Adams Resources & Energy: A Bet On Oil And Management

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Adams Resources & Energy (AE) has always reminded me of a gold mining stock: The wild card that lies between the investor and the commodity is management. I have no more idea about where the price of oil is going than I do the price of gold, but I like to maintain a small position in energy stocks for diversification purposes.

AE has always interested me because of its excellent balance sheet and abundant cash, but then AE has been a perennial under-performer in an under-performing sector.

AE Performance against benchmarks

Since AE’s holds short term inventory of crude oil, earnings (and losses) are impacted by the swings in the price of oil, but it is not a pure play.

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Data by YCharts

While most of their revenue comes from the holding of oil inventories and marketing oil through its GulfMark unit, they have a growing transport business. Service Transport Company (“STC”) transports liquid chemicals and, to a lesser extent, dry bulk on a “for hire” basis throughout the continental U.S., and into Canada and Mexico. For the short term anyway – an investment in AE is still a wager on the direction of the price oil, and a bet on management’s ability to make money transporting oil.

Crude Oil Marketing And Field Level Operating Earnings (FLOE)

Evaluating the performance of the company is tough because it swings wildly with the price of oil. To adjust for this, AE using what they call field level operating earnings when looking at the crude oil marketing segment. This is a non-GAAP metric, which backs out inventory valuation and hedging gains/losses from their Marketing segment earnings.

Crude Oil Marketing Field Level Operating Earnings

This metric still seems to get distorted by energy price swings (Q1 2020 had a huge FLOE number as oil prices crashed), but this metric does work better at evaluating operational performance than looking at raw segment earnings. This FLOE analysis shows a relatively consistent margin on a per barrel basis. In October of 2018 AE acquired Red River Holdings for $10 million, which added 113 trucks and 126 trailers, expanding crude oil marketing operations to North Texas and South-Central Oklahoma. That shows up in the slight growth in barrels purchased per day, and is likely also the factor in the hit to the operating margin. As an investor I will be watching to see if they can grow margins back to pre-acquisition levels, while maintaining daily volumes. I would consider it a positive that volumes only dropped 4% in Q1 2020, given the disruption in the oil prices and drop in demand due to the economic slowdown.

Going back to the gold stock analogy – it is the price of the commodity (OIL) that will drive this segment. So I am not using these metrics for valuation of the company. I am just using these metrics to watch for deterioration of operations which would negatively impact my energy sector allocation.

Increased Focus On The Transportation Segment

The Transportation segment is a little more easy to analyze because its earnings are not tied to oil price fluctuations. This segment has been growing revenue in recent quarters, though earnings have been shrinking:

service transport company performance

In May of 2019 the company purchased EH Transport, which added 39 tractors and 51 trailers to their transportation segment fleet. This acquisition resulted in modernizing their fleet, with the side effect of a 1.4 million drop in earnings for 2019. Earnings were down “primarily due to higher depreciation and amortization expense related to the EH Transport asset acquisition and new assets placed into service and higher insurance expense”, according to the most recent 10-K. Based on the change in miles driven, it would appear that many of acquired units were targeted to replaced existing older vehicles. Most recently, AE announced the purchase of assets from CTL Transportation, which will grow the size of the fleet by over 50% with the addition of 160 trucks and 320 trailers. According to the press release, this acquisition will be immediately accretive to earnings and expected to close in the third quarter. This purchase also includes CTL’s customers in four new markets.

Even in this economic environment, I would hope for margins to stabilize and improve in this segment. Q1 2020 showed that even with the economic slowdown, demand is still there and they can shift their product mix. As per the Q1 2020 10-Q:

Our transportation operations have remained steady during the efforts to curtail the spread of the COVID-19 outbreak in the U.S. as we have transported products including bleach, disinfectant, soap and other similar products that are in high demand.

If an end result of this worldwide COVID-19 disruption is to onshore more manufacturing to North America, I could envision a case to be made that that will serve as a tailwind for this segment with more demand for industrial deliveries. With this most recent acquisition, I expect to see a big increase in revenue for this segment, as well as expanding operating margins.

New Management Across The Board

Over the past year management has been shuffled at AE. Kevin Roycraft succeeded CEO Towns Pressler who left in the fall of 2019. Kevin had been president of STC (the transportation segment), so that left a vacancy for that unit. In January 2020, Wade Harrison, who has been with the company since August 2018, was moved to be the president of STC. Meanwhile, in the crude marketing segment, Geoffrey Griffith resigned as president of GulfMark in August of 2019. Roycraft had been acting as interim president for that unit, until March of 2020 when Greg Mills was named president. Mills is new to AE who comes from Energy Transfer Partners.

Building a brand new team, digesting two new acquisitions in 9 months and dealing with a very uncertain economic environment is an elevated risk. Fortunately for new management, prior management didn’t set a terribly high bar for profitability and execution, with ventures into oil exploration and medical systems leading to write offs. If new management can show improved operational execution, there could be an opportunity here.

Valuation And The Balance Sheet

What initially attracted me to AE was its low price to book, spotless balance sheet and high cash balance. Frankly, it has been a value trap. Currently trading under book value with a price to book of .82 makes it pretty inexpensive, but it has always traded in this range.

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Data by YCharts

It has been cheap on a price to book basis for good reason. In recent years EPS has been near zero, and revenue growth has been non-existent. Granted these numbers would change if the price of oil goes up – but the operational metrics will also need to be watched for deterioration.

Cash per share has always been amazingly high, and it was (prior to the recent acquisition) at $87 million ($20.63 per share), which is actually down from its historic norm.

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Data by YCharts

No price was disclosed for the recent CTL Transport acquisition, but given its relative size to the ~6 million EH Transport acquisition, I would guess at the price in the 20-30 million range, which puts quite a dent in their cash ‘dry powder’ balance. I would be surprised to see any significant acquisitions going forward until the cash balance is built back up.

Conclusion

I have a small position in AE, and will likely hold it if for no other reason that it provides a safe haven in the energy sector. Valuation isn’t particularly compelling, and like a gold stock, new management presents a risk to adding value to my energy sector bet. I have no idea where the price of oil will be going in the next few quarters, so the operational metrics are what are important to me here. The next few quarters will be interesting to watch play out. Will this company morph into more of a trucking company? Can new management execute and will margins improve as these acquisitions are digested? That is the story to watch for the next few quarters.

Disclosure: I am/we are long AE. 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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