The Long Case for Eagle and a Tanker Trading Strategy

Today's post comprises of two parts. In the first part I'll talk about a stock in the shipping/tanker industry, which has growth & income characteristics and in the second part I'm going to detail a strategy I call 'Tanker Trading Strategy'.

Eagle (EGLE) is the largest US based owner of Handymax dry bulk vessels. Eagle transport a broad range of major and minor bulk cargoes, including iron ore, coal, grain, cement and fertilizer, along worldwide shipping routes. Note that when it comes to the shipping industry, there are two types of rates involved: time charter (long-term contracts) and spot charter (short-term contracts).

Catalysts that make Eagle (EGLE) a buy:

Eagle employs a time chartering strategy. They lease their ships for several months to years at a time. According to company filings, time chartering allows the company maintain predictable revenue.

According to Eagle's filings, EGLE's competitive advantage over other bulk shipping fleets is that its ships are relatively new and newer ships means less maintenance and dry-docking fees, thus increasing profits.

Eagle has a dividend yield of 12%. Shareholders receive around 50 cents a share every recent quarter in dividend payments, amounting to $2 a year. Eagle trades at a multiple of 12, which is a premium to the industry 10, but Eagle is also growing at roughly 120% versus its peers such as DryShips (DRYS) and Genco Shipping (GSTL), which are reporting declining revenues. Eagle's gross margins are 81% versus industry's 55%. Second quarter revenues also more than doubled compared to last year, up from $10.6 million to $24.1 million.

Eagle's yield looks tempting, however it’s important to remember that Eagle is a young company, and shipping is a cyclical business. Buying Eagle just for dividends would be a mistake.

However, with a yield of 12% and the distribution of big dividends, Eagle has managed to more than double its cash since the beginning of the year. As of the end of the second quarter, Eagle had $54.5 million in cash.

Eagle is a small company no doubt, but has shown four straight quarters of decent earnings. If it can continue acquiring vessels while controlling its debt, Eagle would be a valuable income and growth stock.

Now on to my Tanker Trading Strategy. The chart below depicts the Baltic Dirty Index, an index of spot charter rates for a variety of tankers of different sizes. This chart shows spot rates going back to the mid way through ‘02.

The seasonality in tanker rates is obvious. Note, in particular, the three spikes in this chart. The spikes occur at the end of each year and the beginning of the year.

These spikes represent the seasonal effect. Demand for tankers is highest in the first and fourth quarters. Therefore, spot tanker rates are also highest in these quarters. During the summer months, day-rates reach their nadir; tanker firms often use this seasonally slow period to repair their ships or perform upgrades. After all, it makes sense to take your ships offline when there's little demand.

Most tanker companies pay variable dividends. These firms pass a good portion of their cash flows to shareholders as dividends. Therefore, in the first and fourth quarters, tanker dividends are much higher than in the summer quarters.

Dividends can be 8 to 10x higher in the fourth quarter than in the third quarter of the year. Many make the mistake of assuming that these lower dividends constitute a dividend distribution "cut." But such variability is absolutely normal.

So you can benefit from this trend by going long the industry during the first three months and short until October then long again.

Keep in mind that we're not yet in the peak season for day rates just yet. The big spike normally begins in a month or two and tops out in late December. Starting from a higher base, I believe that spike will carry significantly higher than it did last year due to strong oil demand.

Disclosure: I do not own Eagle stock.