Monday, November 24, 2008

Over optimism on a quick reversal of the dry bulk market downturn

Whilst it is true that there are numerous cancellations in the pipeline, the impact depends on the size range of the tonnage. In the end, however, the markets will not return to health until greater demand for cargo carried.

The easiest size range for optimism are the smaller units ordered in the 'Greenfields' yards. The yards themselves may never be in a position to execute the orders. The larger sizes are being built in stronger, larger yards.

Cancellations mean losing deposit money. In some cases, companies will make forfeits; in other cases, they will prefer renegations pushing out delivery dates and perhaps substituting for other type tonnage.Scrapping prospects are also uneven. The prospects are brighter for smaller size tonnage because of the higher age profile.

The bargaining positions are now reversed in supply-chain management where it is a buyers' market. The buyers can pick and choose their suppliers and negotiate freight costs. The decline of export markets seems to be affecting the Far East more than originally anticipated. Domectic demand is not soaking up excess production.

I believe in a cautious approach ahead.

TOP Ships revisited after its 3th Quarter 2008 Earnings Conference

TOP Ships has done some very timely restructuring over the past few months, selling vessels restructuring debt and terminating lease obligations. They have improved liquidity and contained leverage. They have increased secured employment cover.

Given that TOPS was in technical loan default with their asset coverage ratio's from the beginning of the year and there was pressure from activist shareholders due poor results, this served as an early warning system that has put them in an improved condition to face the current shipping slump. TOPS also succeeded to finance their newbuilding commitments backed with bareboat employment commitments for seven years.

Profits are still fragile, however, and the situation after financial expense would be close to break without the profits from vessel sales. The forward risks are decline in fleet value, problems with loan coverage obligations and potential charter renegotiations (and even defaults) in the weak shipping markets.

The tanker market picked up considerably from December 2007 especially in the Suexmax sector where TOPS had vessels open. Expected better operating results were slow to appear for TOPS until the latest third quarter earnings results. With the sale of their Suezmax fleet, TOPS is losing the benefit of the volatility and earnings in this sector of the market, which is so far faring better than dry bulk. The vessels, however, were mainly older units and needed replacement. The sales were timely. The biggest benefit of these sales came from the unwinding of their lease commitments.

TOPS has followed a conservative employment strategy reducing exposure in the spot market and increasing time-charter cover. This has allowed them to hedge their position with the bulk carrier acquisitions made at the peak of the dry bulk market last year. Prices and charter rates for these units have recently plummetted as one of the hardest hit sectors in the current shipping slump. On the new-building handymax product carriers TOPS has leased them to another operator on a bareboat basis for the first seven years from delivery so they carry no operational or market risk.

Of course, TOPS does carry counterparty employment risk on both the time charters and lease agreements that could come to roost if market conditions remain weak for a prolonged period ahead, but it would be hard to fault them for their timely efforts to increase secured income in view of their level of debt and newbuilding commitments.

Costs at TOPS remain high. Latest accounts show continuing increases. With a smaller, leaner fleet and tough times; this is definitely an area where management should focus.Another area of weakness in the past has been investor relations.

Looking from the outside, it appears that relations with activist shareholders were not the best. Perhaps these investors would have reacted differently if TOPS had taken a different approach. TOPS might even have benefitted by some new outside BoD members. More diversity on the BoD and in their management could potential assist in strengthening their strategic commerical outlook and opening new opportunities ahead.

I have been envisaging the possibility of a share repurchase program with the very low level of their share price. TOPS officially announced a US$ 20 mio program over the next twelve months. This seems a very sensible solution, reducing the considerable share dilution from the two efforts to raise capital over the past 12 months and taking advantage of very low share price.

Generally it has been a constructive year for TOPS and the management performance has improved considerably.

Tuesday, November 11, 2008

Will Eagle cut dividends?

Eagle has an ambitious newbuilding program ahead in a weakening freight markets and tight credit conditions. It has maintained a generous dividend policy, which is conditional to meeting its debt covenants. It should look to strengthen its balance sheet in current market conditions and the brewing world-wide recession. It should consider seriously cutting dividends until market conditions improve.

Eagle is a well managed group that specializes in the handymax/ supramax sector of the dry bulk market. It has a modern fleet and favorable break-even levels compared to competitors.

This sector of the market has less rate volatility than the larger Panamax and Capesizes. The vessels carry a wider spectrum of cargoes. They serve emerging economies, where growth is likely to remain relatively high.

The tonnage supply situation is more balanced here. The age profile of the world fleet in this size is the highest in the dry bulk sector. There is better potential for scrapping, especially in poorer markets. There are also better prospects for newbuilding cancellations. Many smaller 'Greenfields' yards service this sector. These yard may not have the financial capacity to delivery. There is a higher probability of order cancellations than the larger vessels.

Eagle's latest earnings report (5 November 2008) was very positive. Profits increased 50% over the second quarter with a growing fleet. On the other hand, cash was down from US$ 153 mio to 33 mio due investing activities (newbuilding tonnage).

Eagle is carrying a considerable amount of debit (US$ 858 mio revolving credit facility). It has heavy newbuilding obligations (34 Supramax vessels which will be delivered between 2008 and 2012). This is more than double the current fleet of 21 units. It has a conservative employment policy with period time-charters, but this is prone to risks of charter rate renegation and even possible Charterer defaults in bad shipping markets.

For this reasons, my view is that Eagle would be best served to reduce or even cut entirely its dividends, using its free cash flow to support its asset investing activities, until market conditions improve.

Britannia in senior debt loan default negotiations and receivership

Nordea and Lloyds TSB, which agreed the $170m deal in May on five bulkers, appear to have alleged that “certain events of default” have taken place, including its financial condition changing for the worse. They are said to have provided cash for daily operations and requested vessels to be sold. Shortly thereafter, the company went into receivership, appointing an administrator.

The lenders are top-tier shipping banks with a big experience factor in this cyclical industry. Normally banks work closely with the clients in bad markets, supporting them until conditions improve. Declaring loan default is a very drastic action that banks generally avoid unless the risks of loan losses are very high and/ or their confidence in management is very low.

For these reasons, there appears to be more behind these events than we know. I have previously written on DWT: Britannia Bulk: Perils of leverage, COA's and chartered in vessels on the 29th October, where I lay down in detail the possible factors in Britannia's plight.

Selling vessels under present market conditions is likely to be at distress prices. Older bulker units at record high prices just months ago are not likely now to fetch more than scrap, which is also falling in price. No doubt the units mortgaged to these banks are fairly young, but Britannia is not likely to get much relief unless market conditions improve.

Their banks would appear to believe that Britannia does not have much resilience to survive the downturn. Britannia decided to appoint an administrator under UK law, putting the company effectively under bankruptcy protection.

Britannia Bulk: Perils of leverage, COA's and chartered in vessels

Britannia was one of a very few shipping IPO's this year. It had a rocky start from inception. The original purpose of the IPO was to refinance existing corporate debt. The initial issue did not go well and it has been a downwards trajectory every since. Presently it is caught in a potential liquidity bind with falling fleet utilization, falling charter rates in the spot market, and operating losses in the face of high leverage and ambitious fleet expansion plans. The company has a fleet of mainly older handy-sized bulk carriers and a fleet of five iced-class Panamax units on order for which it has leveraged up its balance sheet to finance.

Britannia specializes in the transport of coal in Europe, trading heavily in the Baltic where ice-classed units are important in the winter. Its employment portfolio is mainly COA's. In addition the company has significant time chartered in tonnage (45 units as opposed to owned fleet of 22 units as per its share prospectus) to service these COA's.

It is fundamentally a logistics operation that is a margin-based business on turnover. They appear to have made a bad timing decision to leverage up and expand the shipowning aspect so late in the game.

The company is exposed to margin compression (and even potential cash deficits) in its chartering business, where it needs to restructure its chartered-in fleet. It is overleveraged in its owned fleet in a falling market. Many of its units are advanced in age with vessel values severely impaired due the precipitous drop in the dry cargo freight rates. It will struggle to take delivery of the new units in the future.

With its shares currently trading at 25 cents to the dollar, Britannia is in a distress situation. If the employment portfolio has any value, it could be a take-over candidate in a merger deal for the contract book. Britannia is in a fight for survival.

Shipping markets and commodities in the financial crisis

The sharp correction in the commodities markets has tipped the supply/ demand balance in favor of the buyers. The buyers are now in a position to pick and choose. They now have far more room than previously to manage their supply chain logistics. Commodities exporting nations like Russia and Brazil are now facing the music.

For the past five years, the demands in emerging markets for commodities like oil, coal and iron ore have outpaced supply. The primary issue was to secure supply for production. This took precedent over other matters like price and delivery costs.

With slackening demand in the current economic downdurn, supply is now exceeding demand. This is changing the structure of the supply chain relations. Matters such as price and delivery cost have come to fore as buyers now have a choice of alternatives. The commodities sellers can no longer impose their terms in the market. For shipping, this is a negative development because it means fewer shipments and very likely shorter distances. Both freight rates and utilization is dropping.

The container ships were the first to be affected. Now the bulk carriers are also under pressure. The tanker sector is suffering, too but there is so far a better supply-demand balance in this sector.