Why I Don't Think Genco's Prices Will Reach Prior Highs

A few days ago, BoomBustBlogger Stuart made the following comments:

I'd be curious to see where you think GNK fits into the mix. They popped up on a screen so I briefly looked at them. Their latest 10Q has a investment in a company called Jinhui. That company trades on the Oslo bors (ticker JIN) and is 54% owned by a Hong Kong company. GNK values their stake at $200 million based on a Sept 2007 stock price. Problem is that JIN has lost about 90% of its value since that time. I don't short stocks so I just eliminated it and moved on. But might be worth a closer look for subscribers, esp[ecially] if a write down triggers collateral posting requirements under their 2007 credit facility.

On a broader note, this research note [the latest shipping company research note] seemed to rely heavily on the order book to current fleet ratio, which would indicate [the] price will not be rising to prior highs anytime soon. But, how reliable is that number? Shipping co's have been canceling right and left and I expect that trend to accelerate as it becomes clear that China will not miraculously boom during a rest of the world downturn. If few of these cancelled ships are completed, then I would expect the order book to current fleet ratio not to accurately predict future supply. For example, with respect to bulk carriers, the Business Times reported recently that an astounding 30% were placed with "greenfield" yards in China. It would shock me if the majority of those vessels (or even a large portion) ever got built. This makes me think that relying on current order book to predict future supply is not reliable and in fact may be wildly off.

We have looked at Genco Shipping (GNK), a carrier of iron ore, coal, grain, steel products and other dry bulk cargoes. Following are some of our observations on the company based on preliminary investigations:

1. As of September 2008, Genco’s investment in Jinhui stood at $60 mn (short term investments based on NOK 21.70 or $3.70 and 16 mn shares outstanding) (instead of $200 mn as stated in the comment below). As of September 2008 the investment in Jinhui represented 3.0% and 7.4% of total assets and shareholders’ equity, respectively.
2. Since September 30, 3008 JIN’s price had declined 67% in local currency and 73% in USD. Based on JIN’s last closing price of $1.0 the value of investment in Jinhui stood at $16 mn representing a loss of $44 mn (representing 5.4% of shareholders’ equity) for 4Q2008.
3. To gauge the impact of this loss we have recreated Genco’s balance sheet. After adjusting for loss of $44 mn, Genco’s BVPS declines to $24.4 from $25.8. The Price-to-book value (after adjusting above loss) is now 0.53x versus 0.50x, previously. Even after adjusting for this loss Genco’s P/B is at a discount to its peers’ which are trading at an average P/B of 0.58x. (Genco is trading at a discount to its peers based on other valuation multiples as well.)
4. Over the past one month, Genco, along with its peers, has seen a sudden spurt in its share price (ranging from 60-120%) due to anticipation of an increase in the Baltic dry index. The Baltic dry index has increased 12% over the past one month, after declining 92% since the beginning of 2008. Baltic dry index is currently at 784 (December 23, 2009) versus 8,891 in January 2008.
5. Despite a 92% decline in Baltic dry index, Genco’s EBITDA margins are strong at 85% (3Q2008). Also, the debt position for the company is reasonable with debt-to-assets of 0.56x and debt-to-equity of 1.14x.
6. In addition to this, the stock has witnessed a decline of 76% over the past one year (despite a 61% increase over the past one month).

With regards to our latest shipping co. research note, we had relied on the company’s presentation and filings for the industry order book. Although we agree with the reader that shipping orders might get cancelled in the near-to-medium term due to financing constraints, coupled with excess inventory buildup-vis-à-vis expected increased in oil production (the reason that drove us to build an alternative scenario in the research note), we continue to believe that prices for VLCC and Suezmax vessels have a downward bias owing to two arguments which were highlighted in the report as well.

The current overbook-to-fleet is substantially high with overbook-to-fleet at nearly 50%. Even if 50% of these orders are cancelled, the order book-to-fleet would still continue to be at elevated levels (25%) which would cause a substantial increase in supply - negatively impacting charter rates.

The second argument is that even with the existing fleet (assuming there are no additions to the existing fleet) industry is going to have excess capacity due to expected decrease in oil production. OPEC has already announced 4.4 mn barrels per day production cut and is expected to announce further production cuts to bring prices into equilibrium. However, with eminent slowdown in developing economies, the demand for oil is expected to be subdued. With decline in oil volumes we believe that even the existing fleet could cause excess capacity and impact charter rates.

I want to inform readers who have not noticed that I will be on a light posting schedule for the holidays.

Wishing you a Merry Christmas, Happy Chaunuka, Happy Kwaanza, and happy holdiays and New Years on behalf of the entire team at BoomBustBlog.com.

Comments

[Bartlesby:]

With all due respect, your frequent reference to oil tankers suggests that you have spent very little time covering the drybulk market. The supply of drybulk ships is largely unrelated to oil production - in fact the VLCC and Suezmax vessels you reference have no relation to the Baltic Dry Index whatsoever. The BDI is comprised of the major drybulk vessel classes (Capesize, Panamax, Handymax and Handysize). The supply of these vessels is largely a function of future expectations for the BDI and the underlying drybulk commodities that these ships transport (e.g. coal, iron ore, grains, etc). Scrapping of old ships can also be a marginal factor in supply. While the orderbook for new buildings remains historically high, tight credit, greenfield shutdowns and plummeting freight rates have substantially slowed the expected delivery of these new ships. Global demand for the underlying commodities, primarily from China, is a much more significant factor at the moment.

Please do not post misguided information on investment topics if you are this unfamiliar with the industry basics. Novice investors have been burned enough this year already.

Here is a good industry background covering these topics and more:

Drybulk Carrier Industry Overview

The marine industry is an essential link in international trade, with ocean-going vessels representing the most efficient, and often the only method of transporting large volumes of basic commodities and finished products. In 2006, approximately 2.7 billion tons of drybulk cargo was transported by sea, comprising more than one-third of all international seaborne trade.
Drybulk cargo is shipped in large quantities and can be easily stowed in a single hold with little risk of cargo damage. Drybulk cargo is generally categorized as either major bulk or minor bulk. Major bulk cargo constitutes the vast majority of drybulk cargo by weight, and includes, among other things, iron ore, coal and grain. Minor bulk cargo includes products such as agricultural products, mineral cargoes (including metal concentrates), cement, forest products and steel products and represents the balance of the drybulk industry.
In terms of seaborne trade volumes (and the shipping ton-miles generated), the dominant influence is that of the major bulk trades, which include coal, iron ore and grains.


Steel-Related Commodities


Iron Ore
Iron ore is used as a raw material for the production of steel along with limestone and coking coal. Steel is the most important construction and engineering material in the world. In 2006, approximately 721million tons of iron ore was exported worldwide, with the main importers being China, the European Union, Japan and South Korea. The main producers and exporters of iron ore are Australia and Brazil.

Coking Coal
Coal is an abundant commodity. At current production rates, coal reserves would provide approximately 200 years of supply, compared with 41 years for oil and 67 years for natural gas. In addition, coal is mined in more than 50 countries with no world dependence in any one region. Coking (metallurgical) coal is used to produce coke to feed blast furnaces in the production of steel. An increase in seaborne transportation of coking coal has been primarily driven by an increase in steel production. The increase in import activity has occurred in a number of regions. Currently, Asia and Western Europe are major importers of coking coal. Australia and Indonesia provide a significant amount of coking coal to Asia, while South Africa and the United States are major sources for Western Europe.


Steel Products
Major importers of steel products are China, the United States and South East Asia. Major exporters of steel products are Japan, Russia and Western Europe. Handymax and Handysize vessels are typically preferred for transporting steel products. For voyages that span the Atlantic and Pacific Ocean, Handymax vessels are frequently used on shorter routes involving intra-Asian and intra-European trades.


Steam Coal
Steam coal is primarily used for power generation. A number of developing countries have decided to capitalize on the recent dramatic increase in oil and gas prices to build new power plants that utilize coal. This has resulted in significant growth in the steam coal trade. The most dramatic growth has occurred in China and Indonesia, both of which have increased their export capacity in the intra-Asian market. Furthermore, in the global market for steam coal, China is a major importer and Australia is the largest exporter.
Asian coal is primarily traded in Capesize and Panamax tonnage. European countries tend to import steam coal from exporters in the Atlantic region using Panamax vessels.


Grain
Grains include wheat, coarse grains (corn, barley, oats, rye and sorghum) and oil seeds extracted from different crops such as soybeans and cottonseeds. In general, wheat is used for human consumption, while coarse grains are used as feed for livestock. Oil seeds are used to manufacture vegetable oil for human consumption or for industrial use, while their protein-rich residue is used as a raw material in animal feed.
Total grain production is dominated by the United States. Argentina is the second largest producer followed by Canada and Australia. In terms of imports, the Asia/Pacific region (excluding Japan) ranks first, followed by Latin America, Africa and the Middle East. The principal vessel classes used in the grain trade are Panamax and Handymax.


Minor Bulks


Forest Products
Over the past decade, seaborne transportation of forest products has increased by approximately 30 million tons. South America has increased its export market share, with an emphasis on the export of wood pulp and lumber. The emphasis on wood pulp and lumber export can be tied directly not only to the increase in wood pulp and sawmill capacity, but also to plantations that have taken advantage of their large wood reserves, which coincided with higher growth of such raw materials. The largest importers of wood products are China, Japan, the United States and Western Europe. The positive trend in the transportation of wood products has benefited Handymax and Handysize vessels, which are the vessels typically employed to transport these products.


Other Minor Bulks
The balance of drybulk trade is represented by agricultural cargoes, bauxite and alumina, fertilizers and cement. Minor bulks are typically transported by smaller vessels of less than 40,000 dwt.


Drybulk Carrier Demand
The demand for drybulk carrier capacity is determined by the underlying demand for commodities transported in drybulk carriers, which in turn is influenced by trends in the global economy. Seaborne drybulk trade increased by slightly more than 2% on an average annual basis during the 1980s and 1990s. However, this rate of growth has increased dramatically in recent years. Between 1999 and 2006, trade in all drybulk commodities increased from 2.0 billion tons to 2.5 billion tons, an increase of 35% overall.
Generally, growth in gross domestic product and industrial production correlates with peaks in demand for seaborne transportation. Certain economies will act from time to time as the "primary driver" of the drybulk carrier market. In the 1990s, Japan acted as the primary driver due to increased demand for seaborne trade and growth in Japanese industrial production. China has been the main driving force behind the recent increase in seaborne drybulk trades and the demand for drybulk carriers.


Ton-Miles
The extent to which increases in drybulk trade have affected demand for drybulk carriers is reflected in estimates of ton-mile demand. Ton-mile demand is calculated by multiplying the volume of cargo moved on each route by the distance of the voyage. Between 1999 and 2004, ton-mile demand in the drybulk sector increased by a total of 25% to 11.5 billion ton-miles.


Drybulk carriers can be the most versatile element of the global shipping fleets in terms of employment alternatives. However, drybulk carriers seldom operate on round-trip voyages. Rather, the norm is port-to-port liner service and triangular or multi-leg voyages. This means that every voyage has a ballast leg that must be paid for by the laden or revenue earning leg. Hence, trade distances assume greater importance in the demand equation.


Seasonality
The three largest commodity drivers of the drybulk industry, iron ore, steam coal and grains, are all affected by seasonal demand fluctuations. Steam coal is linked to the energy markets and in general encounters upswings towards the end of the year in anticipation of the forthcoming winter period as power supply companies try to increase their stocks, or during hot summer periods when increased electricity demand is required for air conditioning and refrigeration purposes. Grain production is highly seasonal and driven by the harvest cycle of the northern and southern hemispheres. However, with four nations and the European Union representing the largest grain producers (the United States, Canada and the European Union in the northern hemisphere and Argentina and Australia in the southern hemisphere), harvests and crops reach seaborne markets throughout the year.


Drybulk Carrier Supply
The worldwide drybulk carrier fleet subdivides into four vessel size categories, which are based on cargo carrying capacity.


Capesize-vessels over 80,000 dwt. While this is the traditional definition of a Capesize bulk carrier, in terms of deadweight, the sector is changing. As per the orderbook detailed below, there have been a number of new super-Panamaxes ordered, which are 82,000 dwt to 85,000 dwt, but which are able to transit the Panama Canal with a full cargo. Thus, a more modern definition of Capesize would be based on vessels over 100,000 dwt. The Capesize sector is focused on long haul iron ore and coal trade routes. Due to the size of the vessels there are only a comparatively small number of ports around the world with the infrastructure to accommodate them.


Panamax-vessels between 60,000 dwt and 80,000 dwt. Panamax vessels, defined as those with the maximum beam (width) of 32.2 metres permitted to transit the Panama Canal, carry coal, grain and, to a lesser extent, minor bulks, including steel products, forest products and fertilizers.


Handymax-vessels between 30,000 dwt and 60,000 dwt. The Handymax sector operates in a large number of geographically dispersed global trades, mainly carrying grains and minor bulks including steel products, forest products and fertilizers. Vessels less than 60,000 dwt are built with on-board cranes that enable them to load and discharge cargo in countries and ports with limited infrastructure.


Handysize-vessels up to 30,000 dwt, which carry exclusively minor bulk cargoes. Historically, the Handysize drybulk carrier sector was seen as the most versatile. Increasingly, however, this has become more of a regional trading, niche sector. The vessels are well suited for small ports with length and draft restrictions and also lacking infrastructure.


Key elements influencing the supply of drybulk carriers are vessel deliveries and the loss of existing vessels through scrapping or other circumstances requiring removal. A comparison of vessels in each category reveals that Capesize vessels have the largest percentage of current fleet on order when compared to the Panamax, Handymax and Handysize categories.


The number of ships removed from the fleet in any period is dependent upon prevailing market conditions, scrap prices in relation to current and prospective charter market conditions as well as the age profile of the existing fleet. Generally, as a vessel increases in age its operational efficiency declines due to rising maintenance requirements, to the point where it becomes unprofitable to keep the ship in operation.
The supply of drybulk carriers is not only a result of the number of ships in service, but also the operating efficiency of the worldwide fleet. For example, port congestion can absorb additional tonnage and therefore tightened the underlying supply/demand balance.


The international drybulk shipping industry is highly fragmented and is divided among state controlled and independent drybulk vessel owners. As a general principle, the smaller the cargo-carrying capacity of a drybulk vessel, the more fragmented is its market, both with regard to charterers and vessel owners/operators.
There remains significant potential for industry consolidation within each vessel type, especially in the Handysize, Handymax and Panamax sectors in which we currently operate.


Charter Market
Drybulk carriers are employed in the market via a number of different chartering options. The general terms typically found in these types of contracts are described below.


A "bareboat charter" involves the use of a vessel usually over longer periods of time ranging over several years. In this case all voyage related costs, including vessel fuel and port dues as well as all vessel-operating expenses such as day-to-day operations, maintenance, crewing and insurance, transfer to the charterer's account. The owner of the vessel receives monthly charter hire payments on a per-day basis and is responsible only for the payment of capital costs related to the vessel.


A "time charter" involves the use of the vessel, either for a number of months or years or for a trip between specific delivery and redelivery positions, known as a trip charter. The charterer pays all voyage-related costs. The owner of the vessel receives semi-monthly charter hire payments on a per-day basis and is responsible for the payment of all vessel operating expenses and capital costs of the vessel.


A "voyage charter" or "spot charter" involves the carriage of a specific amount and type of cargo on a load-port to discharge-port basis, subject to various cargo handling terms. Most of these charters are of a single voyage nature, as trading patterns do not encourage round voyage trading. The owner of the vessel receives one payment derived by multiplying the tons of cargo loaded on board times the agreed upon freight rate expressed on a per-ton basis. The owner is responsible for the payment of all expenses including voyage, operating and capital costs of the vessel. Chartering on a single voyage or a trip charter basis may be referred to as spot chartering activity.


A "contract of affreightment" relates to the carriage of multiple cargoes over the same route and enables the COA holder to nominate different ships to perform the individual sailings. Essentially it constitutes a number of voyage charters to carry a specified amount of cargo during the term of the COA, which usually spans a number of years. All of the ship's operating, voyage and capital costs are borne by the ship owner. The freight rate normally is agreed on a per cargo-ton basis.


Charter Rates
Charter hire rates paid for drybulk carriers are primarily a function of the underlying balance between vessel supply and demand, although at times other factors may play a role. Furthermore, the pattern seen in charter hire rates is broadly mirrored across the different charter types and between the different drybulk carrier categories. However, because demand for larger drybulk vessels is affected by the volume and pattern of trade in a relatively small number of commodities, charter hire rates (and vessel values) of larger ships tend to be more volatile than those for smaller vessels. Conversely, trade in minor bulks drives demand for smaller drybulk carriers. Accordingly, charter hire rates and vessel values for those vessels are subject to less volatility.
In the time charter market, rates vary depending on the length of the charter period and vessel specific factors such as age, speed and fuel consumption. Short-term time charter hire rates are generally higher than long-term charter hire rates. The market benchmark tends to be a 12-month time charter hire rate, based on a vessel of five to ten years age.


In the voyage charter market, rates are influenced by cargo size, commodity, port dues and canal transit fees, as well as delivery and redelivery regions. In general, a larger cargo size is quoted at a lower rate per ton than a smaller cargo size. Routes with costly ports or canals generally command higher rates than routes with low port dues and no canals to transit. Voyages with a load port within a region that includes ports where vessels usually discharge cargo or a discharge port within a region with ports where vessels load cargo also are generally quoted at lower rates, because such voyages generally increase vessel utilization by reducing the unloaded portion (or ballast leg) that is included in the calculation of the return charter to a loading area.


Within the drybulk shipping industry, the charter hire rate references most likely to be monitored are the freight rate indices issued by the Baltic Exchange. These references are based on actual charter hire rates under charters entered into by market participants as well as daily assessments provided to the Baltic Exchange by a panel of major shipbrokers.

2008 Dec 30 06:49 PM

[Reggie Midd...:]

It appears as if you did not understand the post. We were referring to two different companies. One is a shipper of iron ore and dry goods (Genco), the other is a shipper of oil (our latest shipping co. research note). The second company was not named because it was the subject of subscription-only research. I'm assuming you thought the conversation was referring to one and the same company. Thanks for being polite, though.

2008 Dec 31 05:14 AM

[Reggie Midd...:]

It appears as if you did not understand the post. We were referring to two different companies. One is a shipper of iron ore and dry goods (Genco), the other is a shipper of oil (our latest shipping co. research note). The second company was not named because it was the subject of subscription-only research. I'm assuming you thought the conversation was referring to one and the same company. Thanks for being polite, though.

2008 Dec 31 05:15 AM

[oilsands:]

How odd.
Bartlesby, is that long, but informative piece on shipping a quote from somewhere? did you write It?

Middleton, you're note on the oil shipper needed more explanation for those of us who are not regular readers. This is where readers have a right to full expanation, even if it is to say, in the first place, " in other research not related to dry ships ....". You are obviously a competent writer, but you feel into the same trap we all do from time to time,
that of assuming too much.

2008 Dec 31 11:40 AM

[cartledge:]

I didn't read the wall of text above in either the article or the first comment, but I know that the loss on JIN stock in GNK possession is accounted for on their balance sheet already, it will not be recorded on the income statement until they make a sale at either a loss or a gain, but from an asset and equity position, it is already accounted for.

Jan 04 05:42 PM