There are rare instances when a stock returns 200% or 300% in a year. American Shipping Company (OTCPK: OTCQX:ASCJF) and Oslo "AMSC" has given returns of 320% over the last 13 months. There are strong fundamental contributors to the rally and this initiating coverage discusses the positive factors related to the company and industry, which will help the positive sentiment to sustain. At a current market price of $8.07 and a market capitalization of $490 million, American Shipping Company is a good buy and hold with a long-term investment horizon.
Established in 2005, American Shipping Company owns and bareboat charter out US built product tankers to US citizen operators, who in turn time charter out the vessels in the US domestic Jones Act market in a profit sharing arrangement with AMSC.
The business model helps generate a stable cash flow from long term bareboat charters protected from short term market fluctuations, with upside potential through profit sharing arrangements with the charterers. This will be clearer when the company's current operations are discussed.
AMSC currently owns ten modern 46,000DWT MR product tankers built at Aker Philadelphia Shipyard (OTCPK: OTC:OTCPK:AKRRF). All ten vessels are on long term fixed rate bareboat charters with Overseas Shipholding Group (OTCPK: OSGIQ), together with a profit sharing agreement with Overseas Shipholding.
Reasons For The Rally
On looking back at the stock price for American Shipping Company, a major rally started in April 2013 and the momentum still sustains. There are few important factors that the market participants were looking for. As the outcome of these factors was clear, the stock surged.
Factor One - American Shipping Company continued to receive payments from Overseas Shipholding, there were uncertainties related to a potential bankruptcy of Overseas Shipholding. For the same reason, the stock did not see any upside in 2012 even with robust revenue and EBITDA inflow.
It was in November 2012 that American Shipping Company officially announced the bankruptcy filing for Overseas Shipholding. While the stock got listed in the OTC exchange in April 2013, the announcement of the bankruptcy cleared the uncertainties and the stock surged from NOK0.9 to NOK5.5 in the Oslo exchange.
Factor Two - After the announcement of the bankruptcy, American Shipping Company released an all important notice to investors in January 2013.
This was important as the company confirmed in the notice that Overseas Shipholding has continued to make all charter payments to the company on time. With clarity on the bankruptcy and the payment status, the stage was set for the rally, which commenced in April 2013.
However, the major upside came in May 2013 when American Shipping Company released its first quarterly report after the bankruptcy announcement and this was the first financial confirmation of the continuity in business and payments after the bankruptcy. From levels of $1.92 on May 07, 2013 (date of result announcement), the stock surged to $5 by December 2013. This was the first phase of the rally when the stock surged by 160%.
Factor Three - The positive new inflow continued in 2013 with American Shipping Company announcing a recapitalization plan in December 2013. While I will discuss the recapitalization benefits later in the article, the summary of the positive outcome was higher financial flexibility coupled with increased scope of dividend payments after recapitalization.
After the successful completion of the offering in December 2013, the stock has surged by 61% to $8.07 from $5 at the beginning of December 2013. American Shipping Company also announced its first quarterly dividend in May 2014 and this has helped the bullish momentum to sustain.
Reasons For Rally To Sustain
Factor One - While the stock has surged over the last one year, the relative valuation indicates that the rally can still sustain. The valuation is discussed later in the thesis. Further, the company announced its first dividend in May 2014. I believe that as the dividends sustain, investors will view this stock with greater interest as a healthy dividend yielder.
Factor Two - The positive impact of an increased financial flexibility still needs to be discounted in the stock. The company is already in negotiations with Aker Philadelphia Shipyard for a potential delivery of more vessels in 2016-17. If this negotiation is through, the stock will be set for a renewed rally on revision of growth estimates.
Factor Three - The industry factors are positive with increasing day rates. This factor is discussed later in the thesis. However, as day rates trend higher, there will be upside revisions to the EBITDA and the valuation.
Industry Overview And Positives
I mentioned in the company overview that the company's operating vessels are under the Jones Act. Before moving into the company specific positives, I will briefly discuss the act and the advantages for American Shipping Company under this act.
To own a Jones Act-qualified vessel, the Company must as a "qualified leasing company" meet the following requirements:
- The Company must be a leasing company that does not operate any vessel for hire, is not affiliated with any company that operates a vessel for hire and is independent from and not affiliated with any charterer of the vessel
- The vessel must be owned, which implies that title must be held, by a company formed under US laws, that has a US citizen as its CEO and Chairman of the board of directors and no more than a minority of a quorum of its board of directors that are not US citizens; and
- The vessel must be bare boat chartered-out for at least three years to a "coastwise-qualified citizen" (a company that satisfies the U.S. citizenship requirements to operate a vessel in the U.S. coastwise trade).
I mentioned these points to underscore the key positive of high barriers to entry as a result of the Jones Act. The limitation on foreign owned or constructed vessels protects the US point-to-point maritime shipping market from foreign competition and American Shipping Company enjoys this advantage.
To add to the positives, only two shipyards in the United States are actively building Jones Act tankers and have a favourable industry reputation and a track record of delivering Jones Act tankers at competitive prices.
Currently, the capacity at the two U.S. shipyards currently able to build product tankers is nearly fully utilized through 2017, with 11 tankers on order, and a limited number of options available. This limits the risk of oversupply in the industry and should help keep the day rates firm.
I must mention here that the number of Jones Act qualified tankers in the US have declined from 48 in 2009 to 32 in 2013. This decline is likely to continue with 19% of the existing tankers being older than 28 years.
With more stringent environment regulations in the US, the older tankers need to be retired. From this perspective, American Shipping Company has a significant advantage. The company's fleet is just over five years in age and is well equipped to compete in the current market.
Besides the high barriers to entry and the young fleet advantage, the sustained demand for Jones Act vessels is the key factor. The shale oil is the game changer for American Shipping Company. Crude oil production in the US has increased from 5.7 to 7.3 million barrels per day from 2011 to 2013.
The production is further expected to increase to 8.1 million barrels per day in 2014. As crude production increases, costal shipments are also on an increase with oil companies moving crude to domestic refineries. The day rates are therefore likely to remain firm in the medium to long-term as the forecasted production increase (2013-24) is expected to be 114%.
Stable Revenue Inflow Business Model
The company's business model is to generate a stable cash flow from long term bareboat charters. This shields the company from short-term market fluctuations. As of December 2013, all the vessels were on a fixed bare boat charter to Overseas Shipholding until 2019, with evergreen renewal options. Overseas Shipholding has time charter agreements with large US oil companies and this ensures steady revenue inflow.
As of December 2013, the fixed charter agreement with Overseas Shipholding ensures that American Shipping Company has a leasing backlog of $523 million. The profit sharing contribution comes in addition to the fixed bare boat charter revenue.
To put the revenue and cash flow potential into perspective, I will consider the average day rate for 2013 at $70,000 for the forecast for 2014.
The table below gives the sensitivity analysis as per the company for the ten vessels at different day rates. I must mention here that while the bare boat charter is fixed, American Shipping Company receives 50% of the profits generated by Overseas Shipholding under the contract. This implies that an increase in day rates will have a direct impact on the profit share with the bareboat remaining the same.
Therefore, even assuming a stable day rate of $70,000 over the next five years, American Shipping Company is in line to generate an annual EBITDA of $123 million or a five year consolidated EBITDA of $615 million. This is certainly a conservative estimate considering the industry dynamics. I do believe that the day rates would continue to trend higher over the next five years and the EBITDA will continue to trend higher.
From an investor's perspective, the biggest positive is the cash flow certainty, which translates into a stable dividend outflow. American Shipping Company announced its first quarter dividend of $0.1 in the first quarter of 2014. This translates into an annual dividend of $0.4 and a healthy dividend yield of 5.0% considering the current stock price of $8.07.
Valuations Still Attractive
Even after a massive rally of 320% over the last 13 months, forward valuations still remain attractive for American Shipping Company. The primary reason is that the stock was significantly depressed in early 2013. Therefore, the rally does look significant in percentage terms, but the stock still have upside potential.
Considering an EBITDA of $123 million for FY2014 at a day rate of $70,000, American Shipping Company is trading at FY2014 EV/EBITDA multiple of 9.0. I must mention here that the cash and debt numbers for calculation of EV are as of March 2014 and the cash includes the $120 million in new equity raised through private placement.
While Kirby Corporation (NYSE:KEX) is among the larger players, it can still be considered for peer valuation in absence of any same size competitor. Kirby currently trades at a 2014E EV/EBITDA of 11.08. Teekay Tankers is also trading at a relatively higher 2014E EV/EBITDA of 11.82. In other words, American Shipping Company still has upside potential of 27% based on the valuation gap.
My opinion is that as day rates inch higher, American Shipping Company will see further stock upside. A stable cash inflow along with a good dividend yield also makes the stock attractive as compared to Teekay Tankers and Kirby. The 27% upside potential can therefore be considered as a base case scenario and the upside can be more meaningful if day rates inch higher.
The Recapitalization Boost
In the first quarter of 2014, American Shipping Company completed the recapitalization process, which strengthens the capital structure and provides some long-term benefits.
American Shipping Company raised almost $170 million as a part of the process. This includes a $120 million private placement, a $29 million subordinated debt conversion and an $18 million subsequent offering. With the closure of this recapitalization, the company's equity ratio has improved from 7% to 20%.
Further, the company also obtained the approval to extend the maturity of a bond to 2021 and this removes a potential hurdle to refinance the bank debt by 2015-16. The dividend payment is also a result of the recapitalization effort, which has increased the company's financial flexibility.
Post the current recapitalization, the company's leverage is likely to decline to 6.1 by the end of 2014 as compared to a leverage of 9.5 at the end of 2013. American Shipping Company is therefore in a better financial position to capitalize on the continuing growth in the industry.
With a stronger capital structure, the company is already in negotiations with Aker Philadelphia Shipyard for potential addition of vessels in 2016-17. Should this happen, the stock will have a new upside trigger.
The most important risk factor to mention is the Chapter 11 bankruptcy filing by Overseas Shipholding. I do believe that this risk is already incorporated in the stock price as Overseas Shipholding filed the bankruptcy petition way back in November 2012. However, the implications are important to discuss as it clears the doubts related to investing in American Shipping Company.
The first point to mention here is that Overseas Shipholding continues to operate its business and make payments to American Shipping Company while it pursues its options for reorganization. Under the bankruptcy laws, there are three possible outcomes -
- Overseas Shipholding may assume the vessel charters and it would agree to continue to perform under the terms of the charters.
- Overseas Shipholding may decide to reject the vessel charters and return the vessels to the Company.
- Overseas Shipholding may assume and assign the vessel charters to a third party, in which case the third party would replace Overseas Shipholding and assume all of the rights and obligations under the assigned charters and related transaction documents.
The reason for detailing the outcomes is to suggest that American Shipping Company will not be impacted by the bankruptcy of Overseas Shipholding. In the worst case scenario, American Shipping Company will have to fix the bare boat charter with another company. The stock continues to rally because the risk factor is not as troubling for the company as it seems.
American Shipping Company is likely to peruse expansion options in the foreseeable future. There is a possibility of further equity dilution if the company intends to add new vessels to its fleet. This is another factor investors might consider. On the positive side, any fleet expansion will be associated with incremental cash inflow for the company and investors.
An increase in shale shipments is one of the primary reasons for robust day rates in the industry. A decline in US or global economic activity can impact the production and shipment levels. Further, one of the factors that always cast a doubt on the shale boom is the environmental impact. Any production cap can negatively impact day rates.
American Shipping Company has witnessed a massive rally over the last one year. A strong increase in day rates coupled with a firm cash inflow visibility has fuelled the rally along with the factors discussed above.
As day rates remain firm or continue to trend high, American Shipping Company is well positioned to benefit from the incremental cash inflow from the profit sharing agreement with Overseas Shipholding.
An annual dividend of $0.4 and a dividend yield of 5% also add to the positives for a stock, which still seems undervalued as compared to other industry players. I do believe that American Shipping Company is a buy and hold for the medium to long-term.
Disclosure: I 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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