World Fuel Services: Dividend Growth Potential, But A Problem (NYSE:INT)

Introduction

When scouting for new and interesting dividend investments, World Fuel Services (NYSE:INT) caught my attention after seeing their impressive dividend increase of 17% during 2022. Whilst their existing yield is still only a low circa 2%, this nevertheless raises the question of whether a new contender is emerging, especially because the energy sector commonly sees companies with generous dividends given the lack of structural growth for fossil fuels. After digging into their fundamentals, it was somewhat disappointing to see great dividend growth potential, apart from one problem.

Coverage Summary & Ratings

Since many readers are likely short on time, the table below provides a brief summary and ratings for the primary criteria assessed. If interested, this Google Document provides information regarding my rating system and importantly, links to my library of equivalent analyses that share a comparable approach to enhance cross-investment comparability.

Detailed Analysis

When it comes to dividends, I feel that nothing is more important than cash flow performance and most notably, the ability to generate free cash flow. Therefore, it was positive to see their operating cash flow of $229m during the first nine months of 2022 ultimately translated into free cash flow of $173m. After being annualized, it equates to circa $230m that if subsequently compared against their current market capitalization of approximately $1.7b, sees a very high free cash flow yield of almost 14%. Thus far, this sounds very desirable and in theory, it lays the foundations for far more dividend growth in coming years given their existing yield is only a low 2.04%. Although quite oddly, upon looking more deeply into their cash flow performance, their best year from a cash-generating perspective in recent history was actually the Covid-19 ravished year of 2020, which saw operating cash flow of $604m that easily surpassed their more modest results of $229m and $173m during 2019 and 2021, respectively.

Herein lies their one problem, their operating cash flow is extremely volatile with some quarters even posting negative results. Take the fourth quarter of 2021 for example, their reported operating cash flow was negative $50m, which means they burnt cash to merely operate and even if removing their working capital movements, their underlying result was still negative $10m. Likewise, the first half of 2022 was barely any better with their underlying results of only $12m and $29m across the first and second quarters, respectively. Thankfully, the third quarter marked a massive change with their reported result climbing to $259m, alongside an underlying result of $252m, which means virtually all of their recent free cash flow actually stems from merely one quarter.

Whilst this situation could make their free cash flow appear even more impressive, I view it differently because aside from producing free cash flow, great dividend growth potential is enhanced by steady cash flow performance. Take the tobacco industry for example, investors are willing to overlook its secular decline and ethical concerns largely because they produce extremely steady free cash flow that makes funding very large dividends a simple and reliable process.

When a company is dealing with inherently volatile commodities that in this situation, can leave a cash flow drought for several consecutive quarters, they have to effectively hold back a large portion of their dividend capacity. This is less of a problem for big companies, such as Exxon Mobil (XOM) who enjoys extremely deep pockets thanks to their massive balance sheet but as a relatively small company, it significantly complicates their dividend growth. Whilst yes, they can utilize this spare capacity within their volatile free cash flow to periodically fund share buybacks, it brings about associated issues. Since stronger financial performance should correlate with a higher share price and vice-a-versa, it opens the door for their share buybacks to be weighted towards the higher prices of their cycles.

Their volatile cash flow performance may see investors questioning why these results transpired, in particular, as the first half of 2022 saw booming prices for many fuels as Russia invaded Ukraine and set off a chain reaction. Interestingly, they actually benefit as prices decrease and thus enter a contango market structure, whereby future prices are higher than present prices, which is a common dynamic for companies that store and distribute fuels. The end of 2021 and the first half of 2022 saw the opposite market structure, being backwardation whereby present prices were above future prices due to fuel shortages, which actually hindered their cash flow performance.

Since fuel prices eased during the third quarter of 2022, they enjoyed very strong cash flow performance and in theory, the recently ended fourth quarter should also see another strong result given the further fuel price declines in tandem with oil prices. Since the third quarter saw over $200m of free cash flow by itself, another repeat of this during the fourth quarter stands to see a wave of cash hitting their balance sheet.

Even though they have continued producing free cash flow during the first nine months of 2022, their capital structure now sees its net debt expanding to $413m, whereas they normally carried a net cash position in previous years, namely $144m at the end of 2021. This change stems from their acquisition of Flyers Energy Group, which disappointingly, they have not provided any guidance for regarding its expected earnings contribution but at least, they can afford the cost and thus the risks are not too high.

Since they normally operate with a net cash position and thus in my eyes, this change is nothing more than a blip on the radar. Given the aforementioned free cash flow outlook for the fourth quarter of 2022, they should once again see a net cash position in the coming year or so and thus, it seems unnecessary to assess their leverage and debt serviceability in detail. Plus, a quick back-of-the-envelope calculation shows their leverage is still low, as their operating cash flow is over $200m per annum, thereby seeing a net debt-to-operating cash flow of less than 2.00. Likewise, during the first nine months of 2022 their interest expense of $74.8m still saw sufficient coverage of 3.06 against their accompanying operating cash flow of $229m, despite the headwinds they faced in the first half. Going forwards into the future, it may become necessary to assess their leverage and debt serviceability in detail if they do not begin slashing their net debt, either due to weak operating conditions, even higher shareholder returns or more obviously, further acquisitions.

Whilst leverage and debt serviceability are important in the medium to long-term, liquidity carries far more important short-term ramifications. At least on this front, it was not jeopardized by their acquisition and the resulting loss of their net cash position. Even though their respective current and cash ratios declined to 1.11 and 0.06 following the third quarter of 2022 versus their previous respective results of 1.30 and 0.21 at the end of 2021, they still remain adequate. Elsewhere, their credit facility still holds another $300m of availability that does not mature until April 2027, alongside the remainder of their debt that is contained within their term loans.

Conclusion

Even without deleveraging, their solid financial position can easily support dividend growth in the coming years and given their double-digit free cash flow yield, they initially appear to have great potential. On the flip side, their highly volatile operating cash flow routinely turns negative and disappointingly, creates headwinds that lessen this otherwise great potential. After much debate, I only believe that a hold rating is appropriate but at the same time, if their share price were to retrace lower, this may be upgraded in the future.

Notes: Unless specified otherwise, all figures in this article were taken from World Fuel Services’ SEC Filings, all calculated figures were performed by the author.