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On May 20, 2008, the Baltic Dry Index (BDI) hit an all time high of 11,793. Not surprisingly, the market values of dry bulk vessels were also close to maximum. A brand new capesize could be sold for $150 mln, while a new panamax was worth about $100 mln.

It is quite well known what happened afterwards. BDI crashed and never recovered, just like ship prices. By December 10, 2010, BDI was at 2,095, a new capesize could easily be bought for $63 mln. and a new panamax cost less than $45 mln.

Indeed, the dry bulk shipping sector was not the best place to invest on May 20, 2008. Let’s have a look at how pure US listed dry bulk shipping stocks fared since that time.

Company

Total return, including dividends

Excel Maritime Carriers, Ltd (NYSE:EXM)

-89%

Genco Shipping & Trading Limited (GNK)

-78%

Navios Maritime Partners (NYSE:NMM)

+81%

Navios Maritime Holdings Inc. (NYSE:NM)

-56%

FreeSeas Inc. (NASDAQ:FREE)

-89%

Eagle Bulk Shipping Inc. (NASDAQ:EGLE)

-83%

Diana Shipping Inc. (NYSE:DSX)

-60%

TBS International Plc (NASDAQ:TBSI)

-94%

Star Bulk Carriers Corp. (NASDAQ:SBLK)

-74%

Paragon Shipping Inc. (NASDAQ:PRGN)

-79%

How could NMM show such a solid return in a dismal sector? Was it so significantly undervalued in 2008? Maybe the management of this company made something extraordinary to enhance shareholder value? Or maybe it just has become extremely overvalued compared to peers now?

First, let’s have a look at current valuation of NMM. It is quite easy to calculate NAV of this company at current market prices. This company outsources everything, including financial and technical management to its parent, Navios Maritime Holdings Inc. (NM), so the assets of this company consist only of cash, other current assets shown in the balance sheet, its fleet at market prices and the value of charters above the market. As of September 30, 2010, the fleet of NMM consisted of:

Ship type

Name

Year

Market price

Fair value of time charter

Panamax

Navios Gemini S

1994

24

8.6

Panamax

Navios Libra II

1995

25

0.5

Panamax

Navios Felicity

1997

27

8.6

Panamax

Navios Algeria

2004

35

0.6

Panamax

Navios Galaxy I

2001

32

12.5

Panamax

Navios Hope

2005

37

0.1

Supramax

Navios Apollon

2000

26

6.1

Panamax

Navios Prosperity

2007

0

3.7

Panamax

Navios Aldebaran

2008

0

8.5

Panamax

Navios Saggitarius

2006

39

22.4

Panamax

Navios Hyperion

2004

35

24.2

Capesize

Navios Aurora II

2009

62

41.3

Capesize

Navios Pollux

2009

62

37.9

Capesize

Navios Fantastiks

2005

55

10

Total

459

185

Market values are based on recent assessments of shipbrokers and value of time charters are calculated as the discounted cash flow of the difference between the charter in place and expected spot rates based on the Freight Futures Agreement (FFA) market.

The net debt of the company as of 09/30/2010 was $250 mln. So, marked to market NAV per unit as of 09/30/2009 was (459+185-250)/44.2 = $8.91 per unit.

So, NMM is currently trading at more than 100% premium to NAV! Some peers in absolutely the same business, like DSX and BALT, are trading at a discount to NAV, but nevertheless, there are investors willing to overpay twice for NMM. No wonder, the management is taking every opportunity to issue more units. Why are they able to sell such expensive units like hot cakes?

There are two reasons in my opinion:

First is the hefty dividend yield of 8.6% looks quite impressive. How can a stock trading at more than 100% premium to NAV afford to pay 8.6% in dividends? Is dry bulk shipping such a profitable industry to generate cash flow of 17.2% from the assets in market prices? The answer is no, of course. NMM can continue to pay this kind of dividend as long as it has time charters, signed during the dry-bulk boom of 2007-2008. Once these charters expire, cash flow generated from operations will adjust to normal.

As an example, a couple of charters ended this year. Navios Libra II started to earn $18,525 a day vs $23,513 from November and daily earnings of Navios Alegria decreased to $16,984 from $23,750 in December. Out of 14 time charters for the fleet of NMM as of 30/09/2010, 3 expire in 2012, 3 in 2013, 4 in 2014, 2 in 2018 and 2 in 2019. For the next couple of years, the dividend is safe, but what is going to be after? FFA market tells that the rates are going to be significantly lower. Calendar 2013 and 2014 futures for panamaxes are currently trading at $15,500 vs. average rate of $25,362 that 10 panamax vessels in NMM fleet earned in 3Q, 2010.

Nobody can predict the future but what is certain is that the return for a dry bulk vessel without the charter will be the same in 2014, regardless of whether it belongs to NMM or BALT. So, buying BALT for a half of price of NMM will return twice as much.

NMM management is trying to soften the effect which falling charter rates are going to have on its earnings in 2013 and 2014. However, what they are doing resembles some kind of ponzi scheme. A classic ponzi scheme raises money from new investors, just to keep it in the bank and use it to pay dividends or other form of return to existing shareholders. NMM took a more innovative approach. It regularly raises money from new investors and invests half of it in new ships and another half to acquire above-the-market time charters, which are nothing but certain periodical payments for several years guaranteed by an “AA+” rated governmental agency of a European Union member state”, like they state in their financial reports. These payments are used to pay dividends. Once such payments end, investors get nothing but the usual return from shipping assets.

They did not even try to hide this in their financial reports. These above-the-market charters were recognized in financial reporting as favorable lease terms or intangible assets. For example, in Q3 report, we can read:

On January 8, 2010, Navios Partners purchased from Navios Holdings, the vessel Navios Hyperion for a purchase price of $63,000. Favorable lease terms recognized through this transaction amounted to $30,662 and were related to the acquisition of the rights on the time charter out contract of the vessel (see note 5) and the amount of $32,338 was classified under vessels, net.

On March 18, 2010, Navios Partners purchased from Navios Holdings, the vessel Navios Aurora II for a purchase price of $110,000, consisting of $90,000 cash and the issuance of 1,174,219 common units to Navios Holdings. The number of the common units issued was calculated based on a price of $17.0326 per common unit, which was the NYSE volume weighted average trading price of the common units for the 5 business days immediately prior to the acquisition. The per unit price at the day of the delivery was $17.31. Favorable lease terms recognized through this transaction amounted to $42,524 and were related to the acquisition of the rights on the time charter out contract of the vessel (see note 5) and the amount of $67,802 was classified under vessels, net.

On May 21, 2010, Navios Partners purchased from Navios Holdings, the vessel Navios Pollux for a purchase price of $110,000, paid in cash. Favorable lease terms recognized through this transaction amounted to $37,979 and were related to the acquisition of the rights on the time charter out contract of the vessel (see note 5) and the amount of $72,021 was classified under vessels, net.

So, in the first nine months of 2010, NMM spent $283 mln. on new acquisitions. Out of this amount, $172 mln. was spent on vessels and $111 mln. was the payment for the cashflow to be used for future dividends. The source for these investments was the new public offerings, of course.

The second reason for such a spectacular performance of NMM is not in the business of this company, but rather in its name. Apparently, it was a brilliant idea to call a usual dry bulk shipping company a Master Limited Partnership (MLP).

According to Investopedia.com:

Master Limited Partnerships (MLPs) are unique investments that combine the tax benefits of a limited partnership (LP) with the liquidity of common stock. An MLP has a partnership structure but issues investment units that trade on an exchange like common stock. The modern form of MLPs was defined by the Tax Reform Act of 1986 and the Revenue Act of 1987, which outline how companies can structure their operations to realize certain tax benefits and define which companies are eligible. In order to qualify, a firm must earn 90% of its income through activities or interest and dividend payments relating to natural resources, commodities or real estate.

Due to association with energy and other natural resources, as well as tax structure and resulting high yield, MLPs drew significant interest from investors in recent years. There appeared a lot of mutual funds and ETFs dedicated to MLPs.

The vast majority of MLPs are US based pipelines, mines, and other energy and natural resources enterprises that, as result of being limited partnerships, do not pay corporate income tax and work as pass-through entities having to pay all their income as dividends to investors.

However, NMM is not a US entity. It is a Marshall Islands limited partnership. In the Marshall Islands, it makes no difference whether it is a limited partnership or a corporation. The tax rate is going to be the same – zero. Most other US listed companies in the dry bulk segment are Marshall Islands corporations, so they have no difference from NMM at all. The pay the same tax – zero and they operate in the same business – to own and to lease ships. However, to call itself an MLP made a huge difference.

NMM management regularly takes part in different events for MLP investors and is clearly having great success. For example, the latest press release of NMM is called Navios Maritime Partners L.P. to Present at the Wells Fargo Pipeline & MLP Symposium.

It is enough to have a look at the top fund holders of NMM:

  • Kayne Anderson MLP Investment Company
  • Kayne Anderson Energy Total Return Fund
  • Kayne Anderson Midstream/Energy Fund
  • Kayne Anderson Energy/Development Company
  • Cushing MLP Total Return Fund
  • No other shipping company has such investors among its largest shareholders.

In fact, Kayne Anderson Fund Advisors, an investment boutique company specializing in ETFs dedicated to MLPs, bought the majority of the last public offering, apparently because they wanted to diversify their MLP holdings from pipelines. It would really be interesting to find out the reasons for Kayne Anderson Fund Advisors' investment in NMM, having no other shipping companies in the portfolio.

And finally, my advice to NMM unitholders:

If you own NMM because you think it is a solid long-term investment with high yield, you should sell. The dividend is safe for the next two or three years, but your investment is in danger. In fact, if the market is valuing dry bulk ships correctly, you are likely to lose half of your investment in the long run.

If you think that freight rates are going to increase by the time NMM charters expire, you should sell NMM and buy other dry bulk shipping stocks which are trading at a half-price compared to NMM. BALT or DSX are good candidates. In fact, in comparison to NMM, any other bulker will be a great investment. NMM is just too expensive.

If you really need high yield, buy some high-yielding bonds. In this case you will get your quarterly payments and, at the same time, much more likely to get the principal as well.

If you think the strategy of NMM management to run a kind of ponzi scheme and to attract MLP investors will continue to work, and also believe in the greater fool theory, then you should hold NMM. It may work out, just do not forget to sell at the right time.

Source: Skeptical of Navios Maritime's Success: Beware Dividend Longevity and MLP Status