Digging into Shipping

By Julian Murdoch

The Baltic Dry Index (previous articles: The Baltic Bet, 9/16/08 and Follow The Freight, 4/28/08) has taken a beating, as have shipping stocks. But are the two as directly linked as it seems? Or is it possible that shipping stocks, like so many commodities equities, could be undervalued right now?

The Baltic Dry Index (BDI) has lost an amazing 90% of its value since the beginning of the year, and is 93% off the highs of May and June.

As we explained in The Baltic Bet, shipping rates are tracked primarily by the Baltic Dry Index, a blending of the rates to ship bulk dry goods (largely ores and grain) on three different-sized boats on the four main shipping routes. The BDI gives you a good idea of what the spot price is for hiring a ship, and as such, serves as an indicator for supply and demand. The current low level of the index (and this, the spot price) tells you that demand for dry bulk vessels is unbelievably low. This means that somewhere there are lots of enormous ships lying around in ports. Either because there are literally no charters to be had, or more often, the day rate simply isn't high enough to even offset a voyage's expenses, much less turn a profit.

All the things that make a boat go cost money - crew salaries, provisions, lubrication costs - and no company wants to pay for a pleasure cruise when the vessel should be making money. It's worth pointing out that the pressures involved here aren't always easy to tease out from the shipping companies themselves. Eighty percent of the global dry bulk fleet is privately held, and according to Forbes, anecdotal rumors are supporting the idea that many of these private vessels are anchored, rather than operating at low spot rates.

It would stand to reason that shipping companies would be in dire straits with the BDI so low, and at first glance, the company / BDI tie looks dramatically connected.

OK, clear as mud. Normally I wouldn't comment on (or even post) an anti-Tufte mass of indecipherable lines like the one above, but it does illustrate one thing - while the companies trend up and down together, they live in an implied trading range where there's plenty of money to be made.

Making Money

Let's tease out a few companies.

Shipping companies charter their vessels out a few different ways - spot charters, time charters and "bareboat" charters. In both spot and time charters, the boat's owners are usually responsible for operating expenses such as crew costs, provisions, lubricating oil, insurance, maintenance, dry-docking and repairs. The difference is that in a spot charter, the owners are also responsible for any voyage expenses such as port fees and fuel costs, because a spot charter is generally limited to a specific voyage or delivery - take my wheat to China, stat! In a time charter, the boat owner doesn't care about the intended use. The person chartering the ship handles voyage expenses, because the contract is for a specified time period, which can be years in length. It's kind of like the difference between taking a cab downtown and renting your limo for the prom.

By contrast, a bareboat contract is like leasing a car. The charterer is responsible for all voyage expenses, on top of maintenance and other operational costs.

A company can have its boats out in any combination of these ways, depending on its corporate strategy. Historically, companies that are more exposed to the spot market can see their revenue fluctuate wildly. Many companies prefer to lock their fleet into time contracts and a more stable revenue stream, but contracts can be defaulted on, so there are no guarantees.

Because of the variation in mix of charter types each company can have, the industry has devised a way of comparing apples to apples. The time charter equivalent (TCE) is the average daily revenue performance of a vessel on a per-voyage basis. Companies divide operating revenues (minus voyage expenses and commissions) by operating days for a specific time period. This little miracle number allows you to look across companies and compare company performance despite changes in charter mix.

The other handy number the companies report is fleet utilization, a measure of how well a company is using its fleet. It is commonly calculated by dividing the number of operating days by available days during a specific period. "The shipping industry uses fleet utilization to measure a company's efficiency in finding suitable employment for its vessels and minimizing the number of days that its vessels are off-hire for reasons other than scheduled repairs or repairs under guarantee, vessel upgrades, special surveys or vessel positioning." (from Genco Shipping 3Q results)

With those tools in hand, let's take a look at some companies and see how they stack up. Here's a handy chart for easy comparison. The companies are sorted by size.

The key thing to note: As of Nov. 6, not all of the companies have reported their third-quarter earnings. Data for Diana Shipping, Euroseas, TBSI and OceanFreight is from the second quarter and may be higher or lower once third-quarter results are reported, so we've got a bit of a fruit mismatch here.

Diana Shipping

Diana Shipping (NYSE: DSX) is the largest company by market cap, and it's focused on time charters. The downside of this strategy is that they were unable to take advantage of the high spot rates of May and June, unless one of their time charters was up for renewal. The upside to this strategy is less exposure to the BDI's volatility. Here's that chart again.

DSX's stock price has managed to be less affected by BDI's nosedive than any other shipping company. Whether it's a function of size, strategy or reputation, DSX's stock lives inside the trading range for shipping stocks. Third-quarter results should show us how well this holds (Nov. 11).

DryShips

DryShips (NASDAQ:DRYS) has a different strategy than Diana Shipping, with only 54% to 59% of its fleet under time contracts with an average of five years remaining, according to information released with its third-quarter results. The rest of the fleet has been contracting on the spot market, which let them cash in a bit on the spot spike, but leaves it now vulnerable to the spot slump as the company looks around for new time charters at low-low prices.

DryShips has bought three vessels - two with delivery at end of this year and one to be delivered during the first quarter of next year. These vessels are already under time charter.

DryShips has also diversified into ultra-deep-water drillships as opposed to continuing to specialize in dry bulk, which is unusual in the industry, diversifying them further.

TBS International Limited

TBS International (NASDAQ: TBSI) - our chart outlier -  has a different strategy, and different results. Instead of concentrating on only supplying vessels for transport, TBSI concentrates on providing its clients with specialized services. It has an interesting fleet that is made up of 23 bulk carriers and 23 multipurpose tweendeckers - ships that can hold a variety of different types of cargo on one voyage. This gives TBSI lots of flexibility in the charters it goes after. A good article about the company was written by Zachary Scheidt and published on Seeking Alpha on November 4 - TBS International: Underwater, but not Sinking.

In its second-quarter earnings report, TBSI credits its business strategy for the ability to provide steady growth, independent of what is happening on the BDI. We'll see if that logic holds true when the company reports its third-quarter results on Nov. 6 after close of market.

Eagle Bulk

Eagle Bulk Shipping Inc. (NASDAQ: EGLE) released its third-quarter earnings Nov. 5 after close of market. Analysts had been predicting earnings of 44 cents per share and a 41% increase in revenue. Reality was a bit better, with earnings coming in at 49 cents per share and a 50% increase in revenue. The thing to watch with this company is that it currently has 34 contracts for new vessels to be built with delivery dates ranging from 2008 to 2012. Fine and dandy, provided the financing is in place and charters can be found for each vessel as it rolls off the assembly line. So far so good - when the company took delivery of its latest vessel, the Wren, it immediately commenced a charter that will see it busy until at least December 2018.

Euroseas

Euroseas Ltd. (NASDAQ: ESEA) operates five dry bulk vessels, 10 container vessels and one multipurpose dry cargo vessel. The dry bulk vessels are fairly old, with an average age of 21.4 years. In the second-quarter earnings report, 80% of the fleet was "fixed under period charters, already concluded spot charters, or, otherwise protected from market fluctuations." That number drops to 34% for 2009. The same report put three of the five dry bulk vessels under time charter only until the end of this year or beginning of next, with no time charter after January 2009. The remaining two vessels are at spot.

Excel Maritime Carriers

Excel Maritime Carriers (NYSE: EXM) is another company that reported third-quarter results Nov. 5. After a recent merger with Quintana, completed in April, EXM controls a fleet of 47 vessels. This is a company that has a mix of time charter and spot charters. For the remainder of 2008, 85% of its fleet is under time charter. That level goes down to 61% for 2009 - leaving it more vulnerable to the current low spot rates the industry is experiencing. Regarding new ships coming on line, Excel expects that only four of the eight ships currently under new building contracts will be delivered. The other four are new building contracts in which the company owns 50% interest, that Excel does not expect to take delivery on. Tough times to be a shipbuilder.

Genco Shipping

Genco Shipping & Trading Ltd. (NYSE: GNK) reported third-quarter earnings on Oct. 30. Its fleet comprises 31 vessels, and the company was expecting 10 new builds to be delivered in the first quarter of 2009. But things change fast, and on Nov. 4, Genco announced it had cancelled six vessels in order to increase liquidity during this market environment. Even tougher times to be a shipbuilder.

OceanFreight

OceanFreight's (NASDAQ: OCNF) fleet of 13 vessels includes nine dry bulk vessels and four tankers. Its second-quarter earnings data shows 97% of the fleet on time charters for the rest of 2008. 2009 drops to 84% on time charter and to 60% for 2010. With staggered charter renews, the average remaining duration is 2.3 years.

Safe Bulkers

Safe Bulkers (NYSE: SB) is another company that is rapidly increasing its fleet. It currently has 11 vessels (average age 3.37 years), with an additional nine more coming online by mid-2010, according to data from its second-quarter report. We'll see when they report earnings whether they plan on keeping their orders in. So far it looks like they will: The company has bank credit facilities in place for the new vessels coming on line, and several incoming ships are already under long-term time charters that begin as soon as they hit the water. For the rest of the fleet, the remainder of 2008 is covered by time charter. 2009 has 87% of the fleet under contract and 66% under contract for 2010. Safe indeed.

Conclusion

What's the point of the laundry list?

Yes, shipping companies' fortunes are tied to the BDI, but indirectly. The important thing to understand when taking your deeper look at any one of these companies (or indeed, any commodity company) is how these pick-and-shovel players are hedging their business. The revenues for the most hedged - those on 100% time charter - are fairly stable and predictable, living in the middle of the shipper trading range. And that can, but doesn't necessarily, have a bearing on the price of their stock on any given day. On the other hand, companies relying on spot charters will need to do some fancy financial footwork to stay in business if the BDI stays this low.

Extra

If the lull in price continues too long, owners of older ships look at selling ships for scrap metal - an ugly option that's currently even uglier, because scrap metal prices are so depressed. The other option is to sell ships on the secondhand market, but there has been little-to-no activity there, with brokerage companies feeling the effect of the credit crisis. And without this activity in the used ship market, banks have no way to value the market price for ships. During DryShips' recent conference call, the remark was made that at this point, only companies that are actually heading for insolvency will sell their vessels, and it hasn't happened much yet. But it may just be a matter of time. Britannia Bulk, a dry bulk company that operates in the Baltic, has been delisted from the NYSE and is living under the umbrella of the Insolvency Act 1986 of England and Wales.

Comments

[James Wilson:]

If EGLE hits $6 I am selling everything and putting all my eggs in their basket . Then I would never look back.

2008 Nov 06 03:55 PM

[buyforeclos...:]

so do we get our feet wet in shipping after the massive sell off or wait and see? Who has the best balance seet?

2008 Nov 06 07:37 PM

[Steven Hansen:]

thank you for some good work. this is the shake out period - and the longer the economic downturn continues, the more shippers which will fail. i am sitting on the singapore straits, and the amount of vessels sitting here has been growing for the last 6 months. not only are the owners not getting a return on capital, but they still have generators running and crew to pay.

if my memory serves me correct, there are also a lot of bulk carriers under construction also. this is not good.

2008 Nov 06 10:12 PM

[PeteK:]

Be the fittest survive.
To my knowledge, crewmembers are very
loyal to their employers. Good for business.

2008 Nov 07 12:51 AM

[Boubou:]

Although tanker rates have been relatively stable compared to bdi, crude and product tankers have been decimated anyway. This may be an exploitable anomoly.
I am trying to shuffle from dry to tankers for similar dividends and earlier recovery.
I am often wrong.

2008 Nov 07 09:33 AM

[oilsands:]

Thanks for the excellent and thorough analysis. The companies you reviewed are predominantly long term charter, but it looks like the market is treating them as if they are mostly daily rate charters.

Boubou's comments are interesting. Which shippers do oil?

We have stock in DSX, OCNF, FRO and SFL. I watch many other shippers closely, esp DRYS , EGLE, and ONAV.

2008 Nov 07 11:17 AM

[Shabba:]

The stock prices for these type of companies are just ridiculous, DRYS is trading at 70% of last year's earnings. They just reported too, and only missed by 2%. They made about 3.50 a share. The stock is about 15 a share. Yes yes I know, the BDI is low rates are terrible. There is no way it can continue, what, are people not going to eat and import goods?

It's just a big game for the players in the market, let's see how low we can drive shares, cover our shorts, and then hopefully time the bottom correclty. It seems the entire market has completely stopped trading on fundamentals. It's all a mass panic.

2008 Nov 07 11:37 AM

[User 293622:]

It looks like it is very bad and yet they are beating revenue estimates and earnigs estimates. I thing that stock such as DRYS is a bargain at $14

2008 Nov 07 01:48 PM

[SoCalsurfbum:]

Shabba,

You are missing the bigger picture. Ships are expensive capital intensive machines that require a certain utilization rate and pricing in order to cover their "mortgage" with positive cash flow. If they don't get the capacity utilization or pricing, the companies start burning equity at a very rapid rate. Having a ship sitting idle exacerbates this problem. Combine that with the massive amount of new capacity that has come online and is coming, while demand is dropping... and you have a lot of shipping companies with negative cash flow from operations.

I would wait and see who buys the ships when shipping lines go bankrupt (as they always do in these cycles) and buy their stock then. These lines have about as much transparency as Lehman Bros. but with a lot higher fixed costs.

By the way, the fact that they need the cash flow to try to cover some of their loan payments/cash flow problem is why you know that what Forbes rumor about ships being anchored intentionally is wrong. That would be very counter-productive for the companies.

2008 Nov 07 02:07 PM

[Shabba:]

That's true, their is a significant "burn-rate" for these things. They're extremely expensive. It still looks like massive panic to me though based on the total collapse of the spot prices in such a short period of time (down about 80% in 2 months, and close to 95% from the bubbilicous highs). There really isn't anything to explain this on fundamentals. It just seems incredible to me that supply/demand for shipping dry freight could change that much in such a short period of time, especially for a company the size of dryships.

2008 Nov 07 02:21 PM

[notsosmart:]

maybe its less but oil still has to be moved.nobody has figured out a way to pave over the ocean.FRO & NAT are names you might want to check out.i have no agenda here.i own these stocks & have done well.

2008 Nov 07 03:04 PM

[whoknows:]

good analytical overview, DRYS really is in a unique position among the bunch having diversified into the UDW drillships, they recently announced a 5-yr fixture of $640k-$650k/day, even with some spot exposure on the dry bulk side that's alot of cash flow/liquidity to help withstand the current 'storm'

2008 Nov 07 03:35 PM

[Tim McPartland:]

A couple of random items here. Time charters are not worth much if the company that has chartered the vessels has gone bankrupt--and a number of them have already. And secondly most of the covenants of the loans on these ships have a provision that would put companies in dafault if their asset value falls below a certain percentage of carrying value--meaning they would need to put up more money to stay out of default. Anecdotal evidence is that ships are now selling at 55% of book

2008 Nov 08 07:12 PM

[PeteK:]

EGLE & EXM are good companies.
Very stable and well run business.
Own them for good dividends.

2008 Nov 08 07:37 PM

[Dividends A...:]

One company you forgot to mention was SSW. They lease the ships to the bulk carriers and are therefore less exposed to volume as contracts are binding and cost prohibitive to cancel. It also pays a very attractive & sustainable dividend.

2008 Nov 09 01:14 PM