Genco Shipping: A New Bubble in the Making? 31 comments
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There have been a lot of articles lately claiming that Genco (GNK) and other dry bulk shipping stocks are trading at extremely low levels at the moment and will undoubtedly move significantly higher.
Paradoxically, in some way, GNK looks even more expensive than on May 16, 2008 when it was trading at all time high of $84.51 a share.
Main points of those, claiming low valuation of GNK are low trailing P/E ratio, forward P/E, PEG ratio, Price/Book ratio and low current stock price versus the high of the year.
Low trailing P/E is primarily the result of a sudden rise and subsequent fall to a more realistic level of dry bulk shipping rates. Baltic Dry Index (BDI) shot up from 500-2000 range, where it was for years to over 11000. That spike actually started only in 2006. In January of 2006, BDI was at about 2000. It was extremely volatile for the next two years, rising to over 11000 in mid 2008, only to fall back to sub 1000 levels recently. Abnormally high rates resulted in huge profits for dry bulk shippers. Now it is only history, so 2008 earnings should only be considered as a one-time gain. However, this is not the only reason for low trailing P/E.
When freight rates shot up 5 times in 2006-2007, nobody in the shipping industry had any doubts that this spike was temporarily. A vessel for immediate delivery was priced twice as much as a similar newbuild vessel coming from the shipyard two years later. The reason is that half of the price was going to be repaid by abnormally high rates that were expected to last till mid 2009, when a massive number of newbuild ships were to hit the water, bringing BDI back to reality. Unfortunately, such situations are not addressed by GAAP yet. Public shipping companies, like GNK, in reality paid for one-time gains when buying ships in 2007, but recognized them as operating income, significantly inflating reported earnings.
Forward P/E ratio is meaningless mostly due to the same reason. As I wrote above, during the spike in the rates, the consensus opinion was that extremely high levels were going to last till mid to late 2009. So, some customers preferred not to take the risk of further price escalation, but to get ships on long-term charters at present high rates. This way, Genco fixed about 67% of its fleet for 2009. For 2010 this percentage is significantly lower and for 2011 it’s just about 17%. These rates are not sustainable, so such contracts should only be considered as one time gains as well.
PEG ratio also does not make any sense, because apparently, no growth in earnings is expected for GNK in the foreseeable future.
Price/Book ratio is not of great use either. It reflects only historical prices of the acquired vessels, but they are very volatile. According to industry sources, values of dry bulk vessels went down about 70% since May of 2008. Unfortunately, the fleet is not marked to market in the balance sheet.
How to value a shipping company then? The only logical way is, in my opinion, to calculate NAV. Above or below the market contracts should also be taken into consideration, of course. A dry bulk shipping company is, after all, just a set of ships. It's not really different from a closed end fund in this sense. Some premium or discount to NAV is warranted for superior or inferior management, but it should be reasonable anyway.
Dry bulk vessels are very standardized assets, so it is not that difficult to evaluate their market value. Some reputable ship brokers publish their estimates, and information regarding recent deals in S&P market is also available. I developed a DCF based model that allows calculating estimated market value of any dry bulk vessel. Input parameters are based on recently reported deals in the market, so, the results are quite accurate, in my opinion. The values of above the market charters are calculated as discounted cash flow of the difference between the rate of these charters and current market expectations according to FFAs (forward freight agreements).
Here are some of the recent reported deals for modern dry bulk vessels that served as a basis for valuations:
click to enlarge images
Currently, Genco's fleet looks like this:
So, the market value of GNK's fleet is about $1161.9 mln. and the value of above the market charters is about $466 mln. It includes four newbuild capesize vessels (Hadriane, Maximus, Claudius, Commodus) that were not delivered yet as of 09/30/2008.
According to the latest 10-Q report, GNK had current assets of $220.8 mln., current liabilities of $31.1 mln. and long-term liabilities of $1155.1 mln.
$385.6 mln. will have to be paid on delivery of 4 remaining capesizes
$23.9 mln. is unrealized net loss on Jinhui Shipping investment from 9/30/2008 till 1/09/2009
So, net debt of GNK is $1155.1 + $31.1 + $31.5 + $385.6 +$23.9 - $220.8 = $1406.4 mln.
The debt is significantly greater than the market value of the fleet, so GNK is in deep violation of loan covenants. One of covenants says that “the aggregate Appraised Value of the Vessels shall be at least 130% of the aggregate amount of all Loans“. The company is going to have a difficult time renegotiating the loans with the lenders, but it’s really another story.
$1161.9 mln. + $466 mln. - $1406.4 mln. = $ 221.9 mln. or $7.04 per share.
So, GNK is currently trading at a premium of 163% to NAV. I have been following GNK for several years and this premium is at an all time high at the moment. When GNK stock hit an all time high of $84.51 in May, 2008, the premium was also above 100%. But now it is even higher.
I could hardly imagine any serious and reasonable long-term investor buying GNK shares at current prices, if he can buy a dry bulk ship instead, sign a contract with a ship management company and have ROI almost three times higher with significantly lower risk.
Very few of us can afford buying a capesize vessel, of course, so the reason to buy GNK as a long-term hold for some people may be the hope of a dramatic reversal in the dry bulk shipping market that will lead to dry bulk vessel values doubling or even tripling. After all, the values tumbled by 70% very rapidly, so why can they not come back?
The most widely used argument in favor of such a dramatic scenario has become the recent uptick in the BDI from the low of 663 to the current level of 872.
Actually, this rise has always been expected by the futures market. For example, according to Imarex website, on 12/10/2008, when BDI was 691 and Jan 2009 BDI futures were trading at 1550. On 01/09/2009 Jan 2009 BDI futures closed at 1375, lower than that. Such action is quite explainable. BDI is calculated using market rates on different shipping routes. Currently, rates on some routes are deeply below break even on operating basis. It's pretty clear that shipowners are not going to charter their ships at operating loss forever. However, in case of oversupply, the rates will not be able to stay for a prolonged time at a level, significantly higher than operating costs.
Another widely used argument is that China will come back soon and send shipping rates flying again. Chinese imports may start to rise again later this year or at some other point in the future, but it does not necessarily mean higher shipping rates.
Shipping rates are just a product of supply and demand. If demand exceeds supply, rates may start flying through the roof. The only restriction is how much end users can afford to pay for shipped commodities.
If supply exceeds demand however, the rates are going to fluctuate around operating costs.
There was shortage of dry bulk ships to carry iron ore to China in 2006-2008, but that problem has already been addressed. A new class of ships (VLOCs) has emerged and it is going to completely cover the Brazil-China route by 2012. The largest Brazilian miner, Vale, has recently confirmed its plans. Dry bulk fleet was renewed and dramatically expanded and new massive shipyard capacity has been developed. The number of newbuild dry bulk vessels that are going to hit the water in 2009 and 2010 is huge. Just have a look at the orderbook, regularly published by BRS shipbrokers on its website:
It looked huge even before worldwide recession became apparent. Imagine the size of oversupply given the slowdown. Some of the orders for 2010 and beyond will be canceled, but it is already too late to cancel orders with 2009 deliveries.
While shipyards were expanding dramatically in recent years, worldwide demolishing capacity is quite low at the moment. It will keep a lid on scrapping prices and rates. Apparently, the number of scrapped dry bulk vessels, especially in larger segments, is going to be just a fraction of newbuilding deliveries in 2009.
So, is GNK an oversold value play or a new small bubble in the making? I believe the latter looks much more logical. Time will tell.
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This article has 31 comments:
Further more please ad that the Charter parties or ship employment contracts value is not more than the paper, in sooner or later charterers (many collapse) or will come down, is not possible to trade at loss for extended period.
However no one mention such a thing, leaving in a dream world
ATLA
Some things that would be positive for shipping:
1. Revival of China economic growth.
2. Cancellation of many future ship orders that were placed during the high times of 2007 and 2008.
3. In GNKs case, cash flow to maintain the dividend will prop up the stock price and squeeze the shorts.
This article may be correct but bucking the current trend could be unhealthy to someone's net worth.
1) its based on the opinion that the current selling rates for vessels is going to be the norm going forward. If this is the case, then no one would ever order another newbuild again since it would be cheaper to buy a 5 year old ship instead. What will this do to supply and demand.
2) Very few ships have actually been sold at these levels, and the companies that are selling were doomed to begin with, they had failed business plans.
3) You failed to look at the amount of ships that are over 20 years of age and are likely to be scrapped in the next few months (or that have already been scrapped since your date of 9/30/08)
4) As a previous poster commented, the amount of cancellations that are going to hit in the next year of so to the order book. Easy money would say a large portion of these ships will be cancelled.
5) Using out of date information is in poor taste, for someone that is invested in the stock, I would have expected you to know that the Genco Hadrian was delivered and they have a 4-5 year charter on it. You should have included that in your analysis.
I appreciate your attempt to influence the stock for your own personal gain, but you should have done a better job with your analysis.
Saying a shipping company is just a bunch of ships, like a closed-end fund, is completely wrong. A closed-end fund holds stocks. A shipping company is a service provider.
The calculation of NAV is invalid. If you are going to reduce the NAV for things like dividends paid and (unrealized) investment losses since the last statement, you need to increase it by earnings since the last statement. I'm skeptical of subtracting the payment for the remaining 4 ships also, as that is an obligation that's probably already on the balance sheet as a liability. Finally, the covenants aren't expressed in terms of the DCF model you developed, so the whole analysis is moot. The stock yields 20%, so a cut is a simple way for the company to raise cash that is already priced in. No stock trades at a 20% yield with the expectation it will stay there.
I have my own concerns about GNK, mainly regarding its free cash flow and debt. I think it is a good, but speculative, buy.
"Disclosure: I have a short position in GNK"
Well, duh! I figured that out well before I got to that line. It's as if this article were written using the logic of "how can I prove that may decision to short GNK is correct", and then developing the argument based upon a pre-determined conclusion. By throwing numerous formulas and charts up, it even gives it a ring of authenticity. What? We don't like what P/E, Price/Book, or other figures say? They don't support our pre-determined conclusion? What the heck... I'll make up my own measures that do.
I am more suspect of analysts who write glowingly about a company and then disclose that they have no position whatsoever. If the companies are so great why haven't they taken a position?
As for your concern about authors publishing glowing articles, some analysts refuse to take a position in a stock they cover in fears it may bias their judgment on a stock or industry.
1) Do you think shipyards will not lower prices for new orders? As recently as in 2006 they were happy to take orders at prices even lower than estimations. For example, on September 25, 2006 Dryships Inc. announced an order to build 2 panamax drybulk vessels at a first class shipyard at a cost of approximately $33.25 million, each. In 2003, shipyards were taking at even significantly lower rates. Now, shipyard capacity is greatly expanded and steel prices are lower. There have been no new orders in recent months, naturally, but once they will emerge, prices are probably going to be below 2006 level.
2) The number of deals in S&P market is growing and prices are not going higher. Some of the recent deals were reported at significantly lower rates than I presented. Last week, a deal to sell a 12-year-old capesize bulker for $27 mln. was officially confirmed. My model would have produced $42 mln. fair value for this vessel. The point that the selling companies are in distressed situation is not true. Lacerta, for example, was sold by Dryships. A number of vessels were sold by Norden, one of the largest shipping companies in the world.
3) An interesting fixture was reported today. 25-year-old cape was chartered at a profitable $12,000 rate a day for a year. If cape rates reach $30,000, scrapping activity will stall. If they keep at about $20,000 scrapping activity is going be moderate. In case of rates of $10,000 or below, scrapping is going to be significant. However, it is not particularly optimistic scenario for GNK. Besides, scrapping facilities are limited and under no circumstances the number of scrapped dry bulk vessels could exceed the number of newbuilds in 2009.
4) It is just too late to cancel ships for 2009 delivery. Almost all of them will hit the water. Cancellations for 2010 will be significant, but currently are not expected to higher than 50%. Vale recently confirmed its plan to build VLOC fleet of its own.
5) You should have looked more carefully at the table I presented. Genco Hadrian charter is worth $47.5 mln. according to my calculations.
P/E ratio makes sense if earnings are sustainable. If gains are on-time by nature, it is not logical to apply any multiple. Charter rates, that were singed during the boom are not sustainable.
Do you really believe in the growth of earnings for next 5 years? It is laughable.
By saying that a drybulk shipping company is just a bunch of ships, I mean that it is just a holding company for some standardized and marketable assets. It has no competitive advantages or any other kind of intangible assets, other than the ability of the management to make investment decisions.
When making calculation of the value of charters and ships, I took into consideration expected cash flow from 9/30/2008. That is why, Q4/2008 earnings are included in valuation. Remaining payments for new vessels are included in the balance sheet.
The question is, whether China revival will be sufficient to emply drybulk all the drybulk ships. I didn't expect that China growth will be sufficient even during the boom. The vast majority of ships in the orderbook for 2009 will delivered and 2010 is not going to fall far behind even after all cancellations.
Of course, GNK cashflow in 2009 is probably going to be sufficient to pay dividends (if charter contracts will be honored), however I don't think than is going to pay any dividends for the foreseeable future. It is clearly in violation of loan covenants and a typical deal with lenders in such cases invovle restrictions on paying dividends. Have a look at EGLE and OCNF.
2.) Prior to the market collapse the average number of vessels traded was approximately 30-50 a month, I hardly consider a handful of sales significant. I was unable to find any information on the sale of the Lacerta from the DRYS website, the last information they present is the sale the vessel was cancelled at a rate of $55 million. Perhaps they haven't reported it to the SEC yet.
3.) While I am sure that a limit to the number of ships that can be scrapped is true, I am unsure of where you got your fact that scrapping can not be higher than newbuilds.
4.) You say it is too late for cancellations, however on Nov. 4th 2008 Genco cancelled 6 ships that were going to be delivered in 2009, including 3 that were to be delivered in the 1st quarter of 2009 resulting in that case of only a 5 month lead in order to cancel the vessels. While I agree many of the 2009 vessels will be delivered, companies still have plenty of time to cancel.
5.) I admit I missed your calculation of the Hadrian, your use of numerous timeframes had me mislead.
In past, it was easier for the owners of older tonnage to survive due to low capital costs. But TBS and Excel have old tonnage at very high cost.
Any comments?
1) The discussion of shipyards going under is mostly concentrated around emerging greenfield shipyards. Established shipyards have an extensive backlog are not expected to have financial difficulties in the near future. Besides, South Korea, the largest shipbuilder in the world has a bailout package for shipyard industry. New emerging shipyards, account for no more than 30% of orderbook for 2010 and not a material number of 2009 deliveries.
2) The number of deals in S&P market went down and it is quite natural at the beginning of downturn in a cyclical industry. If current situation is not a classical example of the end of a cycle in shipping industry, when rates are at a multiyear low and orderbook is at a multiyear high, than I it is hard to imagine how it could be.
3) I have to admit that I don’t have exat figures regarding scrapping capacity. However, some sources I read regarding India and Bangladesh suggest that it will be hard to imagine recycling 500 ships in 2009. It this happens, however, it won’t be good for drybulk shipping market anyway.
4) Genco didn’t order these ships from the shipyard. It was a resale from a Turkish owner. Genco just cancelled the deal, but the vessels will be delivered from the shipyard anyway.
www.brs-paris.com/mark...
It will probably be reported by DRYS later.
www.telegraph.co.uk/fi...
Your calculation of NAV didn't include cash flow after the last statement, but it did include expenses after that statement, such as dividends paid. That's an error.
If the payment for the four ships is already on the balance sheet as a liability (not sure), you shouldn't be subtracting it AND the liabilities from assets. That's double billing.
I have no idea if your article makes sense or not and could care less. The market makes no sense, so I would rather forgo fundamentals and look for trading channels --- even if they are small.
5-year PEG is laughable because earnings are going to decline significantly for the next several years.
My calculation of NAV does include cash flow since the last statement. It is included in the valuation of vessels and charters.
Only deposits on vessels are in the balance sheet. The remaining payments will increase liabilities, of course.
Good advice!
On Jan 13 10:38 PM einstein p fleet wrote:
> I don't know if it's a bubble, but it channels well between 16.80
> and 17.80. Made the trade several times around a core position, reducing
> my cost basis from a much lower entry point.
>
> I have no idea if your article makes sense or not and could care
> less. The market makes no sense, so I would rather forgo fundamentals
> and look for trading channels --- even if they are small.
>
The general market looked horrible today, especially the financial sector. Would rather own the dry bulk shippers and the American and Canadian natural gas and oil trusts. Just my opinion, but I think oil and natural gas prices have bottomed, along with the BDI.
It's a crap shoot, but it's potentially the investment strategy of a lifetime. The movements have been volatile but that can help. Bought PRGN at 2.50 and sold half the position at 5, then traded around the core position. The strategy has worked well to date and I plan to keep pumping it until the market returns to normal, which may take several years.
You should have covered at $6.65 when I bought long (sold at $17 and now trading the range).
You should've studied more carefully presented data. Cash and short-term assets were of course taken into consideration.