Staying Afloat: A Primer on the Shipping Industry 22 comments
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When I’m looking at the shipping companies, I have four important factors (you could call them business decisions) that make a big difference in how the stocks will trade. Let me list them for you and then we will break them out.
- Capital Funding – Does the company use debt, equity, or internal cash to bankroll its growth?
- Customer Contracts – What type of long-term or short-term agreements are in place for each ship owned?
- Dividends – What are the quarterly payments? Is this a fixed dividend or does it fluctuate from quarter to quarter?
- Vessel Type – Does the company own mega freighters? Nimble smaller ships? In-between, or an assortment?
Capital Funding
Now I could bore you to tears with a discussion of debt ratios and funding strategies, but the only thing you really need to know is “how do they pay for their ships?”
For instance, Diana Shipping Inc. (DSX) has committed to shareholders to keep a low debt level. So while it may draw on a line of credit to initially purchase a new (or used) ship, historically it has very quickly paid down that debt by issuing new shares to the public and using the proceeds to retire debt.
Now this type of strategy periodically dilutes shareholders. So if you owned 10% of the company and it 1) bought a new ship and 2) sold stock to pay for it, you might now only own 8% of the company. But it’s a bigger company now that it has another ship so shareholders still do well.
On the other side of the spectrum we have Genco Shipping & Trading Limited (GNK). The company has huge levels of debt because it has decided not to dilute shareholders by selling additional stock. Instead, when Genco purchases a new ship, it takes out a loan and then uses the cash flow from that ship to service that debt.
Genco’s approach is much more aggressive, and in a thriving economy that makes a lot of sense. Genco could enjoy a very attractive revenue stream and after paying the interest on the debt, there was still a large amount of income left over. But on a percentage basis, this stock has dropped more than some of its peers this summer. The high debt level increases the risk because if the ships are not able to produce as much income, the huge debt level becomes a problem.
So in this particular environment, a conservative approach (low amounts of debt) have served shippers well. But if and when we make the turn and shipping rates rebound, then the more leveraged plays will turn out to be the winners again
Customer Contracts
Moving on to the second metric, shippers must decide whether to lock in long-term contracts with their customers, or to take the going rate on a day-by-day basis. This is sort of like choosing a variable rate savings account or a fixed CD. If rates go higher, then you will make more money with a variable rate. But when rates drop as they have with the dry bulk day rates, then it looks much smarter to be holding a fixed rate contract.
There is a particular company that I have been watching closely which has decided against entering into long-term contracts with customers. It may sound like a stupid decision today with rates at all time lows, but back in October of 2007 and again in May of this year, the stock was a huge winner. Similar to a gold mining company that doesn’t hedge its production, this stock rises and falls with the prices of shipping rates.
In the publication Death Cross Trader we are looking closely at this company and will likely take a position in the near future. Even though the stock has been beaten down more than its peers over the last six months, business decisions have put the company in a unique situation that leverages any improvement we see when demand for shipping goods picks back up
Dividends
Imagine picking up a stock that will pay you back your full purchase price every two years. On top of that, you get to keep the stock which could grow by 30, 50, 100% or much more in the next 12 months.
Just a cursory overview of the stocks in the shipping industry will reveal a couple of names with dividend yields of 50% or more. If you are willing to take a dividend yield of 35% or more, you have at least a half dozen shipping stocks to choose from. Now not all of these opportunities will pay off and each of these companies have their own unique set of circumstances.
Many shipping companies have a dividend policy that requires them to pay out a portion of each quarter's earnings in the form of a dividend. I’ve had professors debate the merits of this strategy, and Warren Buffett is notorious for his commitment to NOT paying a dividend. But we will put all the academics aside for right now and look at the situation from your perspective – the perspective of the investor.
If you own a stock that is paying you a quarterly dividend, you are likely to be a more loyal shareholder. Sure, you hate to see stocks that you own decline – no one likes that. But if you are getting paid a nice sum while you wait for the stock to come back around, you are likely to be a little more comfortable.
Many of the shipping stocks that pay a dividend are trading at levels so low, that the dividend is huge compared to the price of the stock. For kicks and giggles, pull up the following tickers: ESEA, DSX, GNK, EXM, EGLE… You will see that all of these (and more that I haven’t mentioned) pay huge dividends relative to the stock price.
Now before you go buying a bunch of these names, let me tell you there is a REASON that these stocks are so low. There is a significant amount of fear that these companies will either cut the dividends or go out of business altogether. So you should certainly do your homework before jumping into any investment, but I can tell you there are some attractive bargains out there.
Vessel Type
The last issue I will point out is a company’s decision as to what type of vessel it will purchase. While larger ships are typically more efficient per dead weight ton of cargo, smaller ships offer the flexibility of being able to navigate particular passageways and ports. Some smaller ships also feature their own cranes for loading and unloading cargo. This is an important feature if the vessel will be accessing remote ports with less equipment.
Eagle Bulk Shipping Inc. (EGLE) has made the decision to concentrate on smaller ships. While I have issues with other decisions that the managers have made, the decision to stick with a fleet of more flexible vessels has probably kept the company afloat (pardon the pun). While larger ships are struggling to find customers that can fill the mammoth holds, Eagle is able to take an assortment of smaller commissions and still manage a profit.
Age is another important factor which plays into the mix. Cargo ships (much like airliners) often have a useful life of 20 years or more before they require expensive refurbishing or are turned to scrap. With the current global fleet becoming much older as an average, companies are trying to stretch out the service life of each vehicle.
One particular stock that I am watching has made the decision to purchase old decrepit ships from its competition. Management wagers that they will be able to use their expertise to keep the ship in service longer than peers would be able to – thus creating more value out of an older ship than the seller would have gotten.
One key assumption going into this argument was the price of steel. Once a ship is no longer efficient to operate, the only option may be to sell it to the scrap-yard which pays based on the value of the metal. However, now that scrap prices are so low, this stock has been hurt from all sides. The stock has been driven down to such a level that we are paying pennies on the dollar just for the ships. The nice thing about owning this company is that a pickup in either the price of steel – or in the shipping rates, would have a dramatically positive effect on the value of this company. Its nice to have the potential for more than one catalyst to propel the stock.
So in conclusion, there is quite a bit of opportunity in the shipping sector if you know where to look for it. Low debt levels, long-term contracts and high dividends usually lead to a more stable stock. But in this topsy turvey market, we might actually find more opportunity by looking on the opposite side of this metric in the coming months. I will be sure to keep you updated both in ZachStocks discussions as well as through my writing for Taipan and Death Cross Trader.
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This article has 22 comments:
Funny how the OPEC took so many billions out of the worlds economy then people stop buying extras isn't it. People are tired of being screwed over and realize they don't need all these toys.
But your point is good in that as the world economy suffers, countries like China will be less likely to import as much in the way of resources. This is what has driven these stocks so much lower. However, my contention is that the stocks fully (and some more than fully) account for the softening environment and will offer great investments during the next 12 to 18 months.
Thanks much for your comment!
Zach
zachstocks.com
TBSI is a true wildcard. The company has very few long-term contracts with customers and as such will see earnings decline sharply next year. The debt level is high enough to cause concern. However, the stock price is already so low that it would be very risky to short. In fact, I believe the stock represents a "call option" in that you have a good chance of losing your entire investment, but if rates pick up or the company pulls through, you would likely earn a geometric return on capital.
Hope this helps,
Zach
zachstocks.com
I have a family that I need to provide for and I'm sure you have financial responsibilities as well. It is my firm belief that ZachStocks will never thrive if it does not provide helpful and relevant information to readers and so I try to make sure content is of the highest quality. But I will keep your thoughts in mind as I seek ways to make this (and my other ventures) worthwhile to every reader.
Thanks for your opinion - I truly do appreciate both positive and negative feedback.
Zach
zachstocks.com
First, as a generality, the problems in the dry bulk and container sub-sectors are primarily caused by the inability of shippers to obtain LCs for their cargoes due to the unwillingness of banks to issue LCs. At one point recently there were 65 dry bulk vessels sitting offshore Lagos, Nigeria unable to unload their cargoes due to lack of financing, and there are many many more that can't even load their cargoes because of lack of LC financing. That, in my opinion, is what has caused the precipitous decline in the Baltic Dry Index, which has fallen by 95% in a matter on a few months, and the equally steep fall in Forward Freight Agreements which have been shorted by dealers in London and elsewhere.
In terms of other ship owning companies, perhaps the highest quality company is Sea Span, a container company with 34 ships on the water (all chartered for an average of seven years with the first charter not expiring for five years) and another 34 vessels under construction at reliable yards (all chartered for 11 years starting with the delivery of the vessel). It's charter parties are of the highest caliber, including two controlled by the Chinese government, and two that have been around for 100 years or more, during bad as well as good time. Sea Span pays $1.90 in dividends and sell for under $7. The issue here is that by 2011 it needs to raise between $600 to $900 million to pay for vessels under construction and has said that they are not planning on issuing new equity at least for two years. The necessary funds can be raised by using about 15 free and clear ships as collateral, or by joint ventures, or by sale-leasebacks, or by raising funds from the controlling family on a class of shares subordinate to dividends to the common shareholders. Management is absolutely high class.
Similarly Ship Finance International Limited is another class act. It has 70 ships, mostly double hull crude tankers of various sizes, 45 of which are chartered to Frontline on long term charters with a profit sharing component (Frontline has made substantial profits in the past but that is coming to an end at least temporarily since its leased vessels are chartered on a spot rather than a time basis, and while the tanker market has been more stable than the dry bulk market it has declined enough so that Frontline had to cut its dividend). Ship Finance also owns and leases out a chemical tanker, several dry bulk ships, several container ships, and jack-up rigs, drill ships and deep water (semi submersible) drilling rigs. Ship Finance just increased its annual dividend to $2.40 and sells for under $10.
In the dry bulk sector, Safe Bulkers went public in June. It has 11 very modern, new vessels on three to five year charters, and its $1.90 dividend seems safe through 2009 at least. Its time charters will provide adequate cash flow for its dividend in 2009 and it has just closed a $90 million loan which (together with about $60 million cash flow after paying the dividend) is more than enough for its $84 million capex requirements for 2009. However, it does need to raise additional capital in 2010 for payment of newbuilds now under construction.
There are many other interesting companies to look at here but all require nerves of steel, as do the above for that matter.
will kick start with raw materials first, being transported by dry cargoships. Food, like for zimbabwe maybee earlier. Then comes
infrastructure and coal, steel etc again dry cargoe. before the con
sumerproducts fire in 2010/11 the shiping rates will have recovered
partly. Here comes now the right fleet and good org. management.
Then maybee shares will recover and divs will be covered.
I like EXM and just received my dividend and no sign yet of it being changed. According to the CEO of Excel Maritime, they pre-planned for just what is happening currently in shipping. Their acquisition of Quintana has been accretive to net earnings and has more than doubled their dry bulk fleet. Even if they were to cut the dividend by half, it is worth the wait for a couple or more years.
On Dec 07 03:18 PM biomedlives wrote:
> Hasn't DSX already announced that it will suspend its dividend after
> this month, with no indication of when it will resume paying one?
The temptation to purchase dry bulk shares is huge given their low low price (and just look at the massive increases seen today) however as Zach says 'there is a reason these shares are so low'. Dividends may well be scrapped and/or the companies could go out of business. Bear in mind that a fleet of bulkcarriers worth US$2 billiion six months ago may be worth around $500 million today; and that a ship today (and for the foreseeable future) is unable to generate sufficient income to pay its own running costs yet alone service management overhead and debt (in some companies, very considerable debt). So any shipping company that has first class (define first class!!) forward contracts and relatively low debt is probably a safe bet. For the rest I go along with Elliot - you need nerves of steel.
The other thing the author needs to familiarize himself with is that the companies that are going broke are not the GSK's, DSX, EGLE or for that matter DRYS, because they all have long term charter deals signed for the next year at least, for the vast majority of their vessels and these contracts were signed a year ago - AND they all report none of their customers have asked to re-open those contracts, so they do have a steady income stream. The shipers that are going out of business are the spot traders - they companies who charter their ships for one voyage at a time. When the BDI ( Baltic Drybulk Index ) was high, these guys were making out like bandits while the DSX's , EGLE's and GNK"s of the world were getting nailed for chartering their ships longterm at much lower rates. In the end - who was the wiser ??? That is when DRYS switched over from a spot trader to a company whom relies on long term contracts.
In case you missed it - the Chinese and the ore producers just today annonced that they will begin the 2009 negoitiations for the iron ore contracts early this year (January instead of April). The ore producers have been slammed by the Chinese virtually shutting down steel production. Vale's attempt to introduce a 10% price increase in the miiddle of the 2008 contract backfired badly on them and the rumors were that they were offering to ship ore to China for free and without the 10% increase to get production going again. The Chinese were smart. They just stopped buying ore and then the economic crisis hit the rest of the world All they did was sit and wait and watch the price of shipping goods and the raw materials themselves fall because the Chinese ARE THE MARKET. If they buy to much, prices rise, if the don't buy at all, prices fall. They have come to terms with that and they will act accordingly - as will the ore miners and shipowners. It was feast time for awhile, but the famine has been long and hard.
On the news of the possibilty of early ore negotiations, the Drybulk shipers stock all went up today by about 15% - 20% in most cases. Whether China exports toys to the USA or anywhere else has zero to do with Drybulk rates. China's steel will be for internal consumption only as part of the $ 500 billion dollar stimulus package they announced a month ago. They need to rebuild the Provence damaged by the devastating earthquake a year ago, and they have announced thousands of miles of new railway construction. As well - they have annouced that they will be building, over the next 20 years, over 100 new cities - cities that today do not exist, each city with a population of over 1 miilion people. To do that, they will need steel and concrete - the 2 main staples carried by Drybulk shippers.
I now own GNK and I have for a year now. I have taken a bath on it with the market decline, but lets also remember that this sector was hammered by short selling all summer. I have also owned and highly recommend EGLE ( the author is correct about them - they concentrate on smaller ships and they ply the India trade - moving goods form one side of India to the other as India does not have the railroad capacity to do this work). I also like and have owned DSX as well, but why hold them if you do not get dividend payments. I research Drybulk every day - and I would never consider selling because - my dividend yield right now is huge ( and yes they will cut that dividend if the stock price does not improve - but it will still be an attractive dividend even then), and this market will take off. It has zero to do with the USA and the global economy. The Chinese economy is expected to grow by 7 % next year - they have to - if not they have civil unrest, so the government is forced to keep the population working. They will need steel and cement - and that means they will need Drybulk ships. Because many of the new ships that were suposed to enter the sysyem in '09 and '10 have not been constructed, their will still be a shortage of ships and rates will rise again. When they do - the stock prices will rise as fast as they fell. They may not hit the highs of last May, but they will certainly rise. I am ready for the ride. I hope this helps many of you and I am not trying to sell a subscription to anything.
I am don't care about your children, just mine. So, what am I supposed to do?
Thanks for lots of words and no content.
RR
What do we expect? For people to spend hours of their finite lives poring over SEC documents just to post their work online for the benefit of anonymous internet users? We need to accept that everyone has an agenda, and that everyone has to make a living, and to not naively expect some benevolent amateur to do quality work for us for free and then post it online. Be skeptical, but at least appreciate that the information in a good article took hours to produce, yet is being provided to you for free. Again, no comment on the quality of this particular article.
As everyone above is rightfully pointing out, there are many issues which play into the prices of these shipping companies - much more than can be covered in one article.
The fact remains that many opportunities in the next six to twelve months will come out of this sector, so it bears close watch.
Lively discussion and analytical debate certainly make us all sharper and better investors so I appreciate each of your insights and questions.
Zach
zachstocks.com
Call me crazy, but I really don't see why someone would say stick with DSX and go short on Genko. All things being equal, balance sheet vs. long term charter contracts, don't see Diana being a superior play.
Then again, Navios Maritime is my favorite in the sector. NM managed a dividend, although 30% less than previous quarter - after Diana suspended theirs entirely the week prior.
1 YR EPS for NM +24%, DSX - 16% That's NEGATIVE 16% EPS. Most are negative forecast - exceptions being small but mighty EGLE with an EPS of 34% & Starbulk (SBLK) at a whopping 110%.
And yeah, my powder was already all wet when OCNF was driven down so low as to have a dividend yield of 104% this past week. Day late, several thousand dollars short.
I just picked up a mixed lot of 4000 shares recently, all under $10 a share, about half under $5 a share. Felt pretty good day before yesterday... now, eh, the warm fuzzy feeling seems to have disappeared for the moment.
I get a little seasick when the price goes down a few dollars, so can't imagine how those of you who bought in last year are feeling right now. Sorry, but on typical sell off down days like today, at least those of you needing a write off can sell at a huge loss & buy right back in (or hopefully a few dollars cheaper) for the tax advantage.
With growth in China and elsewhere to a lesser extent, a modest uptick in commodity prices, the eventual unfreezing of credit & the certainly that crude ( even if oil hits $25/barrel it has to be transported ) grain, food & steel will have to get from this point to that, especially with government backed infrastructure programs - which will guarantee an increase in the price of iron ore, steel, etc.
I think most finance companies will grant extentions to any shippers in breach of covenants rather than taking action that would guarantee the creditor huge losses. I can't see the BDI staying in the basement too much longer.
Planning on moderate term plays of 50% of the positions, unloading half when they double or triple (depending on where I bought in) which will cover the initial purchase price, anything after pure profit plus those delightful dividends. (and I say if you have to cut or suspend the div to remain viable, please do so if that will keep me from losing my principle)
Am I wrong to think that the tide will have turned by Q3 2009 & that most of them have enough charter contracts in place to keep 'em afloat until then - when it'll be smooth sailing again ?
The next quarter the ticker will be painful to watch, a market filled with bear rally rogue waves... which I'm just brave (or stupid) enough to attempt to navigate, at least until next spring when I'll leave alone for the long haul. Sell the rips, buy the dips with half of my holdings.
Avoid the bear traps, only sell on rallies, never buying into them.
Out at 9, back in at 7... if I play it wrong and the rally is sustained, I've got a modest profit AND still have 50% of the position in play. If I play it right, I don't have to get out at the high or in at the low, and manage to save an extra 20% of my principal.
I don't see a sustained rally until commodities have established a definite uptrend & the credit sector has vastly improved.
Good old NAT - the darling of the sector that likes the spot pricing vs. long term charter rates. More stable stock price than my dryship holdings for sure - which for the moment doesn't work for me as I like to play the volatility as mentioned above - NAT had a $3.50 swing high to low today, a paltry percentage change of 10%. Playing the bargain basement, that same $3 swing more in the 25% range. (seeking delta)
The weak of heart might want to avoid checking the stock price between now & then, it's sure to be a bumpy ride All in all - I feel totally secure in the maritime transport industry and think the next 12-18 months will be outstanding... But - if you happen to see a flare go up from my general direction, please send someone out to search for my remains.
Happy holidays - to a prosperous 2009.
Tim
Talk about a torpedo to the bow of a stock price - at last check down over 26% in after hours trading. But if like Diana, there's so much upside to the sector that the price will rebound shortly minus those just in it for the juicy yields. (You know how those thinned skinned traders are, any port in a storm)
They also renegotiated a charter contract on one of their ships, changing the day rate terms from $42,000 a day to $16,000 a day for approx 3 years.
In the short term the $16,000 is higher than current spot rates - but if it turns around in 2009 like I think it will, being locked into that rate might hurt unless they have a clause to renegotiate in the future if prevailing rates increase X % -
For the press release: www.oceanfreightinc.co...
Just wanted to update in case anyone read my previous post... seems a lot of trading platforms aren't exactly Johnnie on the spot about updating div yield info... mine still hasn't updated DSX to no div or NM to 0.06 per quarter vs. the 0.09 from the previous quarter. The 0.77 cents per quarter OCNF formerly would certainly be a huge factor in deciding whether or not to buy/hold.
Tim