Prior to the prolonged slump in dry bulk, Diana Shipping Inc. (NYSE:DSX) was known for its fortress balance sheet. Shipping is a notoriously cyclical sector. The under-leveraged balance sheet was intended to ensure that DSX would never be forced to sell equity on unfavorable terms at the low point of the shipping cycle. So far DSX has stubbornly refused to dilute shareholders with an equity sale. Weaker peers have not hesitated to sell stock. Safe Bulkers Inc. (NYSE:SB) finally completed a 12/9/2016 equity sale. Star Bulk Carriers Corp (NASDAQ:SBLK) sold stock on 5/18/2015, 2/9/2016 and 9/15/2016. Scorpio Bulkers Inc. (NYSE:SALT) sold stock on 6/10/2015, 3/17/2016 and 6/20/2016.
DSX stockholders might appreciate that they have not yet been diluted, but debt holders would certainly welcome an equity sale. An equity sale would strengthen the company's balance sheet and reduce risk for holders of the DSXN baby bonds. During the Q3 conference call management explained why they do not yet need to sell equity. Perhaps more importantly, the President revealed a willingness and capability to sell stock if necessary. If necessary, CEO (and largest shareholder) Simeon Palios intends to personally participate to ensure a successful capital raise. This is significant news for DSXN holders and provided the inspiration for this article. Here are the top 10 reasons to consider DSXN.
What is DSXN?
DSXN is a par $25 exchange traded debt issue that matures on 5/15/2020. It has an 8.5% coupon and interest is paid quarterly. See prospectus for additional details. At a recent price of $23.35, DSXN is trading at a cash yield of 9.1% and a yield to maturity of 11.4% (calculated from my Excel model). DSXN may be called a par starting on 5/15/2017. Call risk is not a concern with DSXN currently trading at a significant discount to par.
DSXN is a smaller issue with only $55 million par value outstanding and an average daily trading volume of approximately 5,000 shares. Limit orders and patience are advised when trading. There is also a DSX-PB cumulative preferred stock issue. Since DSXN is a debt issue, interest payments are not subject to deferral. DSXN trades at a premium as compared to DSX-PB. There is some risk that preferred dividends could be deferred if liquidity tightens further.
1. Strong liquidity.
As of 9/30/2016, DSX had cash and cash equivalents of $108 million and compensating cash balances of $23 million for total liquidity of $131 million. An additional $9.4 million cash refund was received on 12/22/2016 due to the cancellation of a ship building contract. The unleveraged ship Seattle is valued at about $24 million and is also a potential source of liquidity. See the comment on the Seattle's valuation by CFO Andreas Michalopoulos on page #10 of the Q3 conference call. Taking all of the above items into account, pro-forma liquidity is approximately $164 million.
2 . Substantial insider stock ownership.
As per this 12/13/2016 SEC filing, Chief Executive Officer Simeon Palios controls 18,793,331 shares representing a 22.2% stake. Substantial insider equity ownership is always very comforting to debt holders.
3. The dry bulk sector is improving.
While still not at profitable levels, the dry bulk sector has improved tremendously since the Baltic Dry Index bottomed at historical lows in Q1 2016. DSX has rallied over 85% since hitting an all time low of $1.95 on 2/12/2016. SB, SALT and SBLK have all more than tripled off their Q1 2016 lows.
4. Minimal capital expenditures.
CFO Andreas Michalopouloson discusses remaining capital expenditures in response to analyst questions on the Q3 conference call (see page #9):
"Actually the CAPEX for new buildings is $68.4 million remaining. So as you probably know, the equity on that is not going to be very substantial because we have a loan with China Export Import Bank and this loan is going to -- is at 70% of the market value ..."
As noted above, most of the remaining $68 of million capital expenditures was expected to be covered by a loan from the China Export Import Bank. In response to a follow-up conference call question by analyst Jonathan Chappell, the expected China Export Import Bank loan amount was estimated as $46 million. Therefore, the expected cash requirement for the remaining capital expenditures was approximately $22 million as per the Q3 conference call discussion.
As per this 1/4/2017 press release, the actual cash portion of the capital expenditures turned out to be far less than expected. $57 million ($11 million more than expected) was provided from the China Export Import Bank loan. More bank financing is indicative of rising ship market values. As per this 12/21/2016 press release the total price of the 2 vessels was reduced by $2 million. Therefore, only approximately $9 million in cash was required take delivery.
5. Moderate balance sheet leverage.
The DSX financials show approximately $1.1 billion in shareholder equity. However, this is a largely meaningless number. The book value of ships that is used for accounting purposes does not correspond to their true market value. The ratio of (equity market capitalization) / (total enterprise value) provides a more accurate market based measure of balance sheet leverage. The total enterprise value includes net debt and preferred stock.
DSX has an equity market capitalization of $304 million and a total enterprise value of $803 million. Equity represents 38% of the total enterprise value. SB is far more leveraged. The $106 SB equity market capitalization accounts for just 14% of the total enterprise value including net debt and preferred stock at par value. DSX is slightly less leveraged than SBLK. SBLK has a $348 million equity market capitalization that accounts for 35% of the total enterprise value.
6. An equity sale could raise over $60 million.
The amount of cash that a company can raise in an equity offering is highly dependent on its current equity market capitalization. An equity raise of 20% - 30% of the current market capitalization is typical. With a current market capitalization of approximately $304 million, DSX should be able to easily raise $60 million if necessary.
Contingency plans for such an equity offering were discussed by President Anastasios Margaronis on the Q3 earnings conference call (see page #10):
"...it should be clear to everyone is that -- the main shareholder is going to participate in any equity offering if it happens after a year from today or a year and a half. And he is not -- we are not resisting in diluting the shareholders and Mr. Palios. We are resisting in diluting the shareholders because even if it was to be an equity offering today Mr. Palios was going to participate."
7. An equity sale could facilitate bank concessions.
Peers such as SB, SALT and SBLK have been successfully able to negotiate bank concessions such as relaxing debt covenants and pushing back some principal repayments. DSX failed to get similar bank concessions. Banks are more willing to provide such concessions in conjunction with a capital raise.
8. Small issue size reduces refinancing risk.
The $55 million par value of DSXN makes it much smaller than the DSX common stock which has an equity market capitalization of $304 million. DSXN is also a small issues as compared to the company's current liquidity (see item #1). Smaller debt issues are easier to refinance at maturity. Refinancing risk is low.
9. Near term debt maturity reduces interest rate risk.
Many income investors are concerned about owning long debt maturities and perpetual preferred stock in today's rising interest rate environment. This is not a concern for DSXN holders, given the 5/15/2020 maturity.
10. Experienced management team.
DSX went public in a 2005 IPO and has survived past down turns. The company has a seasoned management team and a reputation for being conservative. DSX did not expand as aggressively as peers such as SALT and SBLK.
What are the major risks?
Dry bulk shipping rates have been recovering but could be harmed by factors such as a global trade war or a recession. DSX has very experienced management, but its still possible that they could misjudge and wait too long to sell equity if the downturn worsens.
DSXN offers an attractive 11.4% yield to maturity. Debt interest payments offer added safety as compared to preferred stock dividends. The dry bulk sector is still challenging, but it has recovered substantially since bottoming in Q1 2016. While Diana Shipping may survive the downturn without raising capital, they are clearly willing and able to raise capital if necessary. This reduces credit risk for DSXN.
Note: My Panick Value Research Report is focused on high-yield preferred stocks, exchange traded debt issues and other undervalued high-yield opportunities. Members receive an advance look at all my articles as well as continued coverage. DSXN was added as a pick at $20.65 on 12/8/2016. Readers are invited to check out the 2-week free trial in the Seeking Alpha Marketplace. Act now as the free trial offer will end shortly on 1/15/2017. Please read our outstanding subscriber reviews here.
Disclosure: I am/we are long DSXN, SB, SALT, SBLK.
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.