When it comes to commodity markets, there are several verticals in which to operate, ranging from the actual exploration and processing of the underlying commodity to, in the case of oil, refining and distribution pipelines. Industries that depend on the price and available supply of crude oil, such as commercial airlines and maritime shipping vessels, look to fuel distributors and logistics solutions providers to navigate volatile commodity prices, challenging supply chains, or sudden shifts in consumer demand trends.
2022 was a wild year for the crude oil markets, and for the subsequent industries that rely on clear expectations of where prices may be headed to plan and budget their operations more effectively. Oil prices started the year hovering around $70 per barrel, reached a high of around $120-$125, only to come back down to levels similar to where the year started. This shock of volatility negatively affected industries like maritime shipping and commercial airlines, among other transportation-focused firms, as margins and volumes became unpredictable.
Profit is Made by Solving Problems
World Fuel Services (NYSE: INT) is dedicated to providing fueling solutions, logistics, and supply chain simplification in the fuel contract services business. Effectively, World Fuel can be the helping hand that companies need when unexpected volatility hits and they are faced with the task of finding affordable fuel supply contracts, as well as a reliable supply chain network and system to better budget and project their operations.
The firm serves clients in the commercial airlines, maritime shipping, and land transportation segments of the downstream fuel space. The company has enjoyed an interesting dynamic in its financials tied to the global oil commodity markets when analyzing a five-year look-back period.
It seems that when oil prices experience a shock and then stabilize, margins for World Fuel expand right alongside earnings per share and free cash flows. This is due, as defined in the Management's Discussion and Analysis section of the annual reports, to the firm's ability to offer risk management products in their outstanding fuel contracts through derivatives of the underlying. Furthermore, they heavily compete against other fuel providers such as Exxon Mobil (NYSE: XOM) and Chevron Co. (NYSE: CVX), who can provide similar solutions and management directly by cutting out the middle man.
However, when prices are relatively high or low compared to the historical "fair value" of oil, these fuel giants cannot pivot their offers and pricing as quickly as a smaller firm like World Fuel can. This is the classic analogy between large-cap and small-cap companies, as they are similar to turning a "shipping bulker" versus turning a "speed boat" in their respective sizes.
Favorable Conditions Allowing for Dividends and Upside Potential
The company reported favorable growth across their segments in their fourth-quarter 2022 results. Posting a 2022 revenue increase of 88.4% and an overall volume increase of 15%, this reflects the effects of the wild volatility experienced in the price of crude oil throughout the year. The aviation fuel segment saw a 22% increase in total volumes, mainly driven by the reopening of nations and, therefore, the air travel industry. The land transportation segment posted a 17% increase in volumes, also driven by the opening of supply chains and pent-up demand across consumer verticals, creating the need for trucking supply and volumes.
Increased activity in their segments also translated to higher costs; regardless, the company generated pre-pandemic levels of earnings per share at $1.82, compared to a 2018 figure of $1.89. In 2018, gross margins were 2.6%, driven by the rapid decline of oil prices toward the end of the year. Despite having only a 1.8% gross margin in 2022, increased volumes and efficiency allowed the firm to buy back six hundred thousand shares and drive up the company's book value as well.
Having sustained increased levels of free cash flow since 2018, and showcasing operational strength and efficiency throughout the peak pandemic effects, management decided to start paying a $0.14 per share quarterly dividend. Investors would be well served by looking at the health of this dividend payout by comparing it to the levels of free cash flow. Based on a five-year average of free cash flow, this dividend payout represents only 27% of said cash balances.
However, based on the 2022 free cash flow, it represents a rather risky 59%. To sustain this dividend payout and continue share buybacks, management must ensure that volumes and/or margins remain consistently within the ranges experienced in the 2018-2022 period.
Given the current environments driving oil demand, such as China's reopening and global travel comebacks, the company may look at future periods of increased volumes and profitability. Looking at the net asset value (NAV), computed as total assets minus total debt divided by the amount of shares outstanding, World Fuel carries a NAV value of $112 per share, however, a reasonable margin of safety should be applied by investors knowing that a good amount (40%) of assets are derived from customer accounts receivable. Analysts agree with some of these views by assigning a 46% upside from current levels.