil and gas companies currently undertaking drilling programs in the region and significant gas discoveries announced by Santos and Chevron during the year."

The four LNG ("Liquefied Natural Gas") projects under construction are extremely significant for Mermaid. Due to high regulatory burdens and construction costs for land-based LNG facilities, some extractors are turning to "Floating LNG" technology. Shell is in the process of building the world's first FLNG vessel, with BHP Billiton and Exxon Mobil to follow. These offshore LNG facilities will require the support services that Mermaid offers, and should provide revenues for decades to come. Exploration and production are also important opportunities for Mermaid. The company recently won its first drilling support contract, serving Santos's Ensco 109 rig.

Let's take a look at Mermaid's historical performance and see what insights arise. All figures are presented in millions USD, converted at $1.00 AUD: $0.94 USD.

Revenue, EBIT and net income growth are all strong since 2008. Margins have varied a few hundred basis points in either direction, but are consistently high. Free cash flow is negative on average, but that's not a bad thing. When a company has as many great investment opportunities as Mermaid does, I don't want it to produce free cash flow. I want it to use every dollar of operating cash flow and more to capture those opportunities. The success of these capex expenditures can be seen in the revenue, EBIT and net income lines. Spending far beyond annual depreciation on capital assets has clearly been a great use of shareholder capital.

While Mermaid's consolidated results have been extremely strong, these results have been generated by a changing mix of revenues. Slowing growth in the vessels division has been offset by rapid increases in supply base revenues.

Most of the revenue growth in Mermaid's vessel division was realized between 2008 and 2011. High utilization rates during those years pushed up EBIT margins, which have since declined. Additionally, vessels segment revenues and earnings growth have not kept up with asset growth, reducing profit per dollar of assets employed. The vessels segment is still a strong contributor, but is no longer the company's crown jewel.

That mantle has passed to the supply base segment. Though its 2013 revenues were only just over half those of the vessels segment, its EBIT was 18% greater. The company credits strong growth at the Broome Supply Base with the segment's remarkable 2013 performance. In 2013, the segment produced nearly 30 cents in EBIT for every dollar of assets employed, an impressive figure that has only grown over time.

The Dampier Slipway accounts for only a small sliver of revenue, but is a solid contributor in terms of EBIT and EBIT per asset employed.

So what must an investor pay for a such a high-achieving company with great prospects for continued growth? Answer: surprisingly little.

Mermaid Marine's trailing P/E is only 14.36, less than one must pay for the broad US and Australian indexes. I find it very hard to believe that Mermaid's future growth will trail the average company in either of these economies.

Mermaid's valuation may be weighed down by fears of a slowdown in the Chinese economy, and by fears that Australia's currency will continue its recent decline. I view both of these factors as short-term in nature and unlikely to interfere with Mermaid's long-term success. The most important factor in long-term equity returns is a company's ability to reinvest earnings at consistently high rates, and Mermaid has demonstrated its aptitude.

Finally, for income-oriented investors, Mermaid Marine Australia pays an annual dividend of 12.5 Australian cents, an increase of 13.6% over 2013. At current prices, this dividend is good for a 3.3% yield.

No position.