Monday, March 30, 2009

Bad earnings results and delays in loan restructuring for DRYS

DRYS's latest quarterly earnings report last week showed that the company closed FY 2008 with a massive US$ 361 mio loss. Very troubling was the US$ $700.46 mio non-cash impairment charge charge relating to the Ocean Rig acquisition as the main culprit behind the large net loss.

Despite previous press reports to the contrary, DRYS has not yet secured waivers for its term debt defaults and negotiations with senior debt lenders are still running. Their auditors expressed doubts about the company’s future in its annual report today. So far DRYS has succeeded to raise US$ 380 mio in their ongoing efforts to increase capital by ATM sales. There has been little cheer for DRYS since my last piece on a new contract for one of the oil rigs.

Like most dry bulk companies, DRYS is engulfed in a battle of attrition to deal with the massive debt accumulated in rapid asset expansion in the recent boom years. The Ocean Rig buy-out and addition rig purchases were the straw that broke the camel's back. Despite the healthy profits accumulate from the dry cargo boom years, this foray into off shore drilling overreached their company free cash flow potential and has now led to serious liquidity and loan/ asset coverage problems.

These setbacks raise again the looming possibility of sacrificing the Ocean Rig acquisition for needed cash to save the core company business. DRYS shares at the time of writing this article are down nearly 18%.

Please refer to my previous article on various future scenarios as well moral hazard issues
for this company.

Saturday, March 28, 2009

Quintana Merger runs amuck for Excel Maritime - a Wall Street parable

Senior debt lenders are now putting maximum pressure on Excel Maritime for new injections of capital for restructuring. In a previous piece "EXM and debt covenants" that I published in September 2008, I had outlined the risks that the Group had undertaken in acquiring Quintana. It seems that these risks have now come to roost. Excel may be taking nearly a $1bn write down on its equity, which would nearly wipe out the shareholders' position!

Quintana was an extremely successful Wall Street 'value' play for its shareholders and management. In business, shareholder value means intrinsic competitive advantage in the market place. On Wall Street, value tends to mean short term gain from building up shareholder expectations and cashing out on shares ASAP at advantageous prices. There is huge space between these two concepts nearly as vast as the oceans. It leads to conflicts all the time between corporate management on the one hand and private equity firms and investment banks on the other hand. It is very common that investment bankers and private equity firms impose conditions on corporations that are not ideal for management in building sustainable competitive advantage for their shareholders.

In the case of Quintana, the price of obtaining private equity PIPE support for their scaling up in the Metrostar deal was the need for low paying long term charter employment to support a large dividend payout. Even on that basis, the PIPE was sold at discount. The financial interests were simply not interested in building a company. They saw the operation as a junk bond transaction or in other words an asset speculation play.

When dry bulk markets soared in 2007 beyond expectations, the only way for QMAR shareholders to benefit was to sell the company and cash out. A charter party default case last fall concerning one of their vessels illustrates their predicament. The subcharter had fixed their unit on a voyage basis at rates in excess of US$ 100,000 per day. The vessel had been let and relet several times with multiple charterers in a chain. Quintana was only receiving US$ 30,000 per day on the vessel as owners. The perils of the vessel provider business model are ending up as a cheap source of capital for commercial operators to make big profits.

They successfully got out in the fall of 2008, which was very fortunate. At the time, there were doubts that their counter party Excel could even execute the deal. The subprime crisis has first broken out and it was beginning to have an impact on the banking industry. Excel had to arrange a massive senior debt facility in excess of US $1 bn to finance this transaction.

In retrospect, I suppose one might ask what was in the minds of the Excel BoD when they approved the M&A deal given the risks involved. The only value in the merger was the QMAR fleet that was locked into low-paying charters. In essence they were paying premium prices for the vessels whilst the underlying intrinsic value of the company was low - an unattractive combination.

Whilst many on Wall Street would likely castigate my constant emphasis on value beyond steel in shipping, I think that this case illustrates the perils in ignoring business fundamentals and seeing every transaction as an asset speculation. For a company, assets are only a means to an end. The bottom line depends on what management does with them to build a business.

Now EXM shareholders are facing an impairment charge and the need to recapitalize that may significantly dilute their interests. Stamatis Molaris, the CEO, recently resigned. The major shareholder, Gabriel Panayotides, may be obliged to sell his controlling share in Torm to cover the losses. Ironically, Torm is a 120 year-old Danish shipping company that has considerable intrinsic value.

Despite this dire situation, EXM shares soared over 10% in Friday trading. It will be interesting to hear the earnings announcements on Monday and see the market reaction.

Tuesday, March 24, 2009

A political impass resolved brings a relief rally

There now seems sense of relief and renewed optimism that Geithner has finally presented a plan to clean up the US financial system from the subprime mortgages. The plan itself is really a reworked version of the old Paulsen Plan.

For political reasons, this matter has been in stalemate for months. US authorities do not want to put any large banks into receivership and reorganization nor do they want to be mixed up with nationalization. Many academics feel that these alternatives are cheaper and more efficient ways to clean up the banking system. The US has very well developed legislation and bureaucracy to do this; but after the LEH debacle last fall, they are very frightened of the fall out in the markets. They are worried about derivative transactions gettling locked up for years in legal proceeding. They seem particularly concerned about backlash from foreign sovereign creditors who would take big losses on their secured debt. Therefore, they prefer this convoluted solution that is in effect another large government subsidy to shore up the lame-duck banks.

There is an increasing trend to avoid US Congress authorization as the public opinion hardens towards the concept of more government bail-outs and subsidies to large corporations. Geithner intends to finance his plan by TARP money, the FDIC balance sheet and private sources. The Bernanke move last week to push down long term interest rates by purchasing US Treasuries and Agency debt obligations expands the FED balance sheet.

There continues to be the issue of huge public deficits and rising public debt in the US on all fronts. Even liberal economists like Paul Krugman feel that the Geithner Plan is going to be a very high price solution. The US enjoys the advantage of extremely cheap financing in the way of US treasuries and printing money via the FED that other countries do not have. In the end, they hope to cover this with growth of tax revenue in a booming economy. On the other hand, the US dollar has started to weaken a bit and commodity prices harden. It is early to call this a trend reversal but in time, this could create problems for a recovery.

Bottom line: there is finally a plan in place to clean up and de-block the financial system. Whether it is a good plan or not is a superfluous issue at this point. The markets feel relieved.

There are currently a lot of cross currents in the financial industry. Some institutions are getting nervous about government involvement in their internal affairs. Politics on the Beltway is ever more chaotic. It remains to be seen how effective this plan will be on implementation.

Sunday, March 22, 2009

The financial crisis has not eliminated inflationary pressures on operating costs

Despite the sharp downturn in shipping markets, operating costs continue on the rise. The main factor is crew costs but there are also other problems as well like rising liability insurance expense and management fees. With falling freight markets and declining cargo volume, this continued cost inflation puts owners in a very unpleasant situation. Earning margins are in an inexorable press between falling revenue and rising expense.

The large orderbook overhang is not only contributing to overcapacity in already softer freight markets. It also expands needs for manning in an increasingly tight market for qualified seafarers. There has been no relief on crew wage inflation - especially for qualified officers - despite the market downturn. The most acute area is the tanker sector because so much new tonnage requires STWC chemical tanker certification. Pressures in the LPG/ LNG sector are also severe due the small pool of experience labor and fleet expansion.

Another area of excalating costs is marine insurance, especially protection and indemnity (PANDI) liability insurance. For some time now insurance markets have been caught with falling premium from 'churning' where newer tonnage at lower rates is replacing older tonnage that was paying higher rates. Claims have been on the rise. The market meltdown in the equity markets has had disasterous results for the investment portfolios of the major PANDI Clubs. The result has been a barrage of supplementary calls to make up for the shortfall at the same time that owners are faced with declining revenues and charter party defaults.

The only relief has been a relative improvement in the value of the US Dollar and the fall in bunker prices. Fuel costs are the major cost element in voyage expenses. Agency costs are another area that has gone up considerably the last few years. Dollar improvement helps to absorb these agency increases and keeps pressure down on oil prices. Unfortunately the fall in freight rates has wiped out any overall benefits.

Time charter equivalents are considerably lower and operating expense continues to rise.

Political dimensions of the financial crisis leading to rising risks

A recent Intelligence Squared debate put the major blame on Washington over Wall Street for the financial crisis. Nouriel Roubini sided – together with Niall Ferguson and John Gordon Steele – with the view that Washington was the real culprit even if many bankers and investors were greedy, incompetent and taking excessive risk. If bad political policies are the mother of the crisis, politics will determine the outcome. There is considerable slippage between effective economic policies and political expedience in the crisis management and major risks lie ahead.

Due the current political lock-up in cleansing the financial system, the US government is effectively subsidizing with capital injections the larger lame duck financial institutions as 'too big to fail'. They fear the domestic dislocation but also the negative repercussions from foreign creditors if their holdings are wiped out by bankruptcy court. So they have short-circuited the traditional institutional means to deal with insolvency and reorganization of failed corporations.

The financial sector is busy setting up arrangements in which employees are guaranteed high levels of compensation if they stay on through the difficult days ahead. These retention-type payments allow firms to survive in their existing form, pursue business as-usual, and gamble for resurrection, i.e., make further risky investments. This is the mildest form of moral hazard stemming from the subsidies. This could degenerate into even worse distortions as the US governments starts to play a stronger hand credit allocation for political ends. Distorted credit allocation and encouragement of securitization from Washington politicians played a major role in creation of the subprime mess in the first place.

These same payment schemes, e.g., Goldman Sachs’ loans-or-employees deal, are a form of poison pill with regard to further bailouts, Whilst the Administration seems to prefer keeping these firms on life support for the reasons above, this kind of tunneling is leading Congress to knee-jerk legislation like the recent 'bill of attainder' taxation on executive compensation. 'No New Bailout Money' is a slogan reaching from here to the midterm congressional elections.

Unless the economy turns around, somewhat miraculously, we are in for a big slump or even for a Great Depression as demonstrated by the words and body language in Bernanke’s interview on '60 Minutes.' As he sees the world, there is only one course of action remaining: print money and hope for a moderate degree of inflation. The money part was, of course, the announcement yesterday from the FED.

The Obama stimulus plan - Bernanke endorsed Obama and this plan of action prior November elections - and ambitious social agenda add to the risks of future inflationary pressures. This expands already over-bloated federal deficits from the bailouts and is leading to record levels of US public debt. So far the financing cost of this has been low with the flight to US government securities from higher risk assets in the financial crisis. The recent FED move to expand its balance sheet and buy US treasuries and agency bonds has brought down longer term interest rates. In effect, the FED is creating another subsidy in the form of artificially low interest rates. Is this situation sustainable?

Here we are come full circle because this is being financed by US treasury auctions to foreign governments. Particularly, the Middle East with its oil surpluses and the Far East (Chinese) with the trade surpluses from their export oriented economies. These surpluses no longer seem sustainable with the fall in oil prices and collapsing export markets as well as rising domestic needs to support their domestic economies and provide stimulus.

Foreign creditors like China are beginning publicly to express their concerns about sovereign debt in the US. Already China seems to have lost confidence in the implicit guarantee that backs the Agency bond market. The recent FED move to expand its balance sheet serves to substitute China and other central banks in this market. Foreign central banks never bought anything close to a trillion dollars of Treasuries and Agencies in a single year. A half trillion or so of annual purchases was more than enough to have an impact.

The inflation part is the potential fly in the ointment for this self-perpetuating FED money machine. If inflation is driven by the so-called “output gap,” i.e., how far the US economy is below potential output, then prices will not increase much, the yield curve steepens moderately, and banks make out like bandits (reflected in the current optimism of lame-duck banks like Citibank in their recent earnings forecasts and stock market rally). But if the whole world is moving more into an emerging market-type situation then (a) inflation expectations become danger (central bank jargon for “really scary”), (b) potential output falls as we massively deleverage, and (b) people move increasingly into alternative assets - storable commodities spring to mind - and we get some serious inflation. If oil prices jump, then we have an even bigger inflation problem. Oil is not storable, supposedly.

A potential run on the US dollar and skyrocketing commodities prices would bring down like a house of cards all this Bernanke financial engineering and the consequences of the public debt pyramiding would come to roost. The killer would be rising interest levels. This would make US public debt very difficult to service much less pay down. It would create a new era of stagflation (stagdeflation?) with sluggish economic growth and high unemployment that may take decades to sort out depending on the political will. Certainly this scenario would serve as a 'cold shower' to the present US administration with its deficit financing and income redistribution policies.

More danger signs of overcapacity and financial strain in the container sector

The availability of containerships on the charter market is reaching frightening proportions, with indications that the number could double to nearly 1,000 by the summer. The number of vessels in layup is already estimated to be in the region of 484, according to the latest figures from AXS Alphaliner. Danaos was obliged recently to fix out a 4,000-teu vessel at a rock-bottom rate of around US$ 7,000 per day - levels 80% down over the year - hoping to park the ship with a charterer for a year just to cover operating costs. Maersk is setting a cost-cutting target of US$ 1 bn in the coming year.

Shipping owning companies in the container sector are facing increased pressures as a deluge of new tonnage is coming into the market and cannot be assorbed. Liner operators are suffering substantial losses so rates have collapsed and more and more tonnage is being redelivered. Liner companies in the transpacific are taking drastic action to raise rates in response to shrinking demand and failure of service closures to lift spot rates.

The TSA's Brian Conrad describes such efforts as a matter of survival.

"The carriers have reached a point where financial survival, not utilisation or market share, has to become the driving force," he said.

State-owned liner companies are less likely to default on charters, but they will probably show increasing preference to their national tonnage. The private liner companies will have to take drastic action to stem their losses. Vessel provider companies like Danaos and Seaspan will increasingly be facing the fallout in the way of redelivered vessels and marginal charter rates.

There is the specter of newly built Panamax tonnage going directly from the yards to layup.

Thursday, March 19, 2009

Some light at the end of the tunnel for Dry Ships?

The recent improvement in dry bulk markets has put rates above cash-break even costs and reduced the likelihood of default for Dry Ships and other dry bulk companies. Ocean Rig, - DRYS's big M&A deal last year that changed the shape of the company - secured a three-year exploration drilling deal with Petrobras in the Black Sea, which will allow its semisubmersible Leiv Eiriksson to pick up around US$ 575,000 per day from the charter. Oppenheimer upgraded DRYS since the end of February to 'market perform'.

Ocean Rig is one of the most valuable assets in DRYS. This new contract may assist the group in the eventual spin-off of this company as a separately traded entity. If done at a premium, it will enhance share value for DRYS shareholders.

Meanwhile the company has had protracted negotiations with major lenders and restructured its senior debt obligations.

So long as current dry bulk market conditions do not deteriorate and the off-shore drilling does not tighten, there seems to be some light at the end of the tunnel for this group.

DRYS shares have been lately in a moribund state, but they now are trading sharply higher today.

Tuesday, March 17, 2009

Will Chinese growth rebound and revive the shipping markets?

For the past six years, the investment paradigm in shipping markets has been driven by the China export growth model. Both the EU and US increasingly outsourced production to the Far East. The Far East exported finished goods to Western consumer markets and imported raw materials and energy resources for production. George Economou, in a DRYS investor presentation, boasted of a commodity boom that would last 20 years and a new era for shipping markets. Orderbooks for new tonnage reached historical highs. Analysts argued that FE growth was decoupled from Western economies and would help shore up any downturn. The issue today is whether we are entering a new era of structural change and how the dynamics will affect the shipping markets.

When the financial crisis broke out last fall and shipping markets collapsed, I turned to macroeconomic analysis of the Far East for guidance. As shipping is a cyclical business, there were calls for caution long before the markets crashed. Unexpected demand, particularly from China, continued to sustain rates in both wet and dry cargo markets.

Christopher Lee, a Chinese-born and unusually astute shipping analyst, had been questioning the sustainability of the boom for some time. He underlined the risks of a real estate bubble in the rapidly developed coastal areas of China. He felt that it would be very difficult to extend the building boom into the Chinese interior and that consumption levels there would remain low. Today there is so much excess capacity in coastal areas that workers are returning to the hinterland. Lee also expressed concerns about non-performing loans in the Chinese banking system.

Michael Pettis, a well known academic who teaches in China, points out that China is very much in the position of the US at the time of the Great Depression. It has far too much productive capacity due to overinvestment. Conversely (and virtually unknown in US political circles who currently seem mesmerized by FDR) the US is now in a very different position today as a debtor nation based on consumer consumption, outsourcing of production and a very oversized financial industry. As Pettis points out, the Chinese trade surpluses are really no more than IOU's to boost exports.

The Chinese export markets have collapsed and demonstrate the need to develop internal consumption, but this will take years to accomplish. If the Chinese revalue their currency, this will cause immense economic dislocation. Yet it has been apparent for some time that China could not indefinitely be a low-cost producer of cheap goods. Already surrounding Asian economies in lower stages of development like Vietnam were gradually taking their place. Already Chinese trade surpluses are shrinking.

The new Chinese economy after the deluge is likely to be quite different from the shipping boom years. Chinese supply chain management is also likely to change with longer term contracts with end users and more shipment of raw materials under contracts of affreightment with priority to Chinese shipping companies.

Savings rates in the US are already rising after years of incredibly low levels. Politicians anguish that tax relief money is being used to pay down household debt rather than spent on consumption. They ignore basic economics. They are looking to reflate the economy with Government spending but there are finite limits on deficits and public debt levels. Already many US states and municipalities are on the verge of bankruptcy. At present it is anything but clear that US consumption levels will quickly rebound to previous levels. It is also questionable that Chinese trade surpluses can indefinitely finance US deficits. The trade surpluses themselves are drying up. There is an increasingly large competition between governments to sell sovereign debt instruments. American consumer spending habits as well as investment risk preception may change and revert to more conservative levels of previous generations.

All this is to say that things right now do not bode well for shipping. The die-hards in the container industry seem to be living on another planet. The excess capacity of container vessels is simply mind-boggling because far too much money was chasing this sector.

There has been some revival in dry cargo but this sector was traditionally very fragmented with a large number of owners competing destructively on rates and keeping them low. The smaller vessels, which are now considered the safest bet, were the least profitable. They lack the earnings volatility of the larger units in good markets but they are also prone to margins pressures due smaller carrying capacity and proportionally higher running costs. The basic investment thesis for all dry cargo vessels is unfettered economic growth in the FE. Slower future growth rates may change substantially this scenario. It may evolve to a market where only the financially strong and commercially well connected owners survive.

The tanker markets are in a somewhat better situation. Energy needs are less elastic. Lower oil prices and the difficulties in bringing in new technologies may keep this market afloat longer than expected. Also very helpful is the 'phase-out' regulation for single-hulled units and changing trade patterns. Stringent vetting standards and port state control create entry barriers. Financial responsibility laws for pollution have forced industry consolidation. There is likely to be increasing demand for clean products and chemicals with changes in trade routes from production at source in the ME and decline in refineries in developed countries. For the clean trades with cargoes in the ME, there is little incoming cargo so this voyage leg will soak up tonnage from the market and help sustain rates. LPG and naptha trade may be cannibalized for increasing chemical production in the ME. The big question remains how soon new refinery projects will be coming on line with the current economic slowdown.

Whilst we should all be optimistic for a speedy economic recovery, we should be prepared for slower growth rates than we have seen in the last years.

Thursday, March 12, 2009

Estimated of US$ 1.4 billion loss on Maersk container operations

Analysts Rikard Vabo and Lars Erich Nilsen say recent developments in the container and oil and gas markets have increased the likelihood of the Danish giant slumping to a loss in 2009 from “possible to probable”. They estimate massive losses of US$ 1.4 billion from their container operations. This will put heavy pressure on the group to redeliver vessels and proceed to renegotiate charters. Likewise they will have little incentive to take on new tonnage from third party owners.

Maersk is estimated to have a group loss of US$ 858 mio in 2009 mainly driven by a loss of US $1.9 bn from containers (2008: US$ 104 mio). These losses may well continue for the next two years. Whether they like it or not, Maersk management will be under intense pressure to contain and reduce their operating losses.

Container shipping companies like Seaspan Corporation with large orderbooks and fleet of containerships base their business model on long-term, fixed-rate charters to major shipping lines. Maersk is one of their major customers. Jerry Wang, Seaspan CEO, often claims that his business model a sure bet. Many major US institutional and German KG investors continue to believe this, too. Whilst the Germans are getting worried by increasing idle tonnage, some on Wall Street are looking to double their bets and take new positions in this beloved sector.

The issue is how customers like Maersk will be able to service the current charters much less absorb the new vessels from their large orderbook. The conventional wisdom is that liner companies have such strong balance sheets that there is only minute default risk.

Seaspan reported net loss of $241.9 million and $199.3 million for the quarter and year ended December 31, 2008 but maintained their cash dividends and paid a fourth quarter dividend of $0.475 per share, expressing optimism about renewed Chinese growth and exports. This operation was financed by a bailout infusion of fresh cash capital from their parent company.

If a major company like Maersk eventually is forced to renegotiate contracts and unable to take delivery of new chartered-in vessels, this would affect severely companies like Seaspan. No one seems to have factored in default risk in their business models. Moreover, they are counting on liner companies to employ their substantial orderbook.

The outcome is highly dependent on renewed growth rates in the Far East and a big comeback in exports to the US and EU. Especially if the anticipated recovery is the US is less than anticipated and there is a period of slower growth than recent past levels with overleveraged US consumers, this could lead to trouble. There is so much money chasing this sector and endemic overcapacity.

Wednesday, March 11, 2009

Challenges ahead for Norden

Dampskibsselskabet NORDEN A/S operates globally in the dry cargo and tanker segments with one of the most modern, flexible and competitive fleets in the industry of 170 vessels. The Norden management paints a relatively gloomy picture of prospects for the dry-cargo and tanker markets going forward with rates set to fall. The bottom line for 2009 is expected to come in vastly weaker to last year. Norden is adjusting capacity, activities and costs to the changed market conditions. Meanwhile, NORDEN is also positioning itself to take advantage of any opportunities to strengthen its position in the dry cargo and tanker markets in the long term.

NORDEN is one of the oldest listed shipping companies in the world. They are one of the world’s largest operators of Handymax and Panamax vessels and also have significant activities in the Handysize and Capesize segments as well as Post-Panamax as from 2009. In tankers, NORDEN is active in the Handysize, MR and LR1 product tanker segments. The Company’s product tankers are commercially operated under the 50%-owned Norient Product Pool, one of the largest product tanker pools in the world.

Unlike most US-listed shipping companies, who are mainly vessel providers; Norden is a major world drybulk cargo operator with direct end user relationships and a large contract book. Their employment portfolio consists of COA's, time charters, FFA positions and spot employment. To service this contract base, they maintain a core fleet of owned vessels and vessels on long-term charter supplemented by short-term charters and vessels chartered for individual voyages. With this fleet mix, they are able to adjust their capacity and costs to changing market conditions.

They have a large number of purchase options for active vessels as well as vessels for delivery. These options contribute to the Company’s flexibility. By contrast, many new US-listed companies have expanded by large block vessel purchases. Nearly all their vessels are chartered out to cargo operators. Navios is an exception with a cargo book and chartered in units, but this business model pre-existed before the present Greek management bought out this, older established company.

The Norden management early worked to reduce capital gearing by selling vessels for which they booked profits of US$ 298.97 mio on disposals in 2008. They maintain considerable liquidity, going into 2009 with US$ 807 mco in cash plus US$ 22 mio in marketable securities. In the short term, the Company is adjusting capacity, activities and costs to prevailing market conditions.

As vessel operators with direct end user relationships, Norden has been feeling the brunt of counter party risk. In a number of situations in their COA business, Norden has aided customers and business partners by deferring contracted cargoes. They were hardest hit with two time-chartered out vessels by the bankruptcy of a dry bulk operator in 2008, which cost them US$9 mio and a further US$17-19 mio hit to be felt from the same bankruptcy this year.

Norden's case is indicative of the current state of the industry right now.

Tuesday, March 10, 2009

Eitzen moves to consolidation after a period of aggressive growth,

The Eitzen group has expanded aggressively in the chemical sector the last few years, becoming a major operator. The rapid growth caused them initially operations problems. They started to suffer in bottom line results last year. Now with the recession leading to declines in both cargo volumes and rates, management has its hands full.

Whilst the major established operators like Odfjell and Stolt enjoyed robust profits in 2008, a slashing of its fleet value and soaring expenses sent Eitzen Chemical to a US$ 192.5 mio loss last year.

Eitzen’s fleet lost 20% of its value in the second half of 2008 leading the Norwegian to book an impairment charge of US$ 156.2 mio in the fourth quarter alone. Over the course of the whole year impairment charges reached US$ 160 mio.

During the last five months of 2008, a fall in seaborne chemical transportation rates was seen in the order of 30% or more. Volumes on key routes like the transatlantic dropped to very low levels. This development was brought about by the plunge in global macro economic activity, which severely impacted chemical demand. Many production plants had to reduce operating rates (and some temporarily idled output) due to the lack of available credit. This further hurt trade, and thus negatively impacted fleet utilization.

The state of the chemical shipping market has so far in 2009 not changed dramatically from that seen towards the end of last year. Volumes remain fragile, and the question is when trade will start to pickup again? Most charterers are fixing only on a short-term trip charter basis until visibility improves.

Eitzen Chemical's average rates for the company’s fleet below 30,000-dwt fell 5.8% from the third quarter to the fourth quarter and those for the fleet above this size slipped 9.4% in the same period.

With a projected gross fleet growth of 20.8% and 12% in 2009 and 2010 respectively, the chemical shipping market is faced with a high delivery schedule of new vessels. The credit crunch could perhaps have some impact on the magnitude of potential order cancelations and renegotiations so the actual delivery schedule could differ.

Whilst major chemical tanker companies like Stolt and Odfjell have largely covered financing needs for their capex requirements, Eitzen Chemical has about $184 m of vessel capex to fund in 2009/2010. They could be exposed to liquidity problems if tight market conditions persist.

Trade patterns are changing with major Middle East refinery projects coming on stream in the next few years. Production at source give them a competitive advantage and chemical production has higher margins than feedstocks. This will increase demand for chemical vessels but it could lead to cannibalization of the product tankers and LNG trade, with increased domestic demand for these products.

In the meantime, the reclassification of vegetable oil cargoes to chemical vessels will help mitigate somewhat this market recession. Intensified scrapping will also assist. There have been major design changes in chemical vessels and much of the older fleet is obsolete.

Most companies in the chemical sector have solid NAV support. That said, the profits are likely to be at sustained low levels. In addition to the potential for further pressure on asset prices, this should induce a pricing discount to NAV.

Selected stocks such as Stolt-Nielsen with their very strong contract base and balance sheet may prove robust value cases in the longer run.

Friday, March 6, 2009

Will NAT be able to keep its dividend pledge?

Herbjorn Hansson’s Nordic American Tanker Shipping (NAT) has vowed to keep coughing up dividends in the face of the economic downturn and widespread expectation that tanker spot rates will retreat. US investment bank Dahlman Rose recently cut its recommendations for Nordic American Tanker shares in view of longer-term tanker prospects. Looking at the earnings obtained at the start of 2009, it seems as if the combined impact of OPEC crude output cuts and newbuild deliveries is to some extent starting to hurt the market balance. There is a big risk that tanker rates will soften as the year progresses. NAT may face difficulties in maintaining their dividends.

NAT has the advantage of being free of term debt and good liquidity but most of its fleet is trading on the spot market.

Last month the shipowner posted a fourth quarter bottom line of US $17.20 mio compared with the US $1.68 mio it recorded a year ago. The $0.50 per share profit was just shy of the $0.54 forecast by analysts. NAT paid out $5.26 per share in dividends during 2008.

The collapse in the world economy has had detrimental impact on global oil demand. With the IEA and other analysts ' estimates having been consistently downgraded through 2008, crude requirements contracted by about 0.3% last year. This was the first negative number seen for about 15 years. For 2009, the oil demand is likely to fall close to 1.2% as a result of the weak economic developments. Subdued crude needs are also anticipated next year, with a modest 1% increase expected.

Although downward revisions in oil demand for non-OECD economies have clearly affected overall growth figures, petroleum demand from such regions is projected to mitigate the effect of negative petroleum needs from Western countries. This contributed substantially to a revival of the tanker markets in 2008. This notion is based on continued expansion in countries such as China and India. This year with the collapse in export markets but the possibility of government stimulus plans, this is much harder to assess.

One interesting factor is the effect of new refinery projects on crude oil trade patterns as they come on stream. The Jamnagar II refinery, for example, in India after a series of delays is to start up in the second quarter of this year. Its impact will likely be negative for the crude trades but positive for products. Crude tankers will be diverted from the long-haul Middle East to US and Europe trades and instead head for a short-haul trip to the more competitive Jamnagar II refinery in north-west India. Refined products from Jamnagar II will then be transported to the US and Far East, extending ton miles. NAT's fleet is smaller Suezmax tonnage and this change in trade pattern - if it develops - may have more direct impact on VLCC's.

Net increases in the world tanker fleet are more subdued than other shipping sectors. There has been less aggressive ordering and due 'phase-out' regulations for single-hull tankers, there are more stringent pressures that compel scrapping of older tonnage. A large proportion of the crude tanker orderbook is moreover being built at either newly established or greenfield shipyards. As a result of capacity constraints (equipment, labor) and (in some instances) uncertain financials, delays (if not cancelations) could be seen. This more likely to impact deliveries from 2010 and onwards.

NAT CEO Hansson estimates that cash break-even for their trading fleet of 13 vessels is below US$10,000 per day per vessel. When the spot Suezmax tanker rates are above this level, the company can be expected to pay a dividend. Latest Suezmax rates are in excess of US$ 30,000 per day and 12-months time charter rates are at similar levels. NAT still has plenty of margin for further rate erosion.

Possible stabilization of earnings in 2010 depends on significant scrapping and increased macroeconomic activity. The jury is still out thereon whether this will materialize.
The container market has seen an unprecedented drop in transported volumes as the economic crisis took a grip, with January 2009 business plunging 20% year-on-year. Overall development for 2009 is expected to be negative. Around 5% of the existing container ship fleet is currently lying idle in order to save costs for the owners/operators. This surplus of vessels is not only adding stress to current charter rates, but there is also the pain inflicted by deliveries of new vessels being felt to a greater extent these days as more mega post panamax vessels are being delivered. Under these conditions, a major liner company failure would cause a chain reaction of defaults in the industry.

The container business was an ongoing love affair with institutional investors for many years. Riding the export boom in emerging Asian markets, the sector seemed to have an insatiable demand for tonnage. Financiers liked the business because of the easy availability of long-term charters with major liner companies. German KG's are heavily invested in this sector. US investors like Fortress also backed the sector.

Yet there have been margin declines in the business for some time now. In the boom years operating expenses outpaced hire levels in longer-term charters and created pressures on profits. Cargo volumes on the US West Coast started to wane even two years ago. Last year huge increases in bunker expense caused havoc with the large liner operators, who were obliged to put tonnage on slow steaming to contain fuel costs.

Generally the industry faced these problems trying to improve earnings by greater revenue volume in massive fleet expansion plans with larger and larger vessels. It got to a point that there was an issue about port facilities able to cope with the envisaged cargo volume from the all the massive fleet expansion plans.

Many container shipping companies have orderbooks equal or larger than their existing fleets. These orders cannot easily be pushed out or renegotiated with the ship years, albeit some companies like Seaspan have had some limited success. A majority of containership owners are struggling to pay South Korean shipbuilders after their refusal to countenance demands for delays, price reductions or cancellation of newbuilding contracts.

The issue is how their counter party charterers will be able to take on and absorb these vessels when a part of their existing fleet is already in lay up and they rolling up operating losses. Many shipowning companies are suffering losses, too. Seaspan, for example, saw their losses widen from US$10.4 mio in 2007, while revenues increased to US$229.4 mio against $199.23m the year before as six newbuildings were delivered. Fourth quarter losses were US $241.9 mio. Their parent company was obliged to bail them out by pumping in US$200 mio through a preferred share deal in January this year.

Some of the major liner companies are State-owned as in China. Others like Maersk have a strong balance sheet. The question is how long will they be willing to subsidize the losses and how soon they will start to take measures to contain the losses? Many are redelivering vessels. Will they continue to support the shipping owning companies and take delivery of their new tonnage? Will there be rate renegotiations and defaults on existing charters?

Relief depends on a pick up in the US, which has been the lead consumer market and secondarily in the EU. Despite mounting losses and parent company bail-out, Seaspan CEO Gerry Wang recently said: "During 2008, Seaspan achieved strong growth in both its contracted revenue stream and cash flow for distribution, a testament to its stable business model.” Wang has always maintained that his business was a virtually risk-free money printing machine.

Since the whole industry is already quite overextended, a major liner company bankrupt or reorganization would be the beginning of an irreversible hard landing.

Thursday, March 5, 2009

Why a positive divergence with rising Baltic Dry Index (BDI) but falling dry cargo share prices?

Let's analyze the positive divergence between the BDI and dry bulk share prices. Does this portend a serious basis for a change in fundamentals in dry bulk companies? My view is probably not at present. Dry bulk freight movements are difficult to predict, especially in these difficult times. One has to place higher importance on solvency and staying power to weather the markets rather than future profit expectations for the time being.

Last year 2008 underlined the difficult aspect of timing. It was really two markets in the from of Dr Jeckyl in the first half of the year with a very strong semester and then Mr Hyde in the second half with a record plunge.

This year 2009 there has been some inventory restocking with the fall in commodities prices of iron ore and coal that has brought cheer especially to the Capesize sector. Panamaxes have consistently underperformed. Handysizes are holding out better than the Panamaxes but not giving the same margins as the Capesizes. All sectors have been treading water with break-even levels but at least there is some breathing space of late except for the Panamax sector.

I place particular emphasis on 12-month time charter rates as a market benchmark. These rates show what an established charterer cargo operator will pay to fix and carry dry bulk tonnage over the next year. This takes out the distortions from spot market volatility. Capesize rates have improved to the levels that I cautiously forecasted last fall for example. The issue remains whether the recent market improvement is sustainable in view of the large orderbook of new tonnage coming out of the shipyards.

Unfortunately 2009 vessel orders cannot easily be turned back since these units are in advanced stages of construction. There is a lot more room in 2010-2012 for pushing out deliveries, canceling and renegotiations. The yards have improved margins due the fall in steel prices and this will lead to a fall in new building prices.

The market ahead is highly dependent on the timing of various Government stimulus packages' impact on dry bulk commodity demand. The risks are that rates may stay subdued (and for a large part below break-even).

We have already seen severe financial strain on a number of companies, with the result being contract defaults/re-negotiations. This applies to bank negotiations for loan defaults, charterer renegotiations for revised charter rates and ship yard renegotiations for pushed-out delivery dates and revised contract prices. So far most companies have met the first hurdles but there have been a few tragedies. It is hard to say that we are out of the woods yet.

Although many listed shipping companies look attractively priced on multiples, the downside risk to both cash flows and asset pricing is substantial if recent improvement in the BDI does not prove sustainable. This explains the increasing weakness in listed dry bulk stock prices despite the recent firming of the BDI.

Some cheer for Eagle (EGLE)

Eagle (EGLE) deserves a break given the beating it has taken lately on its share value. There has been some steady improvement in the Baltic Shipping Index, but 2009 remains a difficult year to predict. Eagle has made some progress, but the the shipping crisis is not yet over. It is also faces some formidable competitors.

Natasha Boyden's upgrade plus a general market short-covering rally led to a phenomenal bounce in Eagle's value. There is currently amazing market volatility in shipping share prices.

Yet Eagle reported fourth-quarter profits of US$9.16 mio, down from US$16.3 mio a year earlier. Operating expenses leapt by 139% to US$43.5 mio. The company finished the year with US$9.21 mio in cash out of US$1.36 bn in assets. It had US$790 mio in long-term debt.

I have sometimes been at loggerheads with Boyden. My views tend to be closer to Jonathan Chappell at JO Morgan, who has done some interesting analysis on free cash flow (FCF) as a means of stock evaluation. In these treacherous markets where there is high risk of bank and charterer defaults, I feel this is an especially important indicator.

In this case, I think that Boyden has things pretty much on the mark with EGLE by revising her price target down to US$ 3 and repeating her concerns about company debt, but maintaining optimism about Eagle Bulk's strategy and supramax focus. I would add that EGLE has a good management team.

In a larger perspective, however, EGLE has formidable competition. Larger and longer established groups like Norden and Pacific Basin have stronger balance sheets and more fleet diversity. Where they really outshine EGLE is their very strong employment portfolios and direct end-user relationships. They also have greater economies of scale and lower operating costs. Pacific Basin, for example, is located in Hong Kong and uses extensively Chinese crew.

On the other hand, they have got more exposure on new buildings (albeit their finance needs are covered) than EGLE and extra liabilities from chartered-in vessels.

All of these companies have their hands full in maintaining employment at rates that give them a comfortable cash margin and renegotiations with the yards to push out new building delivery dates and possibly get some price reductions.

DnB NOR Bank projects net (less scrapping) Handymax fleet growth to be a record 21.7 %and 16.8% respectively in 2009 and 2010. So these are challenging times in this current slow growth environment, waiting for various government stimulus plans to have effect.

Tuesday, March 3, 2009

Conceptual paradigms can create mental blindness

The US is the home of the 'financial crisis', which was created by bad political decisions. Conditions have deteriorated due to bad political management. The concept has been to throw huge amounts of money at the problem, expanding liquidity and financing this by deficits and increased public debt. Unless the US government gets out credit allocation, cleans up the banking system and starts focusing on encouraging savings and cash flow from production, it is unlikely that any recovery will be in sight.

FED Chairman Ben Bernanke is the ultimate in financial engineering. Unable mentally to process what has happened over the last year and half, he seems to see the only possible operative paradigm as the 'status quo ante'. Worse, he has a romanticized view of it too. By minimizing the importance of low saving rates (a cash flow issue) and emphasizing the role of increasing asset values (a balance sheet issue), Bernanke fundamentally misunderstood the vulnerability of households to negative shocks to real income.

Basically he does not seem to understand that having asset appreciation fueled by debt is neither healthy economically nor even sustainable. He seems to ignore the basic economics principle that we cannot divorce credit access from the ability to repay. Repayment is normally by cash flow from earnings and by savings.

Value is determined by a constellation of social conventions at some point in time. If the social convention is that financing is limited by ability to repay, then cash flow (largely income), not asset appreciation, is the appropriate metric for valuing houses. "Restarting" the credit markets alone will not alter this convention; it was the willingness to disregard this convention that was the fundamental failure of credit markets. So trying to pump up the markets by massive government injected liquidity is unlikely to restore asset values and stabilize the markets.

Likewise President Obama is also locked into paradigm thinking that is not constructive. He sees himself as a modern day FDR who is going to replace the private economy with government spending that is financed by – guess what? Deficit spending and public debt! Already the American consumer is busted and bankrupt without saving. Now Obama wants to risk US public debt sovereignty by massive increases in government debt.

It may come as a surprise to him as a politician, but an economy cannot run solely on loans! Credit stopped flowing in the U.S. for a very good reason: there was no more savings left to loan. Government efforts to simply make credit available, without cleaning up the banking system, rebuilding productive capacity or increasing savings, are doomed to destroy what is left of the US economy.

The sad truth is that the productive capacity of the American economy is now largely in tatters. The Obama Administration seems to want to tax and trash the US industrial economy, looking to replace it by a reliance on health care, financial services and government spending as it sees fit. The US needs to get back to the basics of production. The administration does not seem to understand that without production that generates positive cash flow and encouragement of savings, the tax base will dry up and the whole system will simply collapse on its own weight.

They would have us believe that we can all spend the day relaxing in a tub while the FED printing press does all the work for us. The problem comes when you get out of the tub to go to dinner and the only thing on your plate will be an IOU for steak.