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Freeseas: compelling risk-reward at current price

|Includes:FreeSeas, Inc. (FREEF)
Freeseas (ticker symbol FREE) is a microcap shipping company based in the Marshall Islands with offices in Greece.  As of 3/22/2010, the company had a market cap of 37.4 million USDFREE operates primarily in the handy sector of the shipping industryThis sector features smaller (and more versatile) ships when compared with the larger ships of the panamax and capesize classes

FREE reported 4th qtr and full year 2009 earnings on 3/8/2010Qtr (full year #'s in parentheses) numbers include:
  • EBITDA of 5.7 (30.3) million
  • Adj. net income 0.00 (0.27) per share
  • operating free cash flow of 3.7 (21.4) million
At a quick glance, FREE looks cheap considering it's trailing 12-month PE is 4.6.  The Baltic Handysize Index (BHSI) closed on 3/22/2010 at 1490, which represents a new 52-week high and a 30% increase YTDThe BHSI has outperformed the 
Baltic Dry Index (which is an index comprised of shipping rates in the handysize, panamax, and capesize sectors) YTD with the Baltic Dry Index only increasing by 7YTD.  

This overall rise in the BHSI over the last year has been reflected in a steady increase in FREE's new charter ratesManagement continues to have most of their fleet (~80%) in the spot marketAs a result, most of their recent charters range in duration from 30 to 90 daysAssuming that handy charter rates continue to increase, this should allow FREE to capitalize on an advantageous rate environment.  

Based on the bullish performance of the BHSI and the FREE's continued profitability, one would expect FREE's stock price to do the sameYTD, FREE is down 12compared to a 5increase in the S&P 500Furthermore, FREE's stock price has dropped from 3.60 in June 2009 to 1.25 as of March 23 2010

The question then becomes, why has FREE's stock price performed poorly while a quick check of the fundamentals all look positive?? 

I'm now going to highlight possible negative aspects of FREE.

1Significant debt due from 2010 through 2016

FREE needs to repay 15.4 (3.8/qtr), 16.8(4.2/qtr), 33.8, 14.4, 14.4, 21, and 22.3 million USD from 2010 through 2016In 2012, FREE has 33.8 million in debt due which includes a 17.6 balloon paymentOne big question mark is will FREE be able to refinance this payment, i.e. spread it over later quarters?  If so, FREE should be fine.  As stated at the top of the article, FREE generated significant cash in 2009 (21.7 million).  This would be more than enough to payoff the debt due in either 2010 or 2011As handy rates increase, free cash flow should continue to increaseFor example, for the 1st qtr of 2010, I am estimating between 14.6 and 15.6 million in revenue which should create between 4.2 and 5.2 million of free cashNet of the quarterly debt repayment, FREE should have positive free cash flow.  

2FREE Lady 51,000 USD/day charter ends in May

In 2008 at the peak of the dry baltic index, FREE entered into a 2 year charter for their handymax ship FREE Lady.  This charter ends June 2010Current charter rates for similar ships are near 30K/day.  The decrease of 20K/day translates to about 1.5 million in decreased revenues per qtrI believe, however, that recent higher charter rates FREE has obtained will offset this drop such that a lower bound for quarterly revenues for the 2nd half of 2010 remain near 15 millionThis revenue number should allow FREE to remain cash flow positive net of debt repayment for 2010.

3Larger than expected operating costs for FREE's ships

In the 4th qtr of 2009, operating expenses were about 1.2 million larger than expected.  This results in just a break even qtr (as opposed to positive net income).  If operating expenses remain at this elevated level, free cash flow and net income will be negatively impactedIn the latest quarterly conference call, management indicated that they performed a number of ship repairs/maintenance jobs, and the increase in operating qtr over qtr was a one-time issueEither you believe management or you don't.

4Political issues in Greece

Management stated in their most recent conference call that conditions in Greece have 0 impact on the company.  Again, either you believe management or you don't.

In summary, I believe that FREE is a compelling risk-reward play at these price levels.   An inability to refinance  the 2012 debt balloon payment or a drastic drop in the Baltic Handysize Index could negatively impact FREE's stock price.  However, if both of these events are avoided, FREE's stock price could more than double from it's current levels over the next year.

Disclosure: long 5000 shrs FREE
Stocks: FREEF