The dry-bulk shipping sector, without question, has been all but destroyed compared to pre-bear market years. Still, dry-bulk shipping is one of the most vital and heavily relied upon forms of transportation for global commerce. Genco Shipping & Trading (GNK) stands out as a potential value investment in a distressed industry that, in our opinion, has entered a bottoming phase.
To be fair, bears in the past have brought up valid points relative to this industry space but we believe they’re now becoming dated as global GDP continues to increase. There’s no question that strong headwinds still persist, but we stand by the belief that when one finds a bag of lemons, eventually there will come a time to make lemonade – not an eternal bitter pity party with friends.
We feel that now is the time to review the lemonade making opportunity at hand with a name like Genco Shipping & Trading in the dry-bulk shipping space.
The "Ugly Duckling" Status and Déjà Vu
In early 2009, formerly classified “investment banks” got the "ugly duckling" status, as they seemed to then be in equally dire straights as shipping looks today. Fast-forward to today and we see their stock prices as a group are trading substantially higher and they made it after all. The idea of buying Citigroup (C), Goldman Sachs (GS), and/or JP Morgan (JPM) back then was considered “crazy”, but now looks like sage action since Warren Buffett himself, the defender of value investors, went after the opportunity with Goldman Sachs. We feel that this could be déjà vu for the dry-bulk shipping space and Genco in particular.
Overly bearish sentiment relative to dry-bulk shipping now gives Genco the "ugly duckling" status. In that, no one seems to be able to see the hidden value in the industry and or Genco as it slowly turns around. Still, one of the positives about this status is that it reduces earnings expectations and allows firms to often “beat” on earnings moving forward due to extremely low expectations. As we keep seeing structurally improving economic reports, this bodes well for Genco . No one can tell if and when this will be a “swan” again, but we don’t mind waiting to find out as the global economy continues to expand.
The BDI & a Global Rebound
The Baltic Dry Index (BDI) directly measures the current demand for dry-bulk shipping capacity relative to the supply of dry bulk carriers. These carriers primarily transport raw material components for the production of both intermediate and/or finished goods. The BDI itself is viewed by many as an efficient economic indicator of future economic and production growth on a global scale. This is perhaps one of the most closely monitored “variable” relative to any shipping stock such as Genco.
To provide a frame of reference, understand that on May 20th, 2008 the BDI hit its all time high of 11,793 points. Subsequently, on December 8th, 2008 it hit its lowest point since 1986 at 683 points (94% drop from the all time high). As of February 4th, 2011 the BDI is at 1,043 and looks to be creating a multi-year bottom. We feel that the probability of the BDI substantially dropping again is low. In addition, Genco manages the short-term volatility of the BDI by contracting its fleet out over multiyear periods.
Over the next 12 months we are forecasting a continued moderate global GDP given the low it’s coming off of and the cheap cost of capital. Further, with the recovery of key developed countries such as the US and Germany, it seems unlikely that the global economy is about to start faltering again. For the first time in years we are watching both the developed world and emerging markets (BRIC countries) grow again simultaneously. What all this equates to, in our opinion, is the potential for “better than expected” top and bottom line growth for Genco .
Valuation Method and Modeling Method
In our opinion, the fair value of Genco Shipping & Trading is $25/share. Its closing price this past Friday was $12.05/share. The fair value is derived from our proprietary arbitrage model. Arbitrage opportunities worth investigating are rare, but Genco definitely fits the mold. These unique situations are created when one or more markets temporarily misprice assets. Remember, Mr. Market is not known for being rational in nature and or being derived from rational investors.
Genco’s current breakup value (net book value) is $31.27. The equation to determine the net book value of any firm, including Genco , is total assets-total liabilities-preferred securities divided by the diluted # of shares.
Net Book Value on Genco Shipping & Trading
Net Book Value:
Key Statistic Financial Highlights:
|Profit Margin (ttm)||34.26%|
|Operating Margin (ttm)||51.43%|
|Return on Assets (ttm)||4.9%|
|Return on Equity (ttm)||14.50%|
|Quarterly Rev. Growth (ttm)||27%|
|Quarerterly Earnings Growth (ttm)||5.7%|
Warren Buffett once said to “be greedy when others are fearful and fearful when others greedy.” Still, not all companies are built equally and this is why Genco sticks out. Arbitrage opportunities can take time to pan out depending on how quickly the market “fixes” the asset pricing error and we like to wait it out with a firm we feel confident in. Further, this is why we did not provide a timetable or apply our proprietary DCF pricing model. At this point, Genco’s currently depressed valuation of $12.05/share seems unwarranted.
As of January 14th, 2011 there is currently a 15.3% short float on Genco . Given that quarterly revenue growth was 27% and quarterly earnings growth was 5% for the last reporting period we find it a little odd that someone is looking to pick a bone with Genco. Regardless, if this stock starts to recovery quickly we could witness a short squeeze given the small share float in this stock.
- For the first time since before the bear market, we see both developed and emerging markets growing at the same time. This should equate to an increased and sustained demand for dry-bulk materials, ranging from iron ore to coal to grain. The likely effect is a drive up in daily shipping rates along with Genco’s revenue and profit growth numbers.
- Genco has continued to maintain strong liquidity levels on its balance sheet through this last recession and weathered the storm much better than many of its competitors. The firm currently holds an Acid-Test Ratio (Quick Ratio) of 2.63, meaning it won’t have any issue paying immediate liabilities moving forward.
- Bearish sentiment on Genco and the whole shipping space is almost palpable. Currently 9 out of 14 independent research providers we reviewed have a recommendation of “hold” or lower. We see this as an opportunity to go against the grain of Wall Street. Low expectations should make it easy for the firm to “beat on earnings” and attract positive attention provided it illustrates meaningful improvement.
Risks and Headwinds
Genco strongly correlates with the same boom and bust cycles that the global economy provides. Another point of debate and risk is in relation to the amount of new ships coming online, which looks to have further depressed daily shipping rates. No one can truly say how long it will take to potentially absorb and offset the new supply of ships now entering service.
This leads into the next area of risk which deals with its ability to renegotiate competitive contract rates given the current Baltic Dry Index (BDI) levels. The recovery of this industry and the company is dependent upon the global economy, with an emphasis on emerging markets, to sustain their current demand levels for dry bulk materials.
Last, the recent bankruptcy of Korean shipping company Korea Line illustrates the fact that only the strong survive in this industry. Those who cannot navigate and or prepare for rough economic conditions face the worst-case outcome.
Financial Health and Analysis
We feel that Genco’s financial health is fair. It has continued to generate a profit through operations despite the severe downturn in the economy that we just went through. As well, it discontinued its dividend in the downturn in order to strengthen the liquidity on its balance sheet. It now stands with an Acid Test Ratio (Quick Ratio) of 2.3 and manageable debt levels. We see it having no issue handling its immediate and upcoming debt obligations.
The only black eye deals with the renegotiation of its debt agreements in 2009 due to the violation of vessel value/loan covenant terms. We weren’t surprised given the terms of the covenant, the global economic collapse that we saw, and the free fall (94% down from the all time high in 2008) in daily shipping rates. Some competitors were not as fortunate in relation to the same issue such as DryShips (DRYS), which had to dilute shareholders numerous times. Moving forward, we feel that Genco continues to sail a sound ship and that it should be able to continue navigating these improving times without financial strain.
Robert Buchanan, CEO, is a veteran of the shipping industry with over 40 years of experience, six of which are with Genco starting in 2005. John Wobensmith, CFO, has comparable experience with over a dozen years of work experience in the arena of shipping finance. Salaries for these two have remained reasonable over the years, and what sticks out in a favorable manner is that a large part of their compensation comes in the form of restricted stock. Directors receive similar compensation packages that involve equity grants that further align interests with common shareholders.
Overall, we feel management looks good and that there are no areas of extreme concern that warrant further discussion and or analysis.