January 24, 2022

World Fuel Services: Some Thoughts After Becoming An Unleveraged Business (NYSE:INT)

World Fuel Services (INT) completed a sale recently, which is enough of a reason to check on the prospects for this company. Over the past years or decade, the bolt-on deal-making strategy of the company was a compelling one for me, but a few disappointments and secular concerns over the business have resulted in some of that enthusiasm cooling off significantly.

The Business

World Fuel Services is a global business which provides fuel to customers on land, air and sea. In the year 2019, the company supplied nearly 20 billion gallons (or equivalent) of fuel to its customers, generating $37 billion in revenues in the process. The company takes a very small cut in taking care of the logistics of all this fuel. It generated $1.1 billion in gross profits last year for gross margins of around 3%, in fact quite an impressive improvement from the results in 2018.

Adjusted operating income improved quite a bit to $322 million last year. It is fair to say that this is a very low-margin business with operating profits coming in at less than 1% of sales.

It has been August 2018, so little over two years ago, since I last looked at the potential of the company. In that article, I concluded that some stabilization, a short squeeze and some bolt-on deals saved the day with shares trading at $28 at the time.

In the same article, I noted that World Fuel has been a long-term growth story driven by operational excellence, bolt-on deals, yet leading up to 2018, investors have digested quite some disappointments. Shares peaked at $55 in 2015, but ever since have been feeling the headwind from lower marine volumes, deal-making not working out exactly as planned, and investors starting to feel the impact of less or no organic growth.

Trading at $28 at the time with debt being very manageable, while pegging potential earnings around $2.50 per share, valuations were non-demanding. Nonetheless, I used the short squeeze from $20 to $28 as an opportunity to take profits as I was fearful about the long-term potential of the company and deal-making not delivering on its promises.

What Happened?

Since late 2018, the company has seen quite some news flow with shares actually ending 2018 back at $20 again. Shares had seen a big run throughout 2019 ending the year around $45. I closed my remaining position at $35 during the run higher.

2019 has been an eventful year with the quarterly dividend being hiked 66% to $0.10 per share. This was driven by resilient underlying performance and leverage ratios having fallen to 1.4 times by 2018, as the company furthermore announced a $100 million share buyback program. In August 2019, the company announced another acquisition with the $170 million purchase of Universal Weather and Aviation, with accretion seen at $0.16-0.19 per share.

At the start of this year, the company reported its 2019 results, and while sales and volumes were down a bit, it managed to squeeze out higher margins with operating earnings totaling $300 million, thus delivering solid improvements on the bottom line. The company reported adjusted earnings of $2.69 per share, up $0.80 cents on the year before as the leverage ratio dropped to 1 time, although the deal for Universal Weather and Aviation still had to close. These results were obviously the driver behind shares starting the year 2020 around the $40 mark after a very strong 2019, yet these achievements were overthrown of course by the impact of Covid-19.

In July, the company announced a big divestment. It sold its Multi Service payment solutions business to Corsair Capital in a $350 million cash deal, with $275 million payable upon closing and $75 million payable later, the majority of which is tied to achieving financial targets through 2022. The deal will result in a one-time gain of around $65 million, just over a dollar per share.

Of course, the business was hit hard as well by Covid-19, although the impact seems somewhat modest. In July, the company reported its second-quarter results. Revenues fell two-thirds on the back of a 40% drop in volumes, accompanied by some declines in pricing. Notably the aviation segment of course fared very bad with volumes down 68% as declines in the land and marine segment were far less pronounced.

The company did relatively well amidst the volatility in pricing and dislocations, as gross profits held up to some extent, but of course fell alongside revenues as well. Despite a near $19 million asset impairment charge, the company still reported an operating profit of $12 million.

The company ended the second quarter with $305 million in net debt, defined as cash, investments and derivative assets minus debt. Of course, the Multi Service Line deal is not included in these numbers as it closed on the final day of September, translating into basically a flattish net cash position on a pro-forma basis.

Unfortunately, the Multi Service deal did not include any financial numbers in terms of revenues or margins which will leave the door. With shares of World Fuel now back to $22, the 63 million shares represent a $1.4 billion equity valuation. This suggests that the deal might be quite significant, but this is guessing. The second-quarter earnings call hinted that net revenues of the business come in around $90 million, and if that is correct, that is equal to about 8% of the reported gross profits.

What Now?

Essentially, World Fuel is an unleveraged business at this point which is of course dealing with the Covid-19 impact and the impact of the sale of Multi Line, which is quite uncertain at this point in time. Hence, the $2.69 per share in adjusted earnings reported last year is not attainable this year. Despite the dismal conditions in the second quarter, the company still squeezed out an adjusted profit of $0.13 per share. The run rate of $0.50 per share, as a current earnings rate, is not the most important in such an environment, yet survival is. In that sense, it is comforting to see no debt on a net debt basis at this point in time.

Furthermore, it is quite comforting to see that the company sees further declines in operating expenses in the current quarter; the second quarter furthermore included a $25 million bad debt expense. All of this is quite impressive, and while sequential activity should likely improve in the third quarter, credit quality remains an issue, and lower volatility of oil prices will probably hurt the results as well.

To sum it up: valuations are non-demanding, certainly in more normalized conditions, and the balance sheet of course is now unleveraged. The issue which I continue to have is that while shares look optically cheap (at 8 times 2019 earnings), the reality is that even if earnings recover in 2021, there is the overhang of long-term demand concerns (amidst the rise of renewable energy).

That said, every business has a fair price, and if shares fall towards the high teens, I would be interested to initiate a small position, although the long-term nature of the business prevents me from holding a position in size.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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