TUGS Stock Review: Is It The Holy Grail Of The TUG Industry?
Every now and then, I get e-mail and message requests for stocks to review from readers that has grown to 6,000+ subscribers and social media followers.
One of the stocks frequently requested is Harbor Star Shipping Services Inc. (TUGS).
Now listen, whenever someone stumbles upon my blog and requests for stocks to review, I enthusiastically do it because I know that most investors just don't have the passion, time and energy to study the company's fundamentals and numbers.
You see, most investors were led to believe that you can compound your money by investing in any stocks you want.. Little do they know that the real secret to a successful investing career is having the ability to choose stocks with businesses that have sustainable advantages, buying them at the right prices, hold them and let compounding do the work.
This is a very simple common sense advice and yet few people are actually really doing it.
Now, the fact that you're here in this post means that you are wondering if TUGS is a good stock to buy and hold.
So in this post, I'll share my thoughts and do a quick review of the underlying business and fundamental factors of TUGS that makes it a good or a bad investment.
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TUGS Performance Since The IPO Offer
After the IPO listing of TUGS way back in October 2013, the company had many significant improvements in assets. The most visually striking evidence where the P303.2 million IPO proceeds was allocated was the increase in the number of tugboats and barges they own from 2013 to 2015.
Further analysis of its performance showed that from the same period, earnings totaled to P0.58/share. 10.3% of it or P0.06/share went to investor's pockets as dividends and the remaining 89.7% or P0.52/share were retained.
As a result, book value increased from 1.57 to 2.26 per share; or at a compounded annual growth rate of 21.3%
The performance look good but when you look at the performance of its earnings, it tells a different story.
Here's TUGS' earnings from 2012 to 2015.
Earnings Per Share
Before going public, TUGS earned P0.36/share. After the IPO in 2013, earnings showed a declining trend despite of the aggressive expansion they made in that period. Now why is that?
According to the annual reports, the main reasons of earnings decline is the 7-month long congestion in the ports of Manila in 2014 resulting to a decrease in vessel calls which is the core business of TUGS and the economic slowdown in China in 2015.
As a result of the lower earnings, the company failed to produce attractive returns on equity and invested capital.
But despite all of this, the stock performed at an annual growth rate of 21.2%; from its closing price of P1.21/share in 2013 to P2.65/share in 2016.
TUGS Business Analysis
We can argue that the increase in TUGS' share price since the IPO can be attributed to its increase in book value. As mentioned, they invested on additional tugboats and barges to stay competitive.
This puts a speculative pressure on earnings. In a common sense perspective, more vessels means that TUGS can service more clients and that equates to higher earnings. Shareholders expect TUGS to make more money based on this line of thought.
However, TUGS is a capital-intensive business. To maintain its competitive advantage in the tug industry, the company is obliged to allocate capital in the maintenance, repair, retirement and acquisition of tugboats on a regular basis. This in turn lowers margins.
As a matter of fact, TUGS is depreciating its vessels at an average rate of P0.39/share; higher than what the company has earned in each of the years.
To stay competitive, capital expenditure allocation for the last 3 years averaged at P0.61/share. If the company don't allocate capital for the repair and maintenance, their tugboats will be subjected to a higher risk of failure and the quality of their service will deteriorate. If that happens, they will run the risk of losing market share and thus further lower earnings.
With earnings barely covering the maintenance CAPEX, TUGS can either issue equity or take on debt.
The latter is what they did.
Looking at the historical debt levels, TUGS short-term borrowings has increased at an annual rate of 31.2% while long-term borrowings at 13.6%.
Short-Term Debt (in Mil PHP)
Long-Term Debt (in Mil PHP)
What I observe is that the stock price is responding opposite the economic value of the business. If a company increases its earnings on a y-o-y basis, the market responds by increasing its stock price. However, this is not the case with TUGS. Even if the earnings declined, TUGS maintained a strong stock performance.
This effect puts its stock price in the realm of speculation.
The increase in its fleet vessels puts pressure on the ability of the company to generate higher earnings. But because of the industry risks and economic slowdown in China, earnings declined from P0.36/share in 2012 to just P0.13/share in 2015.
Investors are probably waiting for the higher earnings to arrive. They have confidence in the management to turn things around. This might explain the strong stock performance.
Consider this, if the tug industry strengthens, industry risks mitigated and demand for harbor assistance, lighterage, towage and salvage services increases, then we could expect earnings to improve for the next couple of years.
TUGS can now consider to buy out their competitors once retained earnings accumulate. The industry identifies 3 major and 8 regional competitors. If they can acquire these businesses in the future, they can further strengthen their coverage and create a consumer monopoly in the tugboat business.
But unless the management can improve and retain earnings and able to allocate it efficiently to generate above average returns on capital for the next 3 to 5 years, I bet that this will not happen anytime soon.
UPDATE: FY2016 Report Released
Data from the FY2016 earnings report is not included because I wasn't aware of its release prior to this post. The data I used in this post was outsourced from Morningstar which is not updated during the time I wrote this post.
In behalf of the readers, I apologize. Anyway, here's an update from the latest report in the discussion I presented above.
The company reported an increase in earnings. From P0.13/share in 2015 to P0.18/share in 2016. This is still below the previous reported earnings in 2013 and 2014. It would be nice though if TUGS can at least surpass the 2013 earnings. This is something that should be looked at this 2017.
The earnings equates to a Return on equity of 6.94%. A nice improvement from 5.38% of the previous year. But then again, it's still low.
Debt levels increased slightly from P807 million in 2015 to P810 million in 2016. That's a 0.4% increase. According to the report, as at Dec. 31, 2016 and 2015, certain tugboats were used as collateral to secure these loans.
Since TUGS now owns 40 tugboats from the previous 37, depreciation costs now equates at P0.41/share from the previous year of P0.39/share. The company also allocated CAPEX at around P0.64/share. With earnings of just P0.18/share, the only way to be able to cope up with the ever increasing maintenance costs and CAPEX of their fleet is to secure loans, issue more equity or sell corporate bonds.
It's a good thing though that TUGS issued 50% stock dividends instead of paying out cash to shareholders. This is a good move by the management because it's very obvious that they would need all the money that they can get to maintain their cash hungry assets.
On a positive note, the earnings increase and the decision to pay out stock dividends instead of cash is a sign that the management is doing its best to turn things around.
In conclusion, my thoughts about TUGS still remain the same.
I like stocks that I can buy and hold for at least a couple of years without worrying so much about the volatility of the market. One criteria I look for in a company is the predictability of earnings, has impressive future prospects, is conservatively financed and has a management that has the ability to compound the company's earnings at high rates of return.
The company's earnings can't be predicted with a high level of certainty. They also took on more debt which were needed for CAPEX to maintain the fleet's profitability but failed to give shareholders a high return on equity.
But I like the company's future prospect by aiming to be the leader in the tugboat business by rapid expansion. The recent management decision by not paying dividends in cash suggests that the company is doing all its efforts to hasten its growth and profitability.
A stock price that responds opposite the economic value of the company becomes speculative in nature. Based on my analysis, this led me to believe that TUGS is a speculative stock. Putting a higher margin of safety will assure you of minimal losses if you make a mistake of buying at a high price.
But for speculators and momentum investors, the stock price's upward performance may be a good thing though to lock in profits in the short-term.
I expect the price to go up in response to the increase in reported earnings in the FY16 report.
This concludes my TUGS stock review.
If you have any thoughts about TUGS that you may want to share, kindly leave them in the comments section below.
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