Barron’s: World Fuel: A Great Hedge Against Volatile Oil Prices

Investors got nervous when a World Fuel rival went bankrupt. But the more prices gyrate, the better World does.

By Jack Willoughby

 

In early November, the world’s largest supplier of ship fuel, Denmark’s O.W. Bunker, went bankrupt, a seeming casualty of falling oil prices.

The failure, coupled with investors’ generally negative view of energy companies, put pressure on the shares of Miami’s World Fuel Services (ticker: INT), a rival in supplying “bunker” fuel to marine shippers. This low-grade fuel is distributed worldwide through a network of logistical services that try to get the right amount to the right place at the right time. World Fuel also supplies airlines, such as JetBlue, and terrestrial users, including as a wholesaler to 2,000 U.S. gas stations, which sell it for use in cars, trucks, and heavy equipment.

World Fuel’s CEO Michael Kasbar: Building a global energy distribution platform. Photo: Courtesy of World Fuel Services

 

Falling oil prices, however, turned out to be only a partial contributor to O.W. Bunker’s collapse. It also mistimed some of its hedges and didn’t manage its risk well. The company accused two employees in its Singapore office of losing $125 million by exceeding their credit limits. Both deny wrongdoing. The company is in liquidation. But the problems were more about the company than the industry.

Wall Street has started to realize that; shares of World Fuel have climbed 36% since November. Several analysts think they can go still higher, perhaps as much as 15%, in coming months. The company has a market value of $4 billion and a solid balance sheet.

World Fuel also has had to contend with the fallout from a disastrous train derailment in July 2013, in Eastern Quebec, in which spilled oil from one of its subsidiaries caught fire. In all, 47 people died, and World Fuel will have some liability.

More recently, however, better things have been happening. O.W. Bunker was an aggressive price competitor in the marine-fuel business, where World Fuel is now arguably No. 1, giving it some pricing flexibility. And in the past few weeks, the price of oil has been in a volatile uptrend, underscored last week when crude prices rallied for six consecutive sessions, before slipping Friday.

So long as management is careful, volatility can be good for distributors like World Fuel. Sharp price moves make customers nervous. “Sooner or later, companies will look to lock in the cost savings” they’ve realized in recent months and tap the distributors for more supply, says Jack Atkins, an analyst at Stephens, in Little Rock, Ark. “The public doesn’t understand that what makes this stock move is not the price of oil but volatility and volume. And we’re entering a period where rising oil prices will find more customers interested in hedging fuel orders.”

World Fuel CEO Michael Kasbar said as much on a conference call in February. He noted that “the market seems to be poised to move around a bit,” which would help his company’s prospects, as would the demise of O.W. Bunker.

Speaking with Barron’s recently, Kasbar explained: “Energy is 20% or more of the operating cost for transportation, commerce, and industry. The system of delivery is highly fragmented, with thousands of buyers and suppliers and no safe way to interact on a global basis.” World Fuel’s role, he says, is to “provide a global platform that ensures supply and results for the energy industry, handling about 1.5 billion gallons a month.”

WALL STREET HASN’T ALWAYS understood the dynamics of World Fuel’s business. Beginning in 2007, analysts significantly underestimated the company’s profits as the price of oil grew more volatile (see chart). Then, in 2009, their earnings forecasts grossly overshot reality on the upside, as volatility in oil prices–and in World Fuel’s earnings—had begun to recede. Atkins believes we’ve entered a new period of volatility that will continue for a few months and will help earnings. It’s also possible the Street again misses the inflection point.

Like Atkins, Kasbar believes volatility could increase, because oil prices have declined sharply, cutting production, which frequently concentrates supply in fewer hands. That can be destabilizing for prices.

Atkins, who is more optimistic about World Fuel’s earnings prospects than the Street consensus, sees profits rising to $3.85 a share on $43.3 billion in revenue in 2016, up from an estimated $3.55 a share on $40.4 billion in 2015.

Aviation fuel makes up 40% of the company’s revenue and 40% of its gross profit, marine contributes 32% of revenue and 25% of gross profit, and land deliveries bring in 28% of revenue and 35% of gross profit.

World Fuel has a relatively strong balance sheet, with $302 million in cash, manageable debt, and a return on capital of 9.2%, compared with only 2.9% for most industrial members of the Russell 3000.

That money, plus the shifting competitive landscape, could make the company a more active acquirer. Last year, it gained a toehold in the United Kingdom and Europe via an acquisition, and it sees more opportunities there.

A bull on the stock for several months, Atkins has raised his target to $65 a share, 15% above its recent price of $56.17. “Investors,” says Atkins, “are just beginning to understand what a tail wind these shares have.”

He views World Fuel as a logistics company trapped in the body of an oil refiner. Its stock trades at 15 times his forward 12-month earnings, while logistics outfits, such as C.H. Robinson Worldwide (CHRW), fetch 21 times.

If CEO Kasbar can negotiate the oil market’s risks and chart a profitable course for World Fuel, its shares should power ahead.

Share This