Part One: Net Asset Value
I believe the deep undervaluation of Star Bulk Carriers Corporation ("Star Bulk") (SBLK) presents a great opportunity for smaller value-focused investors/funds. Star Bulk is a global shipping company that owns and operates vessels, primarily in the dry bulk sector. The company currently owns thirteen vessels and has contracts for an additional four vessels. The company has also recently completed an equity rights offering to raise a minimum of $75 million in gross proceeds.
Like the overall shipping sector, Star Bulk has suffered from an unprecedented collapse in charter rates since 2008. This collapse, which has seen Capesize rates recently at early-1980s nominal levels, has led to the bankruptcy of several operators and a general revulsion to investments in the shipping sector. However, this general aversion has created an attractive opportunity in the shares of Star Bulk.
I believe the stock market is not fairly valuing Star Bulk since its shares are trading below their current depressed net asset value ("NAV"). This discount is more glaring as the market is not giving any value to its superior management team and/or for the potential normalization of charter rates from current depressed levels.
Due to the detail I hope to present to the reader, I will lay out my analysis of Star Bulk in a three-part series covering its net asset value, its management and the general shipping environment. This first part will be a breakdown of the company's NAV. Please note, to value Star Bulk I had to make some minor assumptions on the uptake of the recent equity offering. I will adjust these values when the actual results of the offering are released over the next few days/weeks though there should be no significant impact on my conclusions.
How does the stock market value dry bulk shipping companies?
There are many dry bulk shipping companies that are listed on global stock markets such as D/S Norden (Copenhagen: DNORD) and Golden Ocean Group (Oslo: GOGL). However, bulk shipping is a relatively new arrival to US stock markets with only one company, Excel Maritime (EXMCQ) listed prior to 2005. Only following the mid-2000s surge in charter rates, did many members of this historically private industry choose a public listing in the US. Indeed, it was in this rush of offerings that Star Bulk came into being with the listing of its predecessor, Star Maritime, a special purpose acquisition company in late 2005.
Those halcyon days soon ended with the financial crisis-induced crash in charter rates, and the ensuing collapse of companies' share prices. From their peak, dry bulk shipping stock prices are down over 90% on average. In fact, the "best" performers such as Diana Shipping Inc. (DSX) and Safe Bulkers Inc. (SB) are "only" down by about 70%. While the worst performers, such as Excel Maritime, have filed for bankruptcy.
Since any stock investment in this sector has proven to be calamitous over the past several years, the market has become very conservative in valuing players. Consequently, the net asset value measure has become the touchstone for market valuation with little premium given for either management quality or the potential for a recovery in charter rates.
Firstly, a note on the fair value of vessels, generally the largest component of NAV: Dry bulk vessels are actively traded and are relatively homogenous according to their size, year built, and the geography of their construction shipyard. Due to this homogeneity and the vibrancy of the sale/purchase market, fleet values can be closely estimated at nearly any point in time. In fact, there are many valuation services such as those provided by VesselsValue.com that are used by creditors and investors to acquire valuations for specific vessels.
By using this NAV metric, it seems the market has separated most public dry bulk companies into two categories, I call: "viable" and "highly levered." Viable companies have a positive NAV and moderate financial leverage. Generally, these companies have the capacity to withstand at least a few more years of low charter rates. Highly levered companies have a negative NAV with their debt loads exceeding the fair value of their assets. In such companies, equity holders are unlikely to recover any value without substantial creditor forbearance even with the assumption of a strong near-term increase in charter rates.
Stocks in viable companies such as DSX, SB or DNORD generally trade at a level that closely approximates their NAV per share. On the other hand, highly levered players trade at very low market values even if they own a large number of ships. Since such companies' NAVs are negative, their stock prices resemble options; holding out for the small and unlikely possibility of very sharp near-term improvement in creditor arrangements, vessel values and/or charter rates. Unfortunately, over the past few years, many of these options have "expired" worthless (i.e. bankruptcy) as the shipping recovery has been pushed further out into the future.
How did the stock market value Star Bulk prior to the equity raise?
Early in 2013 and prior to the announcement of a capital raise, SBLK was trading at an equity market value of roughly $33 million ("MM") or $6/share (5.4 MM shares outstanding). At this time, the company's fleet consisted of six Capesize vessels and eight Supramax vessels with an average age of roughly 10.8 years. The market value of these vessels in early 2013 was conservatively, $230 MM. Additionally, many of these vessels had long-term charters that locked-in rates that were well above current depressed levels. Since these charters were with top-tier charters such as Rio Tinto plc (RIO) and Cargill Inc., the charters also had some present market value ("PV of charter"). [As an aside, just as a building with a strong tenant paying above-market rents has more value than the building alone; a vessel with a prime charterer paying above-market charters has greater value than an unattached vessel.] Adding the value of the vessels to the PV of the charters, I calculated a fleet value of $264 MM.
PV of Charter
Taking this $264 MM in fleet value and adding the $32 MM in cash and the $17 MM in other assets (primarily, trade receivables, prepaid expenses and lubricants/fuel), my estimate of the asset value of Star Bulk was roughly $313 MM. Likewise, I estimated that the company had total liabilities of $238 MM. Therefore, I estimated that the NAV of Star Bulk was $75 MM or $13.90/share.
Thus the company's stock was trading at nearly a 60% discount to my estimate of its NAV. This discount clearly put Star Bulk in the highly levered category of dry bulk players since viable shippers were trading around their NAVs. At the time, I strongly believed this categorization and concomitant discount was unwarranted as Star Bulk was neither facing a liquidity nor solvency issue.
Was Star Bulk facing a liquidity or solvency crisis prior to the equity raise?
Prior to the equity raise, Star Bulk was both solvent and liquid. Its solvency was assured since its NAV was substantially positive and its debt-to-asset value was about 75%. Considering that vessel values were trading over 80% below peak levels and around 20-year nominal lows, this level of financial leverage on long-term, real assets did not seem extreme.
Furthermore, there was little question of its liquidity as it had $40 MM in ready cash and the cash generated by the near-term sale for scrap of the 22-year old Star Sigma. This $40 MM exceeded the $29 MM in debt that was due within one year and was nearly 20% of the total debt due. Additionally, the company had been able to consistently generate positive cash flows throughout its history, and meet its annual financial obligations.
Moreover Star Bulk's above-market time charter contracts provided substantial security for the company to survive even if the current weak freight market continued. Using consensus time charter estimates for 2013 through 2015 from Morgan Stanley and Arctic Securities, I calculated the following cash earnings and cash requirements for Star Bulk per vessel-day. Please note that the low level of analyst estimates shows that they were not expecting any meaningful medium-term normalization of freight rates.
Est. $ per vessel-day
Total est. cash breakeven
Contract & consensus TC
Excess daily cash over costs
What this chart shows is that in 2013, each vessel in Star Bulk's fleet would need to earn roughly $13,700/day to breakeven. This break-even point includes operating costs, interest expense and debt principal repayments. Using the earnings on its contracted fleet and the analyst-estimated earnings on its uncontracted fleet, I projected that Star Bulk exceeded its cash requirements by about $300/day in 2013. This margin increased in 2014 and 2015 as rates were anticipated to have a moderate recovery. Notably, Star Bulk's ability to earn above its cash requirements while having a strong cash cushion shows management was correct in claiming that the company was financially secure.
If Star Bulk was so financially stable, why did the banks require the equity raise?
In early 2013, Star Bulk announced that its lenders were requiring the company to raise a minimum of $30 MM of new equity. Concurrent to this requirement, its lenders renegotiated several terms of the existing loan facilities including a deferral of $24 MM in principal repayments for years 2013 and 2014, reclassification of $7 MM of restricted cash to free cash and the waiving of certain onerous financial covenants.
Star Bulk's vessels, like all other dry bulk vessels, had suffered sharp falls in market value as charter rates collapsed. This drop in vessel value exposed some of the company's vessel subsidiaries to breeches of minimum asset cover ratio requirements. So though the company had the wherewithal to repay its loans, these covenant breeches technically allowed its lenders to reclassify all outstanding debt as short-term requiring near immediate repayment.
So the lenders logically chose to further solidify their security interests by requiring Star Bulk to raise more capital. However, unlike in situations with more distressed operators, the lenders allowed Star Bulk to use this additional capital to purchase more vessels. This lender-approved flexibility in using the proceeds demonstrates that the equity raise requirement was not meant to be punitive to current shareholders. In fact, by having additional capital to invest in historically low-priced vessels, this raise may boost future equity returns.
So what is Star Bulk worth today, after this equity raise?
To value Star Bulk following the completion of its equity raise, I again look to its NAV rather than predicting the company's future earnings. Assuming some efficiency, the market value of a vessel reflects the consensus view of its earnings power. Therefore, I think it is fair to assume that a non-distressed company should have an equity value that reflects to some extent its net asset value.
Firstly, I estimate that Star Bulk has raised at least $85 MM of new equity which implies that there is some uptake of new shares by current shareholders and some new shares created for non-shareholding backstop providers. This would mean that the share count would increase to 21.9 MM from the current 5.4 MM.
Secondly, vessel values have increased by 5 to 10% from recent lows as rates have started improving and expectations of a rate recovery grow. So to calculate the current fleet value, I take the earlier $230 MM value (see chart above) less $10 MM due to the scrapping of the Star Sigma and multiply by 1.05 to conservatively reflect some increase in vessel values. This gives a current fleet value of $231 MM.
Finally, I make adjustments for new developments. The company announced the purchase of four new-builds: two Capesizes and two Ultramaxes. The aggregate purchase price for these vessels is $151 MM and I assume that they will be financed with 60% debt and 40% equity. Also, the Star Borealis' time charter agreement with STX Pan Ocean (Korea: 028670) has been terminated. Accounting for the passage of time, the pick-up in rates and the loss of the STX Pan Ocean charter, my new estimate for the PV of the time charters is roughly $15 MM.
So to calculate the current asset value of Star Bulk, I add the following (data from the 1Q13 company presentation and my estimates):
Current fleet value
$ 231 MM
Value of new vessels
+ $ 151 MM
PV of time charters
+ $ 15 MM
+ $ 53 MM (= $28 MM on books + $25 MM from the equity raise)
+ $ 20 MM
= $ 470 MM
My estimate of the asset value of Star Bulk is $470 MM. Likewise, to calculate the total liabilities following the equity raise and accounting for the new vessel purchases, I add the company's current $212 MM in debt and other liabilities to the $91 MM in debt to be accumulated for the new vessels (i.e. 60% of $151 MM). As a result, I estimate the total liabilities of Star Bulk are $303 MM.
Therefore, I estimate the current NAV of Star Bulk to be $167 MM or roughly $7.60/share. This is about 40% above the recent $5.50 price level.
My view on Star Bulk's valuation
As I mentioned earlier in this report, I believe the stock market is classifying dry bulk operators, as either viable or highly levered. And this classification explains why the company's share price trades at its net asset value or at purely an option-like value. So is Star Bulk viable or highly levered?
I hope I have clearly presented that Star Bulk faces no financial pressures for the foreseeable future especially following the recent equity raise. Even after considering the cost of the four new-build vessels to be paid ratably until their delivery in 2015 and early-2016, the company does not face any liquidity or solvency issues. In fact, its new debt-to-asset ratio has improved to a level of less than 65%. And finally, the higher-than-expected equity raise, the creditors' forbearance and the rapid purchase of attractively-priced vessels shows that investors, lenders and suppliers are confident about Star Bulk's ability to meet its commitments.
Consequently, I strongly believe Star Bulk should trade like other viable companies such as Diana Shipping and Safe Bulkers. To be sure, these companies are trading at premiums to their net asset value with DSX trading at roughly a 10% premium to its $9.60/share NAV. On the other hand, Star Bulk, at a substantial discount to its NAV, is trading more like some of its highly levered brethren. This pricing is unjustifiable and therefore, I believe shares in Star Bulk are undervalued by the stock market.
In the next two reports, I will continue by analyzing the management of Star Bulk and the general shipping market. I hope to demonstrate that the stock market's focus on NAV in valuing shipping companies is not necessarily reasonable or sufficient since I believe equity values should also reflect some value for the quality of management and the potential for a rate recovery over the next few years.
 Roughly, the net asset value equals the value of cash, current fair or market value of vessels and other assets less the outstanding debt and other liabilities. This measure approximates the potential value achieved by equity investors if the company was liquidated in an orderly and equitable manner (assumptions that may not necessarily be realistic).
 All section data from third-party estimates and vessel transactions, and recent company filings; present value calculated using contemporaneous time charter rates and a 10 to 15% discount rate. Sums may not off due to rounding. All calculations on a best efforts basis and I make no claim that the fleet value is realizable nor assume any responsibility for the data.
 Erik Stavseth; Diana Shipping; Arctic Securities; May 22, 2013.
Additional disclosure: I may change my views on Star Bulk and the value of Star Bulk’s shares at any time and for any reason. And I reserve the right to buy or sell shares in Star Bulk at any time. I disclaim any obligation to publicly notify of any such changes.