World Fuel Services is one of the stocks in our Dream Team and therefore could be a stock our clients own in their Emperor portfolios. They are a leading global fuel services company principally engaged in fuel distribution to airports & airlines, retail fuel stations, seaborne shipping companies, NATO, & U.S. & foreign governments. They have some others, but these are currently their core businesses.

The company went public in 1984 as International Recovery Corporation and subsequently acquired Trans-Tec in 1995. Along with Trans Tec came its two founders, Paul Stebbins and Michael Kasbar. Paul Stebbins then served as CEO from 2002 to 2012 and Michael Kasbar subsequently took over as CEO in 2012 and is still the CEO as of today.

Under Paul Stebbins tenure, World Fuel Services grew revenue and earnings from $1.4 billion and $17 million in 2002, to almost $35 billion and $194 million by the time he left in early 2012. This equated to a compounded growth rate of earnings of almost 31%. World Fuel Services was then featured in fortune magazine under the headline “The only fortune 500 company that’s grown faster than Apple”1. What has happened since then? Has World Fuel Services continued to compounded earnings at high growth rates?

Given only the information above, you would have been inclined to say it will probably compound earnings at a high growth rate. Unfortunately, the outcome was the opposite, and over the next 6 years, pre-tax adjusted earnings has gone from $238 million in 2011, to $147.1 million2 in 2017. This equates to a compounded loss of earnings of 7.7% per year. So, what happened?

To answer this question, we  need to understand the economics of the business Рso let’s get started. World Fuel Services relies on three main factors which determine the earnings of their three segments:

1. Underwriting fees from hedging oil prices and delivery dates for clients

The period since the collapse of oil prices has been less volatile than previous periods such as from 2007 to 2010. This has led to a decrease in the quantity of hedging contracts demand by their customers.

2. Spread between the purchase price of processed petroleum products3 and the sale price to customers

It is hard to increase the spread as this is a competitive market and unusually large profits would invite more competitors to enter. This would decrease the spreads as competitors would undercut each other. In addition, NATO and government customers are more profitable, so they offer a higher spread than private enterprise.

3. Volume of fuel sold

Volume sold increases due to either increased use of fuel by World Fuel Services’ current clients and/or market share gains against their competitors.

We conclude that volume of fuels sold, the spread (including the customer base), and the fees earned on hedging some of these contracts are the main drivers of World Fuel Services’ earnings. This minus the operating costs gives us the money the company makes before interest and taxes. Therefore, it is critical that they have a good handle on their costs. The table below provides snapshot of some important figures:

Clearly, the marine and land segments are struggling while the aviation segment is thriving. The rise in unallocated expenses is notable as well as financing costs which are not included but totaled $61 million in 2017. What happened over that time to cause such negative results?

    1. Shipping freight rates have been hitting an all time low in 2016 for dry bulk and container ships7. This is due to an imbalance between supply and demand as shipping companies projected continued expansion in trade flows and seaborne trade approximating the pre-financial crisis level. This has not been the case as trade-GDP elasticity has decreased from 1.3 in the 2000s to 0.7 from 2008 to 2013. The growth in seaborne trade since 2015 has been well below the historical 3% growth in average seaborne traded recorded over the last 4 decades. This has caused a lot of stress on shipping companies with the collective operating loss reported by the container industry amounting to roughly $3.5 billion in 2016. The effect of this is two-fold:
      1. Low freight rates made slow steaming economically attractive which has led to a decrease in bunker used per trip8. This has lowered the volume of fuel consumed per trip therefore the volume of fuel sold by World Fuel Services per trip.
      2. Industry consolidation which is giving fuel buyers more bargaining power and more sophistication. More sophisticated buyers can source straight from the oil majors instead of relying on fuel re-sellers such as World Fuel Services. In addition, buyers have more information on fuel pricing in different ports and arranging fuel delivery. The industry which comprised 20 large scale international carriers has decreased to 17 by the end of 2016. These 17 carriers controlled 81.2% of global liner capacity compared to 83.7% controlled by the 20 main carriers a year earlier. The number has gone down further with a new series of acquisitions concluded in 2017. In addition to M&A, shipping lines have undergone a transformation by reshuffling existing alliances and creating new ones. The top 10 carriers joined forces in 3 global alliances down from 4 at the beginning of 2016. Bunkers represent 60 to 80% of the cost of a voyage and up to 50 to 60%9 of total ship operating costs. Therefore, there is massive pressure to get the best price for bunkers, especially when the shipping companies are losing As a result, this has pressured the spread commanded by World Fuel Services.
    2. The internet is starting to affect shipping and that is having a negative effect on World Fuel Services’ marine segment and traditional business model. Shipping is an industry that is notoriously difficult to change, and prices used to be opaque between ports so that World Fuel Services used to do price discovery for the shipping companies. The advent of online platforms like Clearlynx is eroding that pillar of World Fuel Services’ traditional business model. The barriers to entry in recent years have gone down across all of World Fuel Services traditional businesses due to the power of the internet. Therefore, this is also challenging the spread commanded by World Fuel Services.
    3. Traditional fueling for ships is labor and time intensive. There is also widespread fraud in the quantity of bunkers quoted for sale and the actual quantity sold. The quoted quantity is typically greater than the actual quantity fueled as the suppliers of fuel dilute their bunkers to make more This along with the labor required to fuel a ship has been a positive for World Fuel Services as they have more specialized knowledge of the fuel suppliers at given ports. Faulty bunker fuel damages ships and is a widespread problem in the industry. Additionally, different ships use different blends of fuels. In recent years however there has been a big push to adopt Mass-Flow-Meters (MFM) which measures the quantity of fuel supplied automatically as well as the quality of fuel. Singapore, which is the second busiest port in the world, has adopted MFM starting January 2017. Fuel quality variance using MFM is estimated at a max of 0.5%, lower than the traditional sounding tape method of up to 0.7%. MFM also results in time savings and quicker bunker turnaround without the need to expand port capacity. This means that it will likely be adopted by all ports and is in the process of being adopted by several other ports already. This increased transparency threatens World Fuel Services traditional business model as it relies on opacity to provide its specialized knowledge.
    4. The shipping industry is going through tremendous change with the adoption of 0.5% sulfur content fuel as required starting 2020. Current Bunkers contains 3.5% sulfur and not enough of the shipping fleet have ordered and installed scrubbers to use traditional bunkers10 or ordered LNG burning ships. The alternative to bunker 6 is marine gas oil (MGO) which is more expensive. Nobody can tell what will happen come 2020 in terms of which fuels will be consumed and no one knows how the entire shipping fleet will become compliant so there is a lot of uncertainty. The effect on World Fuel Services is hard to discern, but I believe it will most likely be positive.

The above factors indicate that the marine segment might be experiencing a secular decline instead of a temporary setback. This has been the cause of much of World Fuel’s decline in earnings in recent years. The good news is that it doesn’t look likely that the marine segment’s earnings will decline much further and if it does it is close to zero. The land segment is under some pressure as well but not to the same extent as marine, and the aviation segment is doing quite well.

World Fuel Services contracts with airports around the world to broker and arrange fuel shipments from fuel producers to airports. It also has some government contracts in that segment which are sticky and have higher margins. World Fuel provides fuel management services to ground handlers at airports and are trying to expand into ground handling themselves. Passenger traffic has historically grown by 5% and is expected to grow between 4.5% to 5.5% driven by the decreasing price of travel relative to real income. Efficiency gains in fuel consumption should be around 0.5% to 1% per year and overall growth should be around 4% to 5% in terms of volume.

Income from operations year to date indicate a stabilization in the marine segment, continued strength in the aviation segment, and continued pressure in the land segment. Additionally, World Fuel Services’ assets are capital light.

I estimate pre-tax and interest earning power to be around $25011 million for the current year based on the above analysis. Interest costs are approximately $60 million, and the corporate tax rate is 21%. After tax earnings available to shareholders should be around $150 million per year. A reasonable return on this investment should be somewhere around 8% given a higher net debt load of roughly 2.5x its earning power and some uncertainty about our earning power estimate. This is also the case given current earning yields on utility companies of approximately 5% to 6% with minimal uncertainty about their earning power. This translates to a valuation of roughly $1.9 billion for the equity. World Fuel Services is currently valued at roughly $1.9 bn; if we consider their debt12 then World Fuel Services is valued at 10x EV/EBIT13 which is a reasonable valuation. This analysis assumes the land, marine, and  aviation segments will perform as they have done in 2017.

1 –

2 РNote: This is adjusted for goodwill and restructuring charges as well as excess financing charges. These adjustments require a lot of judgement on the part of the analyst to discern whether there will be further charges that will require a cash outlay from the business or not. These charges reflect the fact that money that could have been returned to shareholders as a dividend in the past has instead been reinvested in the business and those were bad investments. They are an indication of management’s capital allocation decisions and outcomes.

3 – Examples of processed petroleum products includes bunkers for ships & jet fuel for airplanes

4 – Adjusted for impairment of goodwill & restructuring charges

5 – Adjusted for restructuring charges of roughly $52 million

6 – This excludes financing costs

7 –

8 – Bunkers is the term used for super heavy oil used by ships. Slow steaming is intentionally slowing down your ship to save on fuel costs. This is attractive when freight rates are low and oil prices are high. It can still be attractive at low oil prices if freight rates are low enough. This is currently the case:

9 –

10 – Known as bunker 6

11 – 5% growth in aviation segment, flat marine and land segments, add back $40 million in intangible amortization

12 РRoughly $580 million in net debt (long term debt + current maturities of long-term debt – cash)

13 – Enterprise value is the market value of the equity + net debt, we are also using the adjusted EBIT from above

Forward Looking Disclosure

Certain statements that we make above may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning future strategic objectives, business prospects, anticipated savings, financial results (including expenses, earnings, liquidity, cash flow and capital expenditures), industry or market conditions, demand for and pricing of our products, acquisitions and divestitures, anticipated results of litigation and regulatory developments or general economic conditions. In addition, words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “projects,” “forecasts,” and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” as well as any other statement that necessarily depends on future events, are intended to identify forward-looking statements. Accordingly, these statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Forward-looking statements are not guarantees, and they involve risks, uncertainties and assumptions. Although we make such statements based on assumptions that we believe to be reasonable, there can be no assurance that actual results will not differ materially from those expressed in the forward- looking statements. Our actual results could differ materially from those anticipated in such forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks described in any filings with the Securities and Exchange Commission from time to time, including the company’s most recent Annual Report on Form 10-K and subsequent Forms 10-Q, which are available on the SEC‚Äôs website at We expressly disclaim any obligation to update any forward-looking statement in the event it later turns out to be inaccurate, whether as a result of new information, future events or otherwise.