Havyard Group ASA - Overlooked Recent IPO: HYARD.NO

I've run across an interesting recent IPO by the name of Havyard Group ASA. Based in Norway, Havyard designs and builds specialty service ships. Havyard is majority owned by the Saevik family through their private company Havila ASA.

For completely unoriginal reasons, I rarely find IPOs worth investigating. Companies usually go public after a run of strong business performance and are priced for perfection, often resulting in disappointment if results show the slightest weakness. Also, many companies go public to raise funds to bridge over operating losses during their high-growth phase, and I tend to focus on mature companies that are already generating positive cash flow. However, neither of these factors applies to Havyard. First, Havyard is not riding high on a wave of growth. While still strongly profitable, the company's results have actually dipped somewhat since 2012 highs. Expectations for Havyard's future growth likely aren't demanding. Second, Havyard's IPO was an ownership shift, not a capital raise. The parent company, Havila, simply monetized a part of its investment in Havyard by offering it to the public. Havila CEO Pers Per Sævik released the following statement concerning the IPO:

”Our family has broad interests in the offshore supply industry. In light of this, and because we see that we need to optimise the conditions for continued growth for Havyard Group, both on technology and ship equipment, we choose to reduce our ownership. Havyard has a significant potential for growth, but the further development of the company requires more than we as a family company have the possibility to contribute."

Havyard's original intended IPO price was NOK 36.00, which was then discounted by 7% to NOK 33.50. The discounted IPO price reaffirms my belief that expectations and enthusiasm surrounding Havyard are not high. Since the IPO, shares have slipped another 4.5%.

Before discussing Havyard's history and business segments, let's review the company's history in brief. Havyard was founded in 1999 in Norway and got its start building platform service vessels for the North Sea's active offshore drilling market. Over time, the company expanded into various other types of specialty vessels and built up a world-wide clientele. Havyard has expanded beyond the oil and gas industry and now designs and manufactures ships for the fishing and aquaculture and offshore wind farm industries. The company expects these new markets to offer great growth potential. Havyard notes that most fish consumption is likely to increase substantially as the world's population continues to increase and wild fisheries remain in danger of over-harvesting. Offshore windmills will only become more common and economical as wind technology improves and the world's energy needs increase. Today, Havyard bills itself as a ship technology company focused on "Improving Life At Sea." Havyard's self-identification as a technology company is not mere marketing puffery; fully half the company's operating income is earned by its ship and systems design segments.

Here's an example of Havyard's output. The Lewek Inspector is a 110 meter inspection, maintenance and repair vessel designed for fuel efficiency and maneuverability in rough conditions. It was delivered to Forland Shipping in late 2013.

Havyard has four operating segments. The largest by far is the "Ship Technology" segment, responsible for the actual construction of the company's vessels. Havyard's hulls are manufactured under oversight by a partner in Turkey, then tested and finished in Norway. This segment is responsible for the large majority of Havyard's revenues, but only about half its operating income. Havyard's "technological" segments, "Power & Systems" and "Design & Solutions" accounted for just 20% of the company's 2013 revenues, but contributed 52% of operating income. The final segment, "Fish Handling & Refrigeration" is a newcomer. Havyard made its initial investment in this segment in 2012. Fish Handling & Refrigeration accounted for 14% of 2013 revenues, but scarcely contributed to operating income. While this segment currently does not provide much in the way of earnings, Havyard considers it a strategic segment with good growth potential. The chart below breaks out Havyard's 2013 results by segment. The figures diverge slightly from the company's financial statements due to slight differences in presentation methods and are shown in millions NOK.

Havyard's 2013 results were off somewhat from 2012, even though revenues increased substantially due to the acquisition of the fish handling and refrigeration segment. The company attributes the decline in margins and earnings to the expense of developing and producing product prototypes, though I suspect the company also willingly sacrificed some margin to win contracts that allowed it to expand into new industries. Perhaps not a bad long-term strategy, even if short-term results suffer. Nonetheless, the company remains solidly profitable. Management expressed satisfaction with results for 2013 and the first quarter of 2014, noting successes in attracting first-time customers and in delivering new vessel models on time and on budget. Financial results for the trailing four quarters through Q1 2014 as well as for 2013 and 2012 are presented below.

Havyard's balance sheet is healthy, with plenty of liquidity and net debt less than trailing EBITDA. Pinning down Havyard's exact net debt is somewhat subjective due to the presence of substantial investments in associates. As of the end of 2013, Havyard listed a total of NOK 422.7 million in loans to and investments in associated companies, plus NOK 133.2 million unrestricted cash against total debt of NOK 295.2 million for net cash and securities of NOK 260.6 million. Assuming the level of restricted cash remained constant from the end of 2013, Havyard now has unrestricted cash of NOK 50.5 million after deducting dividends payable. The graphic below sets out the various assets and liabilities that go into estimating Havyard's net cash and securities positions. "Other Non-Current Receivables" is Havyard's term for long-term interest-bearing loans to asociates, the terms of which are set out in note 20 of the annual report. At quarter-end, Havyard had net cash and securities of NOK 34.4 million.

At a recent trade price of NOK 32.00, Havyard's valuation is enticing. The NOK 721.0 million market capitalization, combined with a positive net cash and securities position, yields an EV/EBITDA ratio of just 3.7 and an EV/EBIT ratio only slightly higher at 4.1. The company is cheap on an earnings basis as well at only 5.6 times trailing net income.

These ratios are simply too low for a conservatively-financed, asset-light company with good prospects. I expect some raised eyebrows at my characterization of a shipbuilder as "asset light," but you can check the financial statements to see for yourself. Depreciation accounts for less than 1% of Havyard's annual revenues, an astonishingly low figure for an industrial company. In 2013, Havyard managed EBIT of NOK 180.6 million on average invested capital of only NOK 474.3 million, a 38.1% EBIT/Invested Capital figure. Havyard accomplishes this feat by outsourcing the capital intensive part of its manufacturing process, hull-building, to other companies.

Though Havyard's low valuation and reasonably good business prospects support a valuation much higher than where shares currently trade, the company does face risks that must be evaluated. The primary risk is a slowdown in the global oil and gas industry, and in the North Sea in particular. Though it has had success in entering new markets, Havyard's results are still sensitive to the level of demand for oil and gas support vessels. A sustained decline in demand would have a serious impact on Havyard's results. The company also has large exposure to the performance of its associated companies, mostly ownership stakes in and loans to ships and shipping companies. The book value of these holdings is equal to 61% of Havyard's current market value, so their performance may have a serious impact on Havyard's results and value. If these assets perform poorly, large writedowns may result. Investors should also remember that Havyard remains a controlled company. Havila ASA has a long track record of success in the maritime industry, but investors still must trust the Saevik family to manage Havyard well.

Alluvial Capital Management, LLC does not hold shares of Havyard Group ASA for client accounts.

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