Lamprell Plc - Jack-up Rigs

The Arabian Gulf is a low cost source of oil and gas production and the UAE is the hub for support services for the gulf region’s oil industry. 

And, in the UAE (and the region generally), Lamprell is the leading refurbisher and manufacturer of jack-up rigs and Floating Production Storage Offloading (FPSO) structures. 

Which is significant because the UAE is characterized by limited industrial refurbishment and fabrication facilities, and especially limited in facilities with quayside access. Why? Because the physical space for them is limited: a natural barrier to entry. (In this sense, the case for Lamprell echoes the case for Hawaiian Holdings).

In 2010, there were four competitors in this naturally protected market: Lamprell was the largest and the others were Dubai Drydocks, Gulf Piping Co., and Maritime Industrial Services. Lamprell acquired MIS in 2011, and now there are three.

Natural barriers to entry and consolidation should mean above-normal returns on capital. And it turns out that Lamprell returns 33% on its operating capital. It’s a good business.

Note: USD

Lamprell has a newish sideline in manufacturing vessels used in installing offshore wind turbines. It won a 320m contract to supply two such vessels to Fred Olsen, the Norwegian 

shipping firm. One of these ships has been delivered and the other will be, soon. 

Lamprell’s present share price problem is that this project wasn’t executed well: it was a fixed-price contract, there were cost overruns and supplier problems, and there will be late delivery penalties. The total cost of this snafu is in the neighborhood of $175 million (GBP 108 million).

One would expect, therefore, that this amount (41p per share) would have been knocked off Lamprell’s enterprise value.  The market has, spurred on by analyst downgrades and a suspension of the interim dividend, instead wiped 6x this amount from Lamprell’s implied value. 

The result has been to price Lamprell in such a way as to say that either (a) it no longer has a competitive advantage in its traditional oil and gas rig markets or (b) the banks will refuse to renegotiate its loan covenants and will pull it into bankruptcy. 

Both these arguments are absurd; the former implication is plainly wrong and the latter scenario is highly unlikely to come about: Lamprell’s order book stands at 1.5 billion; it is the rare company that finds itself in a leading, competitive position in an industry that will experience steady real growth for decades to come.

Lamprell traditionally converts 10% of revenue into earnings and easily earns 30p per share. The shares are worth more than 300p. My sense is that they will re-price in fits over the next twelve months -- which is why I included them in my UK picks for 2013.

Disclosure: No position

Hawaiian Holdings - Air Transport

Hawaiian Holdings, owner of Hawaiian Airlines (Hawaiian), is in the business of transporting people and cargo to, from, and between the Hawaiian Islands. 

There are no substitutes for Hawaiian’s value proposition: if you want to go to Hawaii, or if you want to get away from it, you either fly or you swim. Whether you choose to fly with Hawaiian rather than with one of its competitors is, in a commodified and competitive arena like air travel, going to depend on price, which itself is going to depend on cost. 

An investment in Hawaiian, therefore, can only be premised on the belief that Hawaiian is – and will remain – the lowest cost airline in its market, a proposition that the remainder of this post will defend.

“Economies of scale” exist when indivisible costs are an important share of total cost, and when the assets represented by those indivisible costs are specific to the market in which the business operates – an increased volume of business will reduce average cost. It doesn’t exist when they’re not. The concept of economies of scale is not so much about size as it is about density – a better term would be “economies of concentration”. 

In the airline business, indivisible costs are those that do not change when new routes are added.  In Hawaiian’s case, those costs are gates, terminals, and runways in Hawaii; management and other overhead expense; and the infrastructure for aircraft maintenance, also in Hawaii.

No other airline has such a concentration of fixed costs in Hawaii. Hawaiian has 47% market share – they call it “seat share” in the airline business – in and out of Honolulu and Kahului; by contrast, the next largest competitors, JAL and United have ~7.5% seat share each.   

The effect is even more pronounced in inter-island flights, in which Hawaiian has 87% seat share. 

Every additional flight, wherever the provenance or destination, has at least one leg in Hawaii, and therefore reduces Hawaiian’s fixed costs per unit – and average cost per unit – even further. 

One would therefore expect Hawaiian to be the lowest cost airline flying to Hawaii, and one of the lowest cost airlines in the United States, and it is:

(Note: Spirit doesn't operate in Hawaii; Allegiant flies to Hawaii but doesn't operate regular scheduled passenger service -- it is more tour operator than airline).

Hawaiian's competitive position appears even better when viewed from the perspective of the interplay between the three distinct markets in which it operates. 

The Interisland market is Hawaiian's stronghold. Demand largely consists of business travelers, on the one hand, and transfer passengers from outside Hawaii, on the other. Virtually every airline that ferries passengers to Hawaii feeds their traffic automatically into Hawaiian's interisland route network. They don't really have a choice.  Demand in this segment is therefore is inelastic, and when inelasticity in demand meets monopoly in supply, it is reasonable to suppose that economic profits are in the offing.

The West Coast segment is Hawaiian's firewall: it is surely  the most contested airline market in the United States. There is no fat in the fares on these routes and Hawaiian flies them at cost, earning a slight premium only in those few city-pairs where it has dominant market share. If Hawaiian is flying these routes at cost, it must be true that other airlines are operating them at a loss. It can be in no-one's interest to lower prices even further, and so prices in this segment have remained relatively stable.

Although this West Coast segment earns no economic profit, it nevertheless serves Hawaiian's strategic purposes in two ways:  first, it ensures that no other airline has an economic interest in establishing a substantial beachhead in Hawaii; and second, the low West Coast fares feed high numbers of passengers into Hawaiian's profitable interisland segment. 

These two segments, then, are interdependent: West Coast erects the barriers to entry and allows Interisland to profit; Interisland puts the fixed assets to heavy use and allows West Coast to be an effective barrier to entry. This interdependence coheres so well that it might even constitute a business model.


An ancillary benefit is that Hawaiian, facing an inelastic demand curve in its interisland market, is able to pass on increased fuel costs without discomfort, thereby improving its cost leadership in the West Coast market.

This has been the happy balance since 2008, when Aloha Airlines, the other Hawaiian airline, fell into bankruptcy,  liquidated, and saw its 30% market share immediately assumed by its old rival. 


Hawaiian's financial performance in this period is a hymn to the blessings of muted rivalry:  

and, from the perspective of owner earnings:

Hawaiian's management, recognizing that this yogic balance between the West Coast and Interisland markets represents a solid foundation, is in the process of assembling a high yield, high demand international segment -- Japan and Korea, in particular, but also Australia and New Zealand -- to lay on top.

Source: my calculations from US DOT data


At an average margin contribution of eight cents per available seat mile, the additional 3.3 billion seat miles in capacity can be expected to contribute at least $100 million in additional annual after tax profit, or approximately $2 per share.


Turning now to the matter of valuation. Hawaiian's Interisland and West Coast markets -- the base -- can be counted on for $161 million in annual normalized operating profit: an average return of 11.5% on installed operating assets of $1,398 million. These two segments alone value Hawaiian's equity at $854 million, or $16.84 per share. (I have used an 11% cost of capital, even though Hawaiian's pretax cost of debt is 5.15%, because, let's face it, it's an airline).

If the international segment can be relied on for an additional $100 million in operating profit, and I think that is a low estimate, then the equity is worth $19 per share. This valuation implies a multiple of less than 4x on forward owner earnings which, even for an airline, is conservative.


Disclosure: I have a position in Hawaiian.