Genco Shipping & Trading (GNK) reported numbers that missed Wall Street earnings estimates. Imagine how simple the world of investments would be if it were as clear-cut as beat, met or missed estimates but unfortunately it’s not. After all, if everything were this straightforward then Genco’s stock shouldn’t have jumped up 6.77% following the next two days of trading (roughly 6% alpha over the S&P 500) after reporting a “miss” on its quarterly earnings.
Now is the time to read in-between the earnings lines to find out what Genco’s numbers are actually telling the investment community. We aren’t about to be thrown off the hot trail of this incredible value stock that operates in a distressed industry. After reviewing Genco’s latest earnings numbers we have indentified three new reasons why we remain bullish on this firm and continue to list it as a BUY.
1. Behind the Earnings Mask
Genco did miss earnings for the quarter but we see a couple bright spots illustrated in the numbers moving forward. First, fourth quarter revenue increased by 35%, to $129M compared with Wall Street’s expectation of $127.2M, which is spectacular. Most shipping analysts and bears on the industry have continued to argue that the flood of new ships “will” make it a very difficult business environment for shipping companies such as Genco but the numbers tell us otherwise. Instead, they are pointing to a strong pick up in business due to the continued strength of the global economic recovery.
In our opinion what made Genco miss earning was the increase in fixed costs as it dramatically expanded the size of its fleet. This increase in costs though didn’t seem to impact the firm too heavily as it still managed to generate $4.07 in diluted earnings per share for the full year of 2010. As well, operating cash flow numbers and liquidity levels continue to be strong, which makes us believe that Genco continues to be well positioned for any short-term contract volatility and a top operator in the industry.
The 4th quarter revenue numbers in our opinion largely ended the debate about how much new ships will be affecting overall demand for 2011. The short-term issue that remains now is pricing power due to the amount of new ships coming online. The pricing power of Genco isn’t going to strengthen overnight and at this point we feel this fact has been priced into the company. As well, with a mind blowing pace 35% revenue growth and an improving global economy it’s only a matter of time before bottom line growth catches up with top line growth.
2. Turning Sour Lemons Into Lemonade
The shipping industry may still be rough but Genco is looking to turn lemons into lemonade based off of positive guidance by management. In addition, we like the fact that firm management has implemented a more responsive contracting strategy given the volatility in the spot market. Historically, Genco has preferred to lease its ships on staggered multi-year contracts to provide more earnings stability. In the past this helped the firm weather the economic storm better than competitors such as DryShips (DRYS) but the times have again changed. Now firm management is opting for more short-term contracts as it sees an upward bias in the spot market moving forward. Given the fact that the Baltic Dry Index, a proxy for daily-shipping rates, remains at all time multi-year lows we agree with their view and like the fact that it isn’t tying up its fleet on bare-bone contracts. Management pointed as well that that these new contracts hold options by which Genco can hike the rate above spot market prices if it wishes to. This means the firm could have more pricing power in 2011 should shipping rates increase a fair amount. The take away point here is that management continues to capitalize on rates be they low or high while keeping the firm nimble based off of global economic conditions.
3. Blue Light Special in the Shipping Aisle
With Genco having reported earnings we can now take a more up-to-date look at its valuation based off a few different multiples. One of the bread and butter price multiples in our opinion is the price/sales ratio. Currently Genco holds a moderate price/sales ratio (P/S Ratio) of 1 while its historical 5-yr. average is 3.4 and the S&500 (SPY) stands at 1.4. Next we looked at the forward price/earnings ratio (forward P/E Ratio) which came out to be only 2.8 while the S&P 500 is 15.7. The third and final ratio we reviewed today is Genco’s 1.6 Price/ Cash Flow ratio (P/CF Ratio). Based off these valuation multiples we feel that Genco continues to be undervalued, is currently pricing like some blue light special item, and that it’s only a matter of time till the market becomes bullish on the company again.
Without question Genco is going to be a bumpy ride but in our view the direction is going to be upward. This firm has gone through a full global economic collapse and is now finally seeing the light at the end of the tunnel. Further, with low valuation multiples any real positive news is going to go a long way given the fact that 14 out of the 16 analysts who cover this company either rate it as a sell or hold. If you would like to read a more in depth review of Genco check out Genco Shipping & Trading: Value Investment in a Rebounding Industry.
Disclosure: I am long GNK.