Kirby Stock: Q3 Earnings Reaping Benefits Of A Tighter Market (NYSE:KEX)

Healthy demand for petrochemicals and a more rational supply situation has benefited Kirby (NYSE:KEX), with the combination of strong refinery capacity utilization and limited new supply driving good utilization and much higher day rates for the company’s barge fleet. At the same time, increased demand for engine and transmission maintenance and overhaul from trucking, power gen, and oil/gas has helped the Distribution & Services (or DES) business perform better.

These shares are up about 3% since my last update; not a great performance, but not bad relative to the average industrial or transportation company (Kirby doesn’t have any good direct comps), and Kirby has actually outperformed oil since that last update (Kirby shares and oil often trade together, given Kirby’s reliance on oil and oil-based refined products). While I do see some clouds on the horizon with the economy, the valuation is still reasonable for a company that has in the past enjoyed a robust premium.

Strong Utilization And Pricing Driving Leverage

Kirby had a solid third quarter all around, with the company beating on the top line (by about 2%), the operating line (by about $0.02 to $0.03/share), and the bottom line (by $0.05/share). Guidance for the fourth quarter was a bit lackluster, and I’ll return to that in a moment.

Revenue rose 25%, with the marine (barging) operations up 28% and the DES business up 20%. Within Marine, Inland revenue rose 35% as ton-miles rose about 9% and revenue per ton-mile rose about 24%. Coastal revenue was down 5%, due in part to a lower number of barges in service (down 6 barges year over year to 29). In the DES business, the oil & gas segment saw 37% growth, while the commercial/industrial business grew 8%.

Strong utilization and pricing are driving strong operating leverage. Gross margin improved 50bp YoY, but EBITDA jumped 42% and operating income rose 148%, with margin up 390bp to 7.9%. Marine profits rose 147%, with margin up 460bp to 9.6%, and Inland margins were in the low double-digits, while Coastal margins were in the low-to-mid single-digits. DES profits doubled, with margin up 290bp to 7.1%; oil & gas margins were in the mid-single-digits, while C&I margins were in the high single-digits (management doesn’t further quantify for the segments).

Healthy Utilization And Pricing, But Not Without Concerns On The Horizon

Management guided to modestly weaker results in the fourth quarter, with the company looking for basically flat results. It’s a modest negative given the outperformance in the third quarter, but not a thesis-changing outlook.

In the short term, Kirby is seeing a headwind from the problems on the Mississippi River. Parts of the river are now at record lows, and even though this only covers about 20% of Kirby’s Inland fleet (most of the fleet works on the Gulf Intercoastal Waterway and Houston Ship Channel) and even though Kirby’s tank barges are able to operate in shallower water than grain barges (around 9 feet versus 12 feet), the reality is that there are still issues due to the low water levels and it will hit earnings in Q4’22.

I also have some modest concerns about the economic outlook. Refinery capacity utilization has seen its typical seasonal step down recently, but is still healthy relative to the norms for October (high 80%’s). If the economy slows in FY’23, though, it seems likely that demand for refined products will slow. How much it will slow is hard to gauge given that many companies are still trying to deliver on backlogs and still looking to rebuild inventories, but the shares of chemicals companies like Dow (DOW), LyondellBasell (LYB), and Olin (OLN) have weakened in recent months.

The prospect of weaker petrochemical/refined product demand in FY’23 sets up an interesting scenario over the next couple of quarters. Kirby saw low-90%’s utilization for its inland barges in the third quarter, with spot prices up in the mid-20%’s and contract renewals occurring with pricing up low-teens.

Management expects a large chunk of its contracted inland fleet (35%) to renew in Q4’22, with the impact showing up in Q1’23 and beyond, but I wonder if customers will try to hold off on renewals in the hope of seeing lower prices and then locking those in. I don’t think this is likely to happen on a large scale, as producers don’t want to end up short of transport capacity, but a few customers may be tempted to play chicken with a weakening macro environment.

As far as the DES business goes, I don’t think a lower outlook for trucking, construction, industrial production and so on in 2023 is too worrisome now, as utilization is likely to still remain healthy. I also think that strong oil prices should continue to incentivize drilling in the U.S., supporting demand for fracking-related construction and maintenance services.

The Outlook

I’ve opted to ease back a bit on my FY’23 revenue estimate (by about 3%), but I’m still looking for long-term annual growth of around 6% from FY’21’s starting point, or around 2-3% from the last cyclical peak.

Modeling margins here is tricky because of the intense cyclicality of the business and the significant operating leverage; if day rates on 30K bbl barges get over $8K, Kirby can earn 20%-plus margins in the Inland business, but margins decline significantly when demand weakens. With that, I know my model will likely be wrong on a year-by-year basis out beyond FY’24, But I do think Kirby can generate average FCF margins in the high single-digits to low double-digits over time, supporting a mid-single-digit FCF growth rate.

Capital demands should be pretty modest. I don’t see Kirby looking to make significant new barge orders (though there is a wind farm growth project I discussed in my last article), and though there are some captive fleet acquisition opportunities, I don’t expect huge capital deployment into capacity.

The Bottom Line

I value Kirby by long-term discounted cash flow and margin/return-driven EV/EBITDA. The shares look priced for a solid high single-digit long-term annualized return on cash flow, while an EBITDA multiple of 10x can support a mid-$70s fair value – that 10x multiple is a compromise of sorts between a historical mean EBITDA multiple in the high single-digits and improving near-term margin leverage.

I do see some economic risk here, and I do have some concerns buying in at a point where utilization rates are already strong and pricing is robust. This was a much easier call back in the fall of 2020 when things were terrible, but I’m not quite ready to call it a day with this name just yet.