In late June 2012 shareholders of Eagle Bulk Shipping Inc. (NASDAQ: EGLE) breathed a sigh of relief for their beleaguered shipping company. Saddled with a massive debt burden in excess of $1.1 billion, the company faced the prospect of violating its debt covenants - or simply running out of cash - by the end of the year.
But when Eagle announced an outline of its amended credit agreement on June 20th, 2012, it appeared as if it had escaped from financial ruin relatively unscathed. In exchange for a higher interest margin and stock warrants, its lenders had agreed to extend the term of the loan to the end of 2015, with no scheduled loan repayments prior to its maturity.
They had also agreed to a new set of covenants to be gradually phased-in, presumably when the company would be in a position to meet them.
With a young fleet of 45 supramax size vessels (average age per vessel of 5.3 years), a market capitalization of approximately $50 million, and no apparent threat of financial trouble in the medium term, investors might be tempted to look at Eagle as a low-cost, long-dated option on a shipping industry recovery, albeit out of the money. (The stock closed last Friday at $3.00 per share, off its all-time intra-day low of $2.51.)
I like to think differently. A close look into the company's amended credit agreement - full terms of which only became available with the company's filing of its quarterly report on August 9th - points to a renewed threat for a technical default and/or a cash crunch, as early as next year.
For example, let's look at the minimum interest coverage ratio covenant. Starting on June 30th, 2013, Eagle must generate trailing four-quarter EBITDA at least 1.3 times its trailing four-quarter cash interest expense. Based on my estimate for the third quarter of 2012, Eagle will have a cash interest expense of $13.2 million. To meet the minimum interest coverage for the quarter, Eagle would have to generate EBITDA in excess of $17 million. For comparison purposes EBITDA for the second quarter of 2012 was just under $10 million.
Or look at the leverage ratio covenant. Starting on September 30th, 2013, Eagle's debt outstanding must not exceed 13.9 times its trailing four-quarter EBITDA. Based on current debt outstanding of $1.1 billion, this translates to a minimum average quarterly EBITDA in excess of $20.3 million starting with the fourth quarter of 2012, i.e. a more onerous covenant than the previous one.
Or finally look at the minimum liquidity covenant. Eagle must maintain at all times a minimum liquidity of $22.5 million (or $0.5 million per vessel). As of June 30th, 2012 the company had total liquidity reserves of $37.1 million (cash on hand of $17.1 million plus a $20 million undrawn credit facility). After taking into account an amount of $5.8 million in unpaid financing costs (related to its latest debt restructuring), that leaves the company with unrestricted cash of just under $8 million to weather the storm.
For the record, Eagle had a negative operating cash flow of $4.1 million during the second quarter of 2012. Coincidentally the spot freight market (where about 60% of Eagle's fleet operates or has exposure) has recently deteriorated below the company's operating cash break-even point of $9,800 per day.
Which brings us to the big picture. The depressed freight market that has persisted since 2010 is the result of a massive oversupply of modern vessels. Even after counting for historically high levels of scrapping activity for older tonnage, and a still robust industrial growth in emerging Asian economies, demand for raw materials just cannot keep up with the frenzy of new-building vessel deliveries still going strong.
Against these industry fundamentals, and based on my analysis of the company's financial position and amended credit agreement, I believe that Eagle is very likely to have to go hat-in-hand back to its lenders for yet another restructuring during 2013.
In the meantime, perhaps the spot freight market will exhibit short-periods of higher rates (more a result of seasonal factors, than a shift in the underlying supply-demand balance). Perhaps Eagle's share price will correspond accordingly. Investors might want to seize these opportunities and buck the trend instead.