Sunday, January 6, 2013

Aegean Marine Petroleum Network: lagging competitors with low return on investment and mounting financial expense eroding earnings margins

Aegean Petroleum (ANW) has an unusual business model compared to its bunker supplier competitors.  Its sole focus is the low margin marine fuel business.  It prefers expansion in physical assets and shuns derivatives to hedge fuel purchases. This asset heavy business model means that expanding bunker sakes put pressure on its receivables financing, resulting in breached loan covenants. Mounting financial expense is eroding profit margins. Sales volume has lately been flat.  Aegean has been consistently behind its competitors in share price and financial performance.

Many investors confuse Aegean for a shipping company. In effect it is a commercial trading company focusing solely on the marine fuel market. This is highly competitive market place with margin pressures. Marine fuel market is less profitable business than aviation or land fuel markets. The shipping industry as a whole suffers from over indebtedness and over investment. Aegean rather than diversifying into more profitable fuel markets is investing heavily in new marine fuel supply points, mainly on the basis of local start-ups as well as building storage facilities for a bigger share in the marine fuel market despite eroding margins, poor shipping industry fundamentals and larger competitors, who are stronger financially and diversified in other more profitable fuel markets.

It is hard to see any coherent strategy for competitive advantage. The original concept of gaining market share from a fleet of double hull bunker tankers scarcely made any sense for a company, whose main activity was buying fuel from major oil companies and selling this to shipping companies at a mark-up for the service. The delivery service with the bunker tankers is included in fuel price and is a cost, not a source of revenue. Fuel oil supply is a highly competitive business, where price and bunker quality are the main customer concerns. Whether the fuel is delivered by a fancy new bunker tanker is not a major factor in choice of supplier.

Aegean, moreover, contracted its bunker fleet prior 2008 at top of the market yard prices. This strategy may actually in retrospect be putting Aegean at disadvantage with competitors, who chartered in tonnage avoiding long term involvement in costly physical assets as well as those who waited and are now covering their needs with tonnage at present lower yard prices. In fact, Aegean has been lately selling off older tonnage to rationalize its fleet at tell-tale vessel disposal losses.

The latest strategy for competitive advantage seems to be investment in storage facilities. This does not seem in concept very different from the old strategy of the bunker vessel fleet. The new storage facilities are not primarily to be rented out to 3rd parties for a new source of revenue, but rather to be used to accumulate fuel for flexibility in customer sales. Note that Aegean’s larger, more sophisticated competitors make use of derivatives desk in managing their customer commitments at lower cost and more efficiently. Some like Chemoil are even divesting of their storage facilities for better asset allocation.

Expanding fuel sales puts pressure on working capital because suppliers must pay in advance for the fuel that they supply to their customers, who then pay later for the purchases. For this reason, bunker suppliers often factor their receivables for cash. Aegean lacks free cash flow to facilitate larger receivables because so much of their free cash flow goes to investment in physical assets and debt service. Their bunker fleet is mortgaged, which entails debt service and interest costs to their bankers. Their quarterly earnings reports demonstrates higher interest expense than competitors like Chemoil, even though Aegean is a smaller company with lower sales turn-over. Larger competitors like World Fuel are much stronger financially with very little debt and their receivables factoring is on much better terms. They have better earnings margin from their fuel sales and more free cash flow available with very little encumbrance for debt service.

Aegean was obliged to state in their 2011 financial report that they had covenant violations with their lenders from their receivables financing. This year a major loan facility is up for renegotiation with lenders. It is hard to see how Aegean will manage lower finance costs than their competitors. This puts Aegean at disadvantage with them, so it is hard to see why Aegean is so interested in expanding when the additional market share is at diminishing financial returns.

Unlike competitors, Aegean also has an unusual management structure. Their management team is from Peter Georgiopoulos, who sits as Chairman. No one in the Georgiopoulos management team has a history in oil trading or bunker supplier business and the Chairman role appears to be largely a figure head position. The major shareholder in ANW owns Aegean Oil, a Greek-based domestic oil retail business, which is their sole physical supplier in Greek ports and has acquired land for envisaged ANW storage facilities in Dubai. Perhaps the shipping background biases this management team toward physical asset plays, albeit the main shareholder has a history of developing a successful retail fuel business in Greece.

The management depth of competitor bunker suppliers is formidable. Chemoil after the founder’s tragic deal was acquired by Glencore a major commodities trading house with enormous financial strength. Its present CEO, Tom Reilly was the former head of OceanConnect Holdings, Inc - an innovative company combining state of the art on-line technology as well as 24/7 traditional expertise to provide global energy and risk management products and services. He also held a major management position in a Texaco Chevron joint venture in bunkering and fuel trading. Michael J. Kasbar, President and CEO of World Fuels has worked in the fuel business all his career and was the driving force in World Fuel’s proven strategic acquisition record in diversified fuel markets.

Aegean stock performance in comparison with World Fuel speaks for itself in terms of the results of its strategy in a striking way as seen in the adjacent stock charts.

Whilst Aegean has fallen significantly since its initial IPO and stagnated with low volume, World Fuel has significantly outperformed and rewarded its investors.

Even Chemoil stock despite the succession turmoil has also outperformed Aegean and it has been improving lately after being acquired by Glencore with revamped management.

Given such dismal share performance with peer companies, what does Aegean management have in their heads using surplus company funds to repurchase shares?  Would not the interests of Aegean shareholders be better served by merging Aegean with a bigger, financially stronger and better managed fuel company like World Fuels in return for INT stock?  Indeed such has been the fate of many a marine fuel supplier company in this highly competitive sector! 

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