Gulf Island Fabrication (GIFI) Stock: The Catalysts Are Closer

Gulf Island Manufacturing (NASDAQ: IGIF) is in the final stages of its multi-year turnaround. The market rewarded the company with a 20% jump in share price after a strong second-quarter earnings report, but investors appear to have missed an exciting catalyst that was mentioned on the conference call. Management basically announced that it had landed a large manufacturing contract that it expects to close in the next quarter; this should have led to a much larger jump than 20%. The shipyard liquidation continues at a slower pace than expected, but GIFI is on course for a strong 2023. I see a clear path to $12 million in net profit and a doubling in share price in 18 months.

Summary of second quarter results

The headline news for GIFI’s second quarter earnings report was the strong performance of the Services division. Boosted by the integration of the recent acquisition of Dynamic, the Services division generated more than $2 million in operating income. This is important because the company’s total overhead is approximately $2 million per quarter; if GIFI were to shut down all other operations tomorrow, they would become a profitable GAAP business overnight. The shipyards division continues to lose money and it looks like the liquidation of this division will take another quarter. Management now indicates that it expects to deliver its last vessel in the fourth quarter.

While the Services division covers the company’s fixed costs and the money-losing shipyard division is set to disappear by early 2023, the remaining X-factor is the manufacturing division. Second quarter figures were disappointing, with the division posting a small operating loss on slightly lower volumes from the prior quarter and year. If you only read the company’s second quarter earnings press release and 10-Q, you’d be disappointed with the lack of meaningful improvement and the absence of a major contract. During the conference call, however, CEO Richard Heo dropped the following bombshell:

We indicated last quarter that we were in discussions with customers for large-scale manufacturing. These customers recognize industry capacity constraints and during the quarter we entered into a facilities reservation agreement with a key potential customer while continuing to negotiate the terms and conditions of a contract. We expect the contract to be completed in the third quarter and expect to begin fabrication work on the project by the end of the year.” (Source)

This is huge news. Although no formal contract has been signed, GIFI has a potential client who is so eager to work with them that they are paying the company a deposit to secure a place for their project. This is a strong indicator that a contract will be signed as you can get it. Clarifying the comments, Heo confirmed that the project in question is over the $50 million mark and that they are in active talks with other customers who are also looking to book capacity from GIFI. Management had previously indicated that margins on large-scale manufacturing work should be around 10%; this means that a single project of a minimum of $50 million should bring the company about $5 million in operating profit. With no long-term debt and more than $100 million in net operating losses carried forward, interest and taxes will be negligible and net income will closely follow operating income.

Outlook for 2023

Putting the pieces of the division together, GIFI is set up for a strong 2023. The losses in the shipyards division will have disappeared, removing the corresponding slowdown in profits. I expect services to remain stable as project activity remains high in the Gulf; extrapolating Q2 results puts annual operating profit at around $10 million. With a $50 million+ manufacturing deal all but stalled and several other customers in talks to reserve utilization capacity, I conservatively estimate $100 million in manufacturing revenue in 2023, which translates to about 10 million additional operating profit. Business general and administrative expenses have been fairly consistent in previous years ($8.5 million in 2020 and $8 million in 2021); I think $8 million is a reasonable estimate for general and administrative expenses for businesses in 2023. That translates to net income of about $12 million and EBITDA closer to $17 million. As of this writing, GIFI’s market capitalization is $60 million. GIFI has $40 million in cash and no debt, so EV is around $20 million. A conservative PE ratio of 10 and/or an EV/EBITDA multiple of 6 translates to a market cap of $120 million, suggesting a 100% upside from the current stock price.

Risks

In addition to the usual risks associated with nano-caps (low stock liquidity and high daily volatility), the two biggest risks to the investment thesis are more delays in shipyard closure and delays in signing contracts. Manufacturing. I was disappointed to see that the shipyard roll-off will last an additional quarter, and it is possible that future delays will occur. I admit that management has lost some credibility in this area. The saying “don’t count your chickens until they hatch” also applies to contract negotiations; even if a customer pays to reserve manufacturing capacity, an agreement is not an agreement until a contract is signed. It is possible that I am mistakenly exaggerating the likelihood of additional manufacturing contracts. Without a major manufacturing contract in 2023, I don’t expect GIFI to do more than break even and perhaps generate modest EBITDA.

Conclusion

I’ve been watching GIFI’s turnaround for several years now and gaining confidence that 2023 will be the year things finally turn around enough for the market to notice. GIFI’s stock price surged after the second-quarter earnings announcement, but has been slowly declining since. The market isn’t quite in a position to see GIFI’s potential just yet, but strong earnings in 2023 should send a clear message to the streets. I add to my position about $4/share and expect to see a stock price north of $8 over the next 18 months.

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