While the company's recent refinancing lowered its cost of debt and annual interest expense, it also raised the company's leverage ratios. The company's debt-to-equity ratio is around 4. Expect interest expense to be roughly 25-40% of operating income for the foreseeable future.
The company has $740M of operating leases related to its fleet held off-balance sheet. This nearly doubles the company's total liabilities to $1.5B.
Moreover, Horizon's Jones Act fleet is fairly long in the tooth at an average of 31 years. Replacing each vessel will cost at least $150M (probably more by this time) and the company has 12 active vessels with 4 in reserve. The company is planning to defer these capital costs for as long as possible.
Finally, Management has set an aggressive goal to expand their logistics operations with a target of $500M of revenues in 5 years. Any failure to meet these goals may impact the share price.
Rapidly rising bunker fuel costs can impact margins as evidenced by the 12% rise from October 2007 to November 2007 which caused the company to reduce guidance for 2007 Q4 and the full year. Moreover, while not as heavily exposed to economic trends as non Jones Act cargo shippers, Jones Act shippers are still vulnerable to lower volumes due to economic weakness.
Many of the operating costs are fixed and are not easily cut as business slows. Example: shippers recover fuel costs through surcharges but if the ships are at half-capacity, there are not enough payers to fully recover the fuel surcharge.
A heavy debt load combined with a still un-budgeted capex program to replace an aging fleet weakens my confidence in the company’s financial position but this is not new information. The rapidly escalating cost of fuel as well as deteriorating results which question the recession-resistant aspect of the investment thesis gives me serious pause.
At this point, the company may be too risky to open a position.
Horizon Lines is the leading Jones Act operator in the Puerto Rico market. Puerto Rico has been in an economic slowdown for over a year now, impacting the company's results.
Furthermore, a bill winding its way through Congress is seeking to retroactively close the tonnage tax loophole as it relates to Horizon's Puerto Rico market. If this bill passes with this provision intact, the company is looking at a $40M+ tax hit.
Industry wide, the Jones Act regulates the conditions on which ships can service inter-US ports. Vessels must be 75% US-owned, US-flagged, American-staffed and built in the USA. These conditions substantially raise the costs of inter-US shipping and keeps foreign competition out of this market. As an example, ships cost almost 3x as much to build in the US than overseas. If the Jones Act were ever repealed, Horizon's viability as an ongoing concern would be questionable.
Even with Jones Act restrictions, competition between vendors can put pressure on rates. Horizon has 1 primary competitor in each of the Hawaii and Alaska markets, 4 competitors in the Puerto Rican market and any number of competitors on its Asian routes, which are not covered by the Jones Act.
While not as heavily exposed to economic trends as non Jones Act cargo shippers, Jones Act shippers are still vulnerable to lower volumes due to economic weakness.