Buying into cheap companies is a great way to generate strong returns in the market. But some companies deserve to be trading on the cheap and, as a result, only give the illusion of upside potential. One such firm, in me opinion, is Great Lakes Dredge & Dock Corporation (NASDAQ:GLDD). After 2019, revenue for the company has been stuck in a fairly narrow range and profitability has been on the decline. Yes, shares of the company are trading at a cheap price, but recent financial performance has been even weaker than it was a year ago and backlog for the company continues to decline. Absent some major change in the company’s operations, I would make the case that while shares are cheap, they deserve to be cheap. And as such, I have rated the company a ‘hold’, meaning that I think it will generate returns that, at best, will match the broader market. But if current conditions continue to decline, the company might warrant a downgrade moving forward.
A unique firm
According to the management team at Great Lakes, the company serves as the largest provider of dredging services in the US. By definition, dredging generally involves the enhancement or preservation of the navigability of waterways, or it involves the protection of shorelines, through the removal or replenishment of soil, sand, and rock. The work that the company performs in the US is really centered around four primary types. The first of these is referred to as capital work. In 2021, this particular activity accounted for 55% of the company’s revenue. Capital dredging consists of port expansion projects that often involve the deepening of channels and birthing basins in order to permit access by larger, deeper draft ships and the provision of land fell that’s used to expand port facilities. Other work under this category includes coastal restoration and land reclamation, trench digging for pipelines, and more.
Next in line, we have coastal protection work. These projects generally involve the moving of sand from the ocean floor to the shoreline locations where erosion threatens shoreline assets. Increased development of properties on the coastal shoreline has made this particularly important in recent years for state and local governments to address. And given that this type of work is generally preferred to the erection of sea walls and jetties, or the revocation of buildings and other assets away from the shoreline, it stands to reason that demand for these services will persist. Last year, these activities accounted for 23% of the company’s revenue. Next in line, we have maintenance work. Dredging under this category usually involves re-dredging of previously deepened waterways and harbors with the purpose of removing silt, sand, and other sediments that have accumulated over time. Management claims that natural sedimentation necessitates this kind of dredging every one to three years in what should ultimately create a recurring stream of revenue for the business. 18% of the company’s revenue last year came from this category.
We also have rivers and lakes dredging, which seems self-explanatory. But it also involves inland levy and construction dredging, environmental restoration and habitat improvement, and other marine construction projects. This type of activity accounted for 3% of the company’s revenue last year. And finally, we have foreign capital projects that typically involve land reclamations, channel deepening, and port infrastructure development for the firm’s overseas customers. But this only accounted for 1% of revenue last year. The company is also working on expanding its operations to include work in the offshore wind energy space. In November 2021, the company entered into a $197 million contract to build the first US-flagged Jones Act-compliant, inclined fall pipe vessel for subsea rock installation for wind turbine foundations with the goal of delivering the vessel to the customer in the second half of the 2024 fiscal year. The company has had other, more recent, wins in this space. In early May of this year, the company announced an award involving subsea rock installation work for two different wind farms on the East Coast. And on August 24th, the company announced a $107 million dredging contract that included $7 million for a New Jersey wind port.
Over the past few years, the picture for Great Lakes has been mixed. Consider, for instance, revenue. This metric has risen in four of the past five years, climbing from $592.2 million in 2017 to $733.6 million in 2020. Then, in 2021, revenue dipped slightly to $726.1 million. When you look at the current fiscal year, it’s looking as though revenue is likely to fall again year over year. For the first half of the year, sales came in at $343.8 million. That’s 1.1% lower than the $347.5 million generated at the same time last year. Although this may not seem like much, it’s worth noting that in the second quarter alone, the company reported a 12.1% decline in sales compared to the second quarter of last year. This decline in sales came even as the capital dredging work for the company grew by 13%. The biggest decline was associated with maintenance work, with revenue plunging by 66.1% from $37.3 million to $12.6 million. Management did not really provide much detail on this, except to say that it was largely due to a decrease in revenue earned on projects in Louisiana and Florida.
Profitability for the company has been largely positive in recent years. The company went from generating a net loss of $15.4 million in 2017 to generating a profit of $66.1 million in 2020. But then, in 2021, the company saw this profit decline to $49.4 million. Operating cash flow has been far more volatile, peaking at $192.5 million in 2019. Since then, it has been on a constant decline, eventually hitting $49 million last year. If we adjust for changes in working capital, however, the picture is not quite as bad. After hitting $118.7 million in 2019, it rose to $131.6 million in 2020 before dropping to $112 million in 2021. Meanwhile, EBITDA has followed a similar trajectory, eventually peaking at $151.1 million in 2020 before dropping to $127.4 million last year.
When it comes to the current fiscal year, weakness for the company has continued. Net income in the first half of the year totaled $7 million. That’s down from the $10.9 million generated at the same time last year. Operating cash flow fell from $35.6 million to just $0.8 million, while the adjusted figure for this fell from $38.1 million to $34.3 million. Meanwhile, EBITDA also declined, dropping from $47.1 million to $39.8 million. Actually, much of all of this pain came in the second quarter of the year. The company’s net loss of $4 million was far worse than the $2.1 million achieved in the second quarter of 2021. Operating cash flow went from positive $44.8 million to negative $25.5 million. Adjusting for working capital, it would have fallen from $15.6 million to $8.1 million. Meanwhile, EBITDA for the company halved from $20.2 million to $10.1 million.
These temporary declines could be, on their own, easily forgiven. But what is absolutely painful is the decline in backlog the company has seen over the years. Backlog in 2018 ended at $707.1 million. It then fell to $589.4 million, with some of that decline attributed to an asset divestiture. But backlog has continued to fall since then. At the end of 2020, it was $559.4 million. At the end of last year, it hit $551.6 million. But the real decline came this year, with the figure plunging to $373.8 million. Most of its activities saw declines from the end of last year through today. The biggest came from the US capital projects the company is working on. Fortunately, the company has not really provided much detail regarding why this decline took place. But they were quick to mention that these numbers exclude the amount of domestic low bids and options pending award. That amount for the latest quarter came in at $540.9 million. At the end of last year, the figure was $567.3 million. This does suggest that the company could still have some nice increase in backlog if things go well. But the decline is disconcerting nonetheless.
This is not to say, of course, that there is no potential for the business. As of the end of the latest quarter, the domestic dredging bid market, according to management, was $938.1 million. That’s almost double the $532.4 million that the market stood at the same time last year. On the other hand, recent bidding activity by the company has been unsuccessful. In the first half of this year, the company won just 11.1% of the overall domestic bids that came into play. That compares to the 35% average that the company has seen over the past three years. Management attributed this decline to an atypical bid market, with the types of projects coming into play being ones that the company would not normally bid on.
Because of the recent pain, it’s difficult to value the firm. Management has also not provided any real guidance for the current fiscal year. But if we annualize results achieved so far for 2022, we should anticipate net income of $31.7 million, adjusted operating cash flow of $100.8 million, and EBITDA of $107.7 million. This implies a price to earnings multiple of 21.5, a price to adjusted operating cash flow multiple of 6.8, and an EV to EBITDA multiple of 8.6, all on a forward basis. If, instead, the company were to revert back to the level of profitability and achieved last year, these multiples would be 13.8, 6.1, and 7.3, respectively. As part of my analysis, I also compared the company to five other industrial firms that are out there. Of course, none of these are very good comparables. But they are probably the best we can get. When I priced to earnings basis, these companies range from a low of 8.8 to a high of 53.3. And using the EV to EBITDA approach, the range is from 2.8 to 15.1. In both cases, four of the five companies were cheaper than Great Lakes. Using the price to operating cash flow approach, only two of the five firms had positive results, with readings of 4.8 and 8.6, respectively. In this case, our prospect was in the middle of the group.
|Company||Price / Earnings||Price / Operating Cash Flow||EV / EBITDA|
|Great Lakes Dredge & Dock Corporation||21.5||6.8||8.6|
|Infrastructure and Energy Alternatives (IEA)||16.4||AFTER||7.5|
|Sterling Infrastructure (STRL)||8.8||8.6||6.2|
|Concrete Pumping Holdings (BBCP)||20.0||4.8||7.1|
|ReneSola Ltd. (SOL)||53.3||AFTER||15.1|
Operationally speaking, Great Lakes is an intriguing prospect and it’s true that shares are trading cheap from a cash flow perspective. Long term, I suspect the company will fare reasonably well. But we are seeing some signs of weakness on both its top and bottom lines. This picture is worsened by the tremendous amount of backlog decline that the company has experienced as of late. For these reasons, I do believe that a more appropriate rating for the business would be ‘hold’ at this time, indicating my belief that it is unlikely, on a risk-adjusted basis, to generate strong upside for investors for the foreseeable future.