This article is a follow up to an article published on January 21st that detailed why Navios Maritime Holdings (NYSE:NM) would not be able to acquire Navios Maritime Acquisition (NYSE:NNA) as a solution to its increasing financial enfeeblement due to the collapse in dry bulk rates and its excessively leveraged balance sheet. It is also a response against Kevin Quon's recommendation of NM Series G and H Perpetual Preferred Stock as an investment that was published on January 25. I was dismayed at the optimism expressed by some readers about the ability of NM to survive until the maturity of the 8 1/4% Senior Notes in February of 2019 and then the recommendation of the preferred stock by Kevin Quon (who has done some nice work on Solazyme (SZYM) in the past). The purpose of this article is to take a deeper dive into NM's financials and to detail the risks to liquidity during the next six months.
Over the long term, companies are forced to restructure or enter bankruptcy due to excessive leverage but the short-term trigger is usually the lack of access to liquidity, i.e. cash, to avoid defaulting on payments associated with these liabilities. The analysis of NM is complicated since its 67% ownership interest in Navios South American Logistics ("NSAL") is consolidated for GAAP purposes in its financial statements and its ownership interests in NNA, Navios Maritime Partners (NYSE:NMM), Europe I and Europe II are accounted on the equity accounting basis, also proper GAAP. The GAAP accounting treatment results in a more flattering consolidated financial picture than looking on the NM Dry Bulk segment on a standalone basis since NM does not have unfettered access to the cash flows and capital of these subsidiaries and affiliates.
The consolidated financial statements flatter to deceive and to understand what is happening in the Dry Bulk segment on a standalone basis, we need to peel back the financial onion. This is particularly important when dealing with covenants on the various tranches of the Dry Bulk segment debt such as the Incurrence of Indebtedness and Issuance of Disqualified Stock and Preferred Stock or the Restricted Payments covenants from the indenture of the 8 1/4% Senior Notes.
As discussed in my prior article, the NM Dry Bulk segment had only $86 million of cash on the Balance Sheet as of September 30th and it did not have any undrawn banklines or credit facilities that it could utilize (see Moody's downgrade report of NM issued on January 12th as confirmation of this fact). In Footnote 11 on page F-17 of the September 30, 2015 financial statements, the nine-month net loss attributable to the Dry Bulk segment is <$86.9> million and Net Earnings attributable to Logistics $13.3 million. I have used this as a starting point to calculate the cash flow losses for the Dry Bulk segment for the nine months ending September 30, 2015 and these net losses and negative cash flow figures are used as a basis to predict future net losses and negative cash flow figures further below in the article.
There were insufficient financial disclosure regarding changes in working capital for the dry bulk and logistics segments to include them in the above table but that information would not meaningfully alter the large cash flow losses that NM suffered in its dry bulk segment. Most of the information in this calculation comes from Footnote 11 of the September 30th financial statements as discussed above.
Affiliated Equity earnings are subtracted since this is a non-cash number reflecting the earnings of NNA, Navios Maritime Partners, and Europe I and Europe II (the "Affiliated Entities") accounted for on the equity basis. The Dividend from Affiliates line is the actual dividends received by NM on its ownership interests in NMM and NNA and this is the only cash that it receives from NSAL or any of the Affiliated Entities. Please note that Europe I and Europe II are cash flow negative as is NSAL, due to $110 million in CapEx between September 30, 2015 and early 2017 in business expansion projects.
Preferred Dividends are the amounts paid on the Series G and H Preferred Stocks. The Credit Facility Debt Payments is from Note 5 page F-9 of the financial statements (difference in the year-over-year balances) and is confirmed on the Consolidated Statement of Cash Flows on page F-4. The Balance Due to Affiliates is the $21.3 million disclosed on page 29 of the September 30th financial statements (6-K).
Most readers will be shocked at the cash flow losses suffered by the Dry Bulk segment. In Kevin Quon's article arguing for the purchase of the very junky Series G and Series H preferred stock (implied rating of Ca2), he incorrectly states that NM is cash flow positive. This is a common misconception about NM but the cash flow losses of the Dry Bulk segment should not be a surprise since NM on a consolidated basis suffered a nine-month decline in cash of <$74.2> million (Consolidated Cash Flows, page F-4 of the 9/30 6-K). This is despite the Logistics business earning $13.3 million (page F-18 of the 9/30 6-K) and generating cash flow of $17.7 million (see table above). NM's complex corporate structure obscures what is really happening financially in the Dry Bulk segment and it is the cash burn in the Dry Bulk segment that will trigger a liquidity crisis and force a restructuring OR bankruptcy during 2016 IF DRY BULK RATES DO NOT REBOUND DRAMATICALLY (emphasis is on this qualifier is important). The prospects of such a recovery seem doubtful. This report by BIMCO makes for grim reading. The start point of the liquidity analysis for the period October 1, 2015 to June 30, 2016 is the $86 million Dry Bulk segment cash balance at September 30 and incorporates projections of cash burn for the ensuing quarters.
The cash flow burn for the Dry Bulk Segment during Q3 2015 is presented below and is based on the information from page F-17 of 9/30 6-K.
The item that stands out is the prepayment of Management Fees recorded as Balance Due to Affiliates (i.e. NNA, NNM, and Navios Midstream Partners (NYSE:NAP)). The $17.8 million is the quarter-to-quarter change based on the disclosures in the 6-Ks for June 30 and September 30th. It had the effect of increasing Dry Bulk segment cash and decreasing Dry Bulk segment cash burn by $17.8. The true cash burn for the Dry Bulk segment was a whopping <$33.9 million> and that is the starting point for the fourth Quarter cash burn estimation.
As I noted in my prior article, NM experienced the expiration of 30 charters-out in its fleet of 59 operating vessels during the fourth Quarter (it lists 65 vessels in its fleet but six of these vessels will only enter operations in 2016). To illustrate the financial bind that management is in, I opted for revenue maximization for the charter-out renewals and assumed that all the expirations for the fourth Quarter were fixed on two-year charters-out at a 10% premium over the average of the rates posted by Alibra on December 2, 2015 unless otherwise specified on the fleet report posted on the NM website.
This assumption resulted in forecasted day rates for the vessels up for charter renewal more than $2000/day greater than if the vessels were assumed to be chartered out at the 6-month Alibra estimate, an optimistic proxy for the spot market rate. Since these renewal rates were higher than the rates on the expiring charters-out, I also assumed that the new charters occurred at the first day of the quarter as a means of boosting the favorable impact on earnings and cash flow for NM's Dry Bulk segment. These lenient assumptions resulted in an average day TCE for the 59 vessels in operation of $9,098 in comparison with the $8,570 TCE for the 3rd Quarter (page 18 of the NM third Quarter 2015 Earnings Presentation).
Assuming no commission and 100% availability during a 90-day quarter, this would result in a revenue increase of $2,806. These assumptions are reflected in the Charters-out Renewal Benefit for the Qtr Ending 12/31/15. For the Charters-out Renewals during Q1 of 2016, I used the average of the rates posted by Alibra January 13, 2016 plus a 10% premium. I also used the Alibra six-month rates to adjust revenue for NM's floating rate contracts that would suffer rate diminutions due to the collapse in the BDI. This resulted in a Charters-out Renewal decline of <$748K> for the quarter.
For Q3, I assumed there was no further impact from Charters-out and that spot rates were flat quarter to quarter. The Bunker Fuel Price Decline Benefit is calculated based on the actual Bunker Fuel Index Prices provided by bunkerindex.com. This captures the decline in bunker fuel prices during the Qtr Ending 12/31/15. For the Qtr ending 3/31/16, a bunker price reflecting a $30 oil price was used and for the Qtr Ending 6/30/16, a bunker price reflecting a $35 oil price was used (and due to the quarter-to-quarter increase resulted in a negative impact in the last quarter).
Please note that the Depreciation and Amortization, Dividends from Affiliates, and Preferred Dividends on Series G and H remained the same from the third Quarter 2015, though the preferred dividends will likely be suspended at some point during 2016. Credit Facility Debt Payments is a pro rata allocation of the Current Portion of Long-term Debt liability (page F-4 of the 9/30/15 6-K). As part of the Europe I and Europe II deal agreements, NM is contractually obligated to provide Credit Facilities to these entities to fund working capital shortfalls, see page 30 of the Q3 6-K. At September 30, NM's remaining obligation under these facilities was $4.3 million and $11.7 million to Europe I and II respectively. These entities have previously drawdown amounts under these revolvers and with the declining charter rates in the Dry Bulk and Container segments, it is likely that the remaining amounts will be drawn during the 15 months from September 30, 2015 to December 31, 2016. I have assumed the drawdowns increased during 2016 in concert with the decline in rates for bulkers and containers. The following table details CapEx.
|Qtr Ending 12/31/15||Qtr Ending 3/31/16||Qtr Ending 6/30/16|
|Dry Bulk Maint||2,500||2,500||2,500|
The CapEx budget for the NSAL business is approximately $110 million for 2016 and 2017 (page F-13 third quarter 6-K). Assuming 70% of this is debt funded, NM would need to fund approximately 67% of the $33 million in equity financing, or $22 million. Even though most of the NSAL CapEx is projected for 2016, I have assumed the equity is spread out over nine quarters. The CapEx for the new vessels is disclosed on page 23, footnote 3, of the 3rd Quarter 6-K.
NM provides Charter-out counter party default guarantees (if the charterer defaults, NM pays the revenue lost due to the default to NMM) to NMM on vessels that it dropped down into the partnership up to an amount of $20 million cumulatively across all vessels. This is detailed on page 28 of the Q3 6-K. I have assumed that no drawdowns occur on this guarantee but there is certainly risk due to the financial distress of many dry bulkers. NM also is contractually obligated to provide credit facilities of $60 million to NMM (see page 30 of the Q3 6-K). I have assumed that NMM will not need to draw on this facility.
So what are the conclusions? Despite providing for the most generous revenue assumptions by opting for a maximization of revenue strategy on the charter-out renewals and giving the benefit of the doubt on CapEx requirements and bunker fuel prices during the first two quarters of 2016, NM's estimated cash balance for the Dry Bulk segment is just below $21 million at June 30th. Locking in two-year charters will not generate sufficient revenue to stanch the cash flow bleed between September 30, 2015 and June 30, 2016 and it puts NM in the zone of insolvency (this is a legal term) during the second quarter if it cannot source additional capital or sell unencumbered assets.
In the management discussion section of the 6-K filed for the third quarter, management estimated that it had enough working capital for the next 12 months, i.e. through September 30, 2016, but that it would need to address its working capital needs during this period. Since this disclosure dry bulk rates have declined relentlessly, so my prediction that NM faces a liquidity crisis during Q2 of 2016 comports with management's comments and will surely be echoed by management in its 20-F for 2015 (which unfortunately will not be filed until April of 2016). It is highly unlikely that management opted to renew all its expiring charters-out for two-year periods at what it probably thought was the bottom of the cycle during the fourth quarter.
NM's Dry Bulk segment cash flow losses are therefore likely more than what I have estimated. In my next article, I will discuss the Indenture for the 8 1/4% Senior Notes and its impact on NM's ability to seek out financing or sell assets and the failure to meet the Loan to Value covenant under the Credit Facilities. In the mean time, do not follow Kevin Quon's advice regarding the Series G and H preferreds. Sell NM's common and preferred if you own them and seriously consider selling the 8 1/4% Senior Notes if you hold them.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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