Diana Shipping: Expect More Tender Offers And Buybacks

Summary

• Diana Shipping has completed four tender offers since late last year.
• Older ships have been sold to fund the buyback.
• The tender offers have not increased balance sheet leverage.
• Tender offers with a fixed price and firm end date represent a shareholder-friendly buyback strategy as it reduces the odds of overpaying.
• Investors should expect more ship sales and tenders in the future.

Introduction:

Diana Shipping Inc. (NYSE:DSX) is a dry bulk transportation company headquartered in Greece. As of June 2019, it operates a fleet of 45 ships which range in size from relatively small Panamax and Kamsarmax vessels to large Capesize and Newcastlemax ships.

Here at Contra the Heard Investment Letter, we own the company at an average price of $3.86. DSX caught our attention when the industry fell from darling to dog between 2012 and 2015. Unlike many of its peers, however, the entity had a relatively clean balance sheet, had engaged in low dilution over time, and had shorter depreciation assumptions. Insider ownership was also significant, and management structured the enterprise to generate more predictable revenue streams than many competitors. Instead of chartering vessels at spot market prices, charters are set at a fixed price. This means revenues are more stable; they are basically hedged for the duration of the time charter contract. In addition to using fixed price charters, contracts across the fleet are staggered over time to further smooth out the revenue.

Moreover, the executive team appeared to have a clear strategy for different market environments, whether good or bad. As a result, we bought the stock thinking that the combination of a (relatively) strong balance sheet, fixed-price time charter revenues, and a competent c-suite would result in solid returns when the sector recovered. Shipping has not yet recovered, but management’s adjustments to changing conditions continues to confirm our thesis and the new buyback exemplifies this point.

Diana’s Tender Offers:

Since the fourth quarter of 2018 the corporation has engaged in four tender offers:

Source: table was generated from the numbers in the press releases linked here:

• December 31, 2018: DSX announced it had purchased 4.167 million shares at $3.60 for total proceeds of $15 million. Shareholders tendered 11.02 million meaning the tender offer was oversubscribed.
• April 2, 2019: DSX announced it had purchased 3.89 million shares at $2.80 each for total proceeds of $10.89 million. They had offered to buy 5.18 million meaning the tender offer was undersubscribed.
• June 5, 2019: DSX announced it had purchased 3.125 million shares at $3.40 each for a total of $10.63 million. Shareholders had tendered 5.85 million meaning the tender offer was oversubscribed.
• July 31, 2019: DSX announced it had purchased 2 million shares at $3.75 a piece for a total of $7.5 million. Shareholders had tendered 2.62 million meaning the tender offer was oversubscribed.

In total, these activities have resulted in the repurchase of 13.18 million shares, for an average price of approximately $3.34 per share and a total cost of roughly $44 million. In the latest quarter ended June 2019, the weighted average number of shares outstanding was 96.87 million versus 105.23 million at September 30, 2018. The share count should fall further next quarter as the newest offer was not on the books by the end of Q2 2019. These activities also take a chunk of the 20.13 million shares issued at $4.00 in early 2017 off the market. Back in 2017, the corporation used the proceeds to buy relatively new – 2013 built – ships being sold second-hand.

Over the last decade many companies have repurchased their own stock, and within the shipping space a growing number of companies have implemented some sort of buyback. Sometimes companies fund share count reductions by taking on debt. This has not been the case with Diana. Instead, DSX has paid for the tender offers by selling some of its older unencumbered (debt-free) ships. The use of proceeds from ship sales – plus positive free cash flows – means the net debt position and debt to equity ratio have actually improved since the first tender was announced.

Though there is strong evidence buybacks are an effective tool to increase shareholder value, executive teams can fall into the trap of overpaying. Using a tender offer with a fixed price and firm end date reduces the odds of overpaying and telegraphs to the market that while the company will be a buyer of its own stock, it will not be an acquirer at any price. In short, the executive team is reducing the corporation’s share count in a shareholder friendly way.

Diana’s Buyback Outlook:

Going forward, investors should look for more of the same. On the latest conference call, management indicated the organization would continue selling older vessels and using the proceeds to repurchase stock, assuming it trades around the current valuation. Furthermore, they intend to do so while maintaining a cash balance between $140 million and $150 million. The top brass is not in a rush, however, and intends to execute the plan in a “scattered manner”. This means they are willing to wait for attractive prices.

Although investors should anticipate more of the same in the future, over the longer-term management believes the share price will go “back to normal levels,” at which point they will implement a new plan. They’ve also stated they will not take the strategy so far as to impact the corporation’s publicly tradable float, or the liquidity either.

This outlook should benefit short- and long-term owners. Short-term investors and traders, for example, can buy up stock after a tender is announced and look to cash in on whatever spread prevails at the time of their purchase. Long-term investors can hold or increase their position, and hopefully benefit from owning more of the name (and its earnings) over time.

Dry Bulk Conditions Today:

Though Contra the Heard has a stake in Diana Shipping, and we look forward to the prospect of additional tenders, the enterprise and the dry bulk industry are not for the faint of heart. DSX may have a better balance sheet and business strategy than many of its peers, but it is still a debt-heavy venture. The Baltic Dry Index, which tracks the cost of moving freight around the world, is very volatile. Today the index is riding a multi-year high, but it was only a few months ago that it traded near all-time lows. The prospects of a protracted trade war, persistent oversupply via new ship building, and how the International Maritime Organization 2020 Global Sulphur Limit will impact shipping companies also loom over the future. The dry bulk sector has been tumultuous over the last decade, and that seems set to continue. This said, Diana returned to revenue growth in 2017, and then to profitability in 2018. Our assumption that management would be able to navigate the industry’s challenges has worked out so far.

Conclusion:

Diana Shipping is a well-managed company with a relatively clean balance sheet and a habit of hedging revenues through fixed-price contracts. Over the past three quarters, the organization has engaged in four tender offers. Tenders like this, which use a fixed price and have a firm end date, represent a shareholder friendly buyback program, as the strategy reduces the odds of overpaying. These repurchases have been funded by selling older vessels and have not increased balance sheet leverage. Going forward, management intends to continue selling older vessels and reducing the number of outstanding shares so long as they can both sell ships and acquire stock at reasonable prices. This should help short-term and long-term investors alike.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. Contra the Heard Investment Newsletter provides research, it does not advise. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

Analyst’s Disclosure: I am/we are long DSX. 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.