Gulf Island Fabrication (GIFI) Stock: Catalysts Draw Closer

Gulf Island Fabrication (NASDAQ:GIFI) is in the final stages of its multi-year turnaround. The market rewarded the company with a 20% share price jump after a strong Q2 earnings report, but investors appear to have missed an exciting catalyst that was mentioned on the conference call. Management essentially announced that they have landed a major fabrication contract that they expect to close in the next quarter; this should have led to a far larger jump than 20%. The shipyard wind-down continues at a slower than expected pace, but GIFI is poised for a strong 2023. I see a clear path to $12mm in net income and a doubling of the share price within 18 months.

Q2 Earnings Recap

The headline-grabbing news from GIFI’s Q2 earnings report was the strong performance of the Services division. Boosted by the integration of the recent Dynamic acquisition, the Services division generated over $2mm in operating income. This is important because total corporate overhead runs at about $2mm per quarter; if GIFI were to stop all other operations tomorrow, they would become a GAAP profitable company overnight. The shipyard division continues to lose money and it looks like the wind down of this division is going to take an additional quarter. Management is now guiding that they expect to deliver their final vessel in Q4.

With the Services division covering the company’s fixed costs and the money-losing shipyard division on track to be off the books by the start of 2023, the remaining X-factor is the fabrication division. Q2’s numbers where underwhelming, with the division showing a small operating loss on slightly decreased volumes relative to the previous quarter and year. If you only read the company’s Q2 earnings press release and the 10-Q, you would end up disappointed by the lack of meaningful improvement and the absence of a major contract. On the conference call, however, CEO Richard Heo dropped the following bombshell:

We indicated last quarter that we are in discussions with customers for large-scale fabrication. These customers recognize the industry capacity constraints and during the quarter, we entered into a facility reservation arrangement with one key potential customer while we continue to negotiate the Ts and Cs of a contract. We expect the contract to be completed in the third quarter, and we hope to begin fabrication work on the project by the end of the year.” (Source)

This is huge news. Although a formal contract hasn’t been signed, GIFI has a potential customer that is so eager to work with them that they are paying the company a retainer to hold a place for their project. This is about a strong an indicator that a contract will be signed as you can get. In clarifying comments, Heo confirmed that the project in question is above the $50mm mark and that they are in active talks with other customers who are also looking to reserve GIFI’s capacity. Management previously guided that margins on large-scale fabrication work should sit at about 10%; this means that a single project at a $50mm minimum should net the company about $5mm in operating income. With no long-term debt and over $100mm in net operating loss carryforwards, interest and taxes will be negligible and net income will track closely with operating income.

Outlook for 2023

Putting the divisional pieces together, GIFI is set up for a strong 2023. Losses from the shipyard division will be gone, removing the corresponding drag on earnings. I expect services to hold steady as project activity remains high in the Gulf; extrapolating Q2 results puts annual operating income at about $10mm. With one $50mm+ fabrication deal virtually locked-in and multiple other customers in talks to reserve utilization capacity, I conservatively estimate $100mm in fabrication revenue in 2023, which translates to roughly another $10mm in operating income. Corporate SG&A has been pretty consistent over the previous years ($8.5mm in 2020 and $8mm in 2021); I think $8mm is a reasonable estimate for corporate SG&A in 2023. This results in net income of ~$12mm and EBITDA closer to $17mm. At the time of this writing GIFI’s market cap is sitting at $60mm. GIFI has $40mm in cash and no debt so EV is roughly $20mm. A conservative PE ratio of 10 and/or an EV/EBITDA multiple of 6 results in a $120mm market cap, suggesting 100% upside from the current share price.

Risks

In additional to the usual risks associated with nano-cap companies (low share liquidity and high daily volatility), the two biggest risks to the investment thesis are more delays in the shipyard wind down and delays in fabrication contracts being signed. I was disappointed to see that the shipyard roll-off is going to last an additional quarter, and it is possible that future delays will occur. I admit that management has lost a small amount credibility in this area. The saying “don’t count your chickens until they hatch” applies to contract negotiations as well; even though a customer is paying to reserve fabrication capacity, a deal isn’t a deal until a contract is signed. It is possible I am mistakenly over-emphasizing the probability of additional fabrication contracts. Without a major fabrication contract in 2023 I don’t expect GIFI to do any better than break even from an earnings perspective and maybe generate modest EBITDA.

Conclusion

I’ve been watching GIFI’s turnaround for multiple years now and I am gaining confidence that 2023 will be the year things finally turn around enough to make the market take notice. GIFI’s share price jumped after the Q2 earnings announcement but has slowly declined since. The market isn’t quite able to see GIFI’s potential yet, but strong earnings in 2023 should send a clear message to the Street. I am adding to my position around $4/share and expect to see a share price north of $8 sometime in the next 18 months.