Gulf Island Fabrication (NASDAQ:GIFI) is the largest position in my portfolio and my highest-conviction value investment. The company has everything I look for in a value name: assets that provide downside protection, a clear path to improved earnings and cash flow, and a management team I trust. I’ve been following’s GIFI’s turnaround for years now; the company has taken some bad beats since my last article with the loss of their large fabrication contract and an unfavorable legal settlement, but I continue to see a robust margin of safety at the current share price. My personal price target is $8/share, with downside asset protection at $3.50/share and potential upside north of $10/share.
A Brief History of Gulf Island Fabrication
GIFI is a steel fabricator and specialty services provider to the industrial and energy industries. The company’s operations are based in Houma, Louisiana and their customers have historically been oil and gas companies operating in the Gulf of Mexico. GIFI’s fortunes have been closely tied to cycles in the energy industry; when oil prices are high GIFI has generally done well, and they have done poorly when oil prices fall and energy companies spend less on infrastructure and operations. In an attempt to diversify their business, GIFI acquired the assets of LEEVAC Shipyards in 2016. GIFI had performed maintenance work on ships in the Gulf of Mexico as part of their services business, so getting into shipbuilding seemed like a reasonable move. In practice, GIFI was terrible at it. GIFI had trouble staffing their shipyards, underbid on a number of large projects, and made costly engineering errors. The shipyard was losing millions of dollars while at the same time the fabrication yards remained underutilized and unprofitable.
GIFI’s situation has steadily improved since 2019 when a new CEO joined the company. Richard Heo had once been a customer of GIFI in a previous role (source) and accepted the job as CEO to try and return the company to its fabrication roots. Since joining the company, Heo has sold off the shipyard division’s backlog and assets, returned bidding disciple to the fabrication division, and made a successful acquisition in the services space.
Recent Events and Updates
There have been two major developments since my last article about GIFI. First, GIFI announced the signing of a major fabrication contract worth ~$100mm in September of 2022 (source). By the time GIFI announced FY 2022 results in March, the customer had put the project and hold and the contract was formally canceled in Q2 of this year. GIFI has been paid for the work performed on the project, but it is a meaningful setback towards fully utilizing the fabrication facilities. Management is actively bidding on other projects and is confident that they can replace the lost work (source).
Second, GIFI announced on Oct. 8th that they settled the ongoing litigation between themselves and Hornbeck Offshore Services (source). Hornbeck was a shipyard customer who terminated a contract back in 2018 due to complaints about the quality of GIFI’s work and significant project delays. Hornbeck had demanded the ships be delivered mid-construction, refused to pay the outstanding balance due to GIFI for work already performed, and demanded compensation for financial damages incurred by the delays. A trial date was set for later this month, but GIFI decided to settle ahead of the trial. The end result is that GIFI agreed to forfeit the remaining contract receivables ($13mm) and to pay performance bond company Zurich American Insurance $20mm and 3% annual interest over 15 years to make Hornbeck whole. This is not the outcome I was hoping for as a GIFI investor, but the silver lining is that the matter is now resolved and a large cloud of uncertainty has been lifted off of the company. Despite the negative outcome, the market was generally pleased to have the matter resolved; GIFI shares are up ~13% since the settlement was announced.
Why GIFI is an Appealing Investment
Assets Provide Adequate Downside Protection
The foundation of a good value investment, in my opinion, is downside protection. GIFI provides investors downside protection via its robust balance sheet. At the end of Q2 GIFI had total assets of $136mm (including $40mm of cash and short-term investments) against total liabilities of just $32mm. Post-settlement, GIFI’s assets have decreased by $13mm (due to written-off contract receivables) and its liabilities have increased by $20-29mm ($20mm does not include the 3% annual interest, $29mm is the total amount due to Zurich over the next 15 years). I’m not sure if GIFI will treat the liability like debt and only include the $20mm or if they will list the entire $29mm as an “other noncurrent liability”. GIFI’s book value is between $3.50/share and $4/share after adjusting for the settlement and taking out goodwill and intangible assets. At the time of this writing GIFI is trading at $3.71, so net assets provide nearly 100% downside protection.
GIFI’s cash pile is robust and cash burn has been minimal so far in 2023 (I expect them to be cash flow positive over the remainder of the year), but in a hypothetical liquidation event I think GIFI investors would be well protected. The company’s PP&E at cost comes in at about $125mm against accumulated depreciation of about $100mm. GIFI’s fabrication facilities and equipment have been underutilized for nearly a decade, and I suspect their deprecation schedule has been overly aggressive as a result. Buildings, equipment, and machinery still wear down without use, but I estimate that a lot of their PP&E is in better shape than the balance sheet would suggest. I also think at-cost book value undervalues GIFI’s strategic location within 30 miles of the Gulf of Mexico and increased equipment and building replacement costs due to the recent spike in inflation. In the event of a liquidation, GIFI’s assets could likely be sold for more than their stated book value, not less.
Earnings and Cash Flow are Improving
After six consecutive years of net losses, GIFI has posted two consecutive quarters of positive net income. There are three levers that are driving the improvement. First, GIFI’s services division is firing on all cylinders. Thanks to the tuck-in acquisition of Dynamic Industries in late 2021 and a new “Spark Safety” product offering, services revenue is up and margins have improved dramatically. For comparison, through the first two months of 2022 the services division generated $3.5mm in operating income on $43mm of revenue; in the first two months of 2023 the services division generated $5.6mm in operating income on $46mm of revenue (source).
Second, GIFI has been winding down its money-losing shipyard division. Despite selling off the majority of shipyard assets back in 2021, GIFI has been slowly and painfully working to finish work on its remaining shipyard deliverables. Delays and cost overruns on the final projects have been an unexpected drag on performance; through the first half of 2023 the division has cost GIFI over $4mm in operating income. If Q3 went according to plan, the final ship should have been completed and delivered in September and the long shipyard saga should finally be over (source). The shipyard division was supposed to have finished winding down nearly a year ago, so it is very possible that the final delivery was delayed again. That being said, tangible progress has been made and I think the division should be fully wound down by the end of 2023.
Finally, GIFI is actively bidding on multiple large fabrication projects and hoping to close one “in the second half of 2023” (source). Management has guided that a “large” project is $50mm or more in billings. As we saw in 2022, GIFI was able to land a fabrication contract over $100mm, so it isn’t far-fetched to think they can land another deal. Q1 of this year included two months of work on the aforementioned large fabrication project. With just two months of large project work, fabrication division revenue for the quarter was $40mm and operating income was $2.2mm. At full capacity, management has guided that the fabrication division can reach 10% margins (source), so an additional large contract is likely to boost margins as well as topline revenue.
Valuation
I think there are three ways to think about valuing GIFI: an asset valuation, a valuation that assumes no major fabrication contract is signed, and a valuation that assumes GIFI can land another large fabrication contract. The asset approach assumes the operating business gets worse and that the company is worth more as a pile of “stuff” than as a functioning business. As discussed earlier in the article, I estimate GIFI’s conservative net asset value to be somewhere between $3.50/share and $4/share.
GIFI looks modestly undervalued if we assume that Q2 was a good approximation for how the services and fabrication divisions will perform in the future and no large fabrication contract is ever signed. Extrapolating Q2 results over a full year (and removing the shipyard segment), we would expect GIFI to generate ~$9mm in net income and ~$15mm in EBITDA. The default conservative multiples I use in my valuations are 10x net income and/or 5x EV/EBITDA. 10x net income and 5x EV/EBITDA both work out to a market cap of ~$90mm ($5.50/share).
In the event that GIFI lands a major fabrication contract, valuing the company becomes more speculative. A valuation would depend on the size of the contract and what affect it has on fabrication margins. Using management’s estimates of 10% operating margins at full capacity, a $100mm deal would add another $10mm in annual income and somewhere between $50mm-$100mm in additional market cap. This range would put GIFI’s share price somewhere between $8.50 and $11.50.
I think it is more likely than not that GIFI lands a large fabrication contract in the next year, and I am setting my own personal price target at a conservative (but still very appealing) $8/share.
Catalysts to Unlock Value
I see two potential catalysts on the horizon that could send GIFI’s share price closer to my target. First, I expect the market to take notice of GIFI’s improving fundamentals. If the company can continue to print consecutive quarters of net income and cash flow growth, the company will move from annual losses to annual net income and begin to both screen better and potentially attract more growth-oriented investors.
The more exciting catalyst is tied to GIFI’s large cash balance. Now that the Hornbeck litigation has been resolved, there is little need for the company to hold so much cash. Management hasn’t yet provided guidance as to how the cash will be used, but a one-time dividend or share repurchase program would likely drum up additional attention from investors. M&A is also on the table. GIFI’s shipyard acquisition was a disaster, but that was made under previous management. Heo’s acquisition of Dynamic Industries has fared much better. GIFI paid $7.5mm for Dynamic and is reaping roughly $5mm in additional annualized operating income. An accreditive deal like that could also act as a short-term catalyst.
Risks
GIFI has low liquidity risk now that the Hornbeck litigation has been resolved. The settlement adds a long-term liability to the balance sheet but GIFI will retain its roughly $40mm cash pile that can cover all short-term capital needs. If unforeseen circumstances arise and GIFI was forced to liquidate, I estimate that shareholders would receive a decent percentage of their investment back (as detailed earlier in this piece).
That being said, I see two risks to my investment thesis. First, if GIFI never actually lands a large fabrication project my expected return drops significantly. Second, the thesis depends on the market giving GIFI a higher earnings multiple as earnings improve. GIFI hasn’t been profitable for many years now, so it is hard to say if the market will agree with me and award a PE ratio above 10.
Conclusion
GIFI has everything I look for in a value opportunity. GIFIs assets protect against significant long-term loss, earnings and cash flow are improving, and I love the management team. I think a bare-minimum price target is $5/share without a major fabrication contract; a $100mm or more contract could add up to $6/share in additional value. My personal price target is $8/share, a 115% increase from the current share price of $3.71.
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