Nuclear Story with an Unexplosive End

How about a post-bankruptcy, spin-off monopoly today?

I came across Babcock & Wilcox (BWC) in this free issue of Grant’s Interest Rate Observer that has been making the rounds on Twitter (my handle is @DGenchev).  The story of a naval nuclear monopoly business with a hidden SMR (small modular reactor) gem is enticing.  But, the idea is definitely not one I would normally consider.  I guess this is a sign of the times.  Without further ado…

BWC is the only company able to build and service the naval nuclear reactors for the Navy’s nuclear propulsion program.  You don’t have to be nuclear physicist to realize this is a pretty good place to be.  Despite all the quirks of working for the government and all the talk about military budget cuts, BWS’s nuclear operations segment occupies a decently stable niche.  The product the company offers is highly sophisticated, there are few or no alternatives, and the client likely won’t bargain down to the last penny when negotiating nuclear reactor deals.  The nuclear submarines and aircraft carriers in which these reactors go have no substitutes and once built they can stay in service for over 50 years.  BWC is the only company that can service the reactors.

In addition, there is a free option on SMRs.  The more technically and energy minded may already be aware of the SMR hype.  They are the smaller, safer, cleaner, more reliable, more efficient, and a cheaper alternative to conventional nuclear power plants.  Here are some resources on the topic:

Here is what the article says about BWC’s SMR:

The design, called mPower, is a 180-megawatt, light-water unit only one-fifth to one-tenth the size of conventional reactors. No need to plant mPower near a big body of water: it’s designed to be cooled by air as well as by water. And no need to cart away the spent fuel: mPower’s can be stored on site. As to refueling, once every four years will suffice, compared to the standard 18 to 24 months for the kind of reactor that powers such legacy nukes as Indian Point Energy Center north of New York City or Calvert Cliffs Nuclear Power south of Annapolis.

As I said, this is the free option that you get when you buy the stock of BWC.  The first mPower is yet to be deployed.  The good news is that BWC was the only company to receive government funding to build a prototype.  No one else was eligible.

The bread-and-butter business of the company is boilers (where coal is turned into steam, which then turns a turbine that generates electricity) and filters (reducing the toxicity of emissions) for coal-fired power plants.  Coal use may be in decline (or so it has been claimed) and it may be the dirtiest energy source, but it still accounts for over 40% of US, and global, electricity generation and worldwide coal use is only increasing.  As a matter of fact, in 2011 coal was the fastest growing form of energy outside renewables.  Now, imagine the base of renewables and the base of coal and you get the picture.  Not only the increase in coal consumption is good for BWC, but also the fact that it is so dirty makes tight environmental protection standards inevitable, which bodes very well for the company.

I don’t know about you but I loved the story at first sight: a company with a solid foundation (the power generation segment, 54% of 2012 revenues), a strong moat business (the nuclear operations, 33%), plus a promising option thrown in (the nuclear energy segment, 10%).  Add a $250m share-buyback plan and the good stuff doesn’t seem to end.  Two things, however cooled my enthusiasm.

First, I don’t know much about coal-fired power plants and naval nuclear reactors.  I have to rely on the research of others for this.  So, my comfort about the company’s core business and its moat in naval nuclear reactors may be just a delusion.  Yet, I think that it is a safe bet, judging from history, that coal-fired power plants will be with us in the next 10, 20, 30 years.  I feel less strongly about naval nuclear reactors.  It is entirely possible that a disaster or a new technology renders them unlawful or obsolete at any time.  Still, BWC will continue servicing those installed reactors for a very long time.

Second, the current price, $31.41, seems to be well within the fair value range.  Here is what I base this on.

Sum of the Parts 3y avg EBITDA Multiple EV
Power generation             197 8.9         1,759
Nuclear operations             232 10.0         2,322
Technical services                59 0 0
Nuclear energy             (63) 0 0

I use average EBITDA over the past 3 years.  The multiple for the nuclear operations segment comes from the article while that for the power generation segment is the average for the power industry from Aswath Damodaran’s website.  The two small segments net out.

Net cash nearly covers adjusted pension and other post retirement obligations liability, so I take EV to equal the value to shareholders.  With 119m shares outstanding, this number translates to $34 per share.  That’s not much different from the current price.

Not a very exciting conclusion to a very interesting story.  That’s why I didn’t intend to make this a full article.  It’s more that I wanted to share the story but there you go.