Few investors have heard about China’s Winland Ocean Shipping Corp. or Denmark’s Copenship A/S. But these firms are the proverbial “canary in the coal mine.”
Both have declared bankruptcy in recent weeks, and they may soon have plenty of company. That’s what happens when heavily-indebted companies square up against deep industry distress.
That industry: dry bulk shipping, which involves everything from iron ore and other commodities to processed industrial materials. The major shippers build massive (and expensive) boats and then hope that those boats can garner sufficiently high daily lease rates.
Those rates, as measured by the Baltic Dry Index, have just moved to levels not seen since the 1980s. The index typically had support in the 650 range during past downturns, but we’ve now shot past that mark. (Remarkably, this index hit almost 12,000 back in 2008.)
Why is this index plumbing fresh lows with each passing week? Demand for dry goods, especially in China, appears to be quickly slowing. Moreover, dry bulk shippers ordered a lot of new ships in 2013, many of which started plying the waters in the past 12 months. Too many ships chasing too little market action has led to price wars. It’s the sort of “beggar thy neighbor” policy that means that all shippers are either operating at a loss, or at greatly reduced levels of profit.
Frankly, a wave of defaults hits this industry every time the BDI stumbles badly. Back in 2012, Overseas Shipholding Group, Inc. (NYSE:OSGB) sought protection from its creditors. The next year, Excel Maritime went belly up. And in 2014, even as the BDI staged a temporary rebound, Genco Shipping had to file papers with the bankruptcy court. And those are just U.S. listed stocks.
The fresh pullback in the BDI makes this a good time to pursue a two-pronged strategy: First, identify the companies with the weakest balance sheets, some of which may represent solid short-selling candidates. Second, identify the industry’s strongest players that will be eventual beneficiaries of an industry shakeout that reduces competition.
The Weak Hands
Investors have already lost considerable sums of money by investing in Eagle Bulk Shipping, Inc. (Nasdaq:EGLE). The shipper announced a massive debt restructuring in August 2014, which left its shares nearly worthless. The company subsequently re-listed its stock, thanks to a cash infusion that was backed by a $225 million term loan and a $50 million credit line.
Trouble is, Eagle Bulk hasn’t generated a quarterly profit since the second quarter of 2013, and thanks to the fresh pullback in the BDI, it will likely bleed cash for the foreseeable future. Securing fresh funds, as Eagle has, makes sense when industry conditions are stable, but that $225 million term loan comes with cash flow covenants that will be hard to meet if the BDI stays below 750.
Another distressed firm: DryShips, Inc (Nasdaq:DRYS), which has seen its stock fall 75% in the past year to around $1. This shipper had historically survived the bad times by relying on its ownership stake in Ocean Rig, UDW, Inc. (Nasdaq:ORIG), which owns and leases offshore oil rigs. That industry is now in distress as well.
In a bid to buy time, DryShips sold 250 million shares four months ago (at $1.40 a share) and is now in the process of burning through that cash. For a company with more than $5 billion in debt, the fresh plunge in the BDI cannot be very reassuring to bondholders — or equity investors.
The Healthy
Yet this cloud also has a silver lining. The healthier operators appear poised to ride out the bad times and should also benefit from the chance to acquire distressed assets as they come through the bankruptcy courts. Take Diana Shipping, Inc. (NYSE:DSX) as an example.
We’re always on the lookout for quality tonnage and the ships we have purchased thus far have proven their superior technical standard,” said company president Stacey Margaronis on the Q3 conference call. Indeed Diana has consistently used its financial strength as a weapon whenever the industry has hit an air pocket.
At the end of the third quarter of 2014, Diana had $200 million in cash, compared to $400 million in long-term debt. None of the debt is due in the next three years. Diana has been using its financial strength to both buy back shares and upgrade its shipping fleet. Buybacks make sense when you consider that shares are currently valued at 68% of tangible book value (of $10.54 a share).
That’s not to say that shares can’t slip further. Diana has eight ships coming off of long-term contracts, and the BDI plunge means that new contracts will be priced much lower. Diana reports results on March 4, 2015, and industry analysts are waiting to see how the company’s 2015 operating outlook has been affected by the BDI pullback. Assuming the firm is in a position to still generate positive free cash flow in 2015, then investors may be greeted with a new share buyback announcement.
Investors may also want to research Navios Maritime Holdings, Inc. (NYSE:NM), which has ample cash, a profitable logistics business and a generally low expense structure. Navios just reported Q4 results, and management provided a solid overview of current industry conditions, which you can listen to by clicking here .
Risks To Consider: If the BDI remains below 600 for all of 2015, then even the stronger industry players will remain out of favor.
Action To Take –> It’s increasingly likely that we’ll see additional bankruptcy filings in this beleaguered industry. That should set the stage for a rationalized global fleet, which should eventually lead to firming lease rates, especially as the global economy picks up steam. The current industry distress gives investors an opportunity to take long or short positions on the stocks mentioned above or any number of other industry players.
Source: StreetAuthority
