Wednesday, June 24, 2009

Distressed asset opportunities for listed shipping companies

The recent Navios acquisition of three Capesize units seized by Commerzbank may set a precedent for similar deals to come. Current economic conditions are stressing shipping companies. As time goes on, senior lenders will be increasingly pressed to cleanse non-performing loans from their balance sheets. An obvious means to reduce losses is to shift assets to stronger owners.

Private companies have a financing advantage over private companies. They can raise capital in public markets. They have many options like issuing more shares, doing a preferred issue or going to the corporate bond market.

Navios, of course, has its own share of problems with charter party defaults and downside earnings announcements and it is not the most transparent company, but recently Neuberger Berman increased their share in the group. Generally analysts like Omar Nokta of Dahlman Rose have become bullish again on the dry bulk sector.

The Capesize sector has performed well in this year's improvement on the BDI. The rate volatility attracts owners to this size. There are only a few major cargoes for the larger bulkers. When market orders rise, rates surge. When they wane, rates collapse. The effects are multiplied by port congestion and longer voyages in boom times. The profitability has been very good the last few years before the crash. These vessels in the Navios deal come with attractive charter commitments.

Dry bulk is very dependent on continued China growth. The issue is whether the recent increase in demand is sustainable. I believe that the surge in dry bulk rates this year is due to Chinese inventory stockpiling. The Chinese renegotiated supplier rates with substantial discounts. They have been more successful than the US in their stimulus program. Government easy money policies lead the way to commodities speculation regardless of demand in the underlying economy.

On the other hand, I do not see a lot of evidence yet that Chinese export markets are coming back. After all, Europe is really in the doldrums and the US consumer markets have not turned around. China has a lot of excess capacity. They will have to restructure. They cannot go on indefinitely by stimulus money. If there is a sluggish recovery in 2010, China may have a growing problem of non-performing loans. Meantime, the dry order book is still big despite cancellations.

All in all there is a high probability for future distressed asset deals. Publicly listed companies will be favored players for many senior lenders.

Monday, June 15, 2009

George Economou vs Jim Kramer

Both George and Jim are iconoclastic personalities. They both have had a mixed performance record with personal ups and downs. Until 2008, DRYS had an exceptionally successful strategy of building up its fleet by retained earning from profitable operations and vessel sale transactions. The company seems often a one-man show with lack of transparency with the Principal appearing to use his private company for business development and passing the transactions to the public company for financing. Stockholders have benefited by this process in results in the past but lately they have been taking some hard hits. The turning point for DRYS was Economou's decision to diversify into the offshore drilling business acquiring OceanRig and ordering additional deep water oil rigs. The financial crisis hit DRYS very hard. Since then, DRYS has been increasing capital with major share dilution. George Economou is not as bad as Kramer says but he has been struggling lately.

The offshore transaction was large for the existing DRYS balance sheet. It absorbed the companies reserves and required a substantial increase in leverage. The company postured itself by reducing spot market exposure on its fleet and moving to longer term employment. The timing was good.

Last fall Economou added some new building contracts generated from his private company that later DRYS was forced to cancel and take losses. This caused some negative comments.

This year, DRYS has been raising capital by issuing new shares and dribbling them out at the market prices. This increase of capital was initially needed in the Groups arduous loan restructuring negotiations for its loan/ asset coverage clauses. In subsequent share issues, DRYS announced a strategy to acquire additional vessels, but there has been some market skepticism about company capacity for additional finance to leverage this new capital.

The China story has enthralled investors in the dry cargo sector for many years now. In the boom years, Far East demand consistently soaked up new tonnage in the market and drove rates to ever higher levels. China now has a great deal of over capacity that it has built largely to service its export markets in the US and EU. These markets have now collapsed.

The US seems to be improving since March this year if one takes Wall Street as a guide but mainly in the financial sector due public monetary policies to bail out lame duck companies and reflate asset prices. The EU has been worsening. It is still an open question how robust the recovery will be so the revival of Chinese export markets is still in question.

China has ample reserves for stimulus and they have probably outperformed the US in putting this money quickly to work. They have renegotiated their commodities contracts and moved to inventory replenishment that has brought a revival in the BDI for dry cargo sector. The Capesize tonnage has had the most benefit with a recent mini-boom. It is not clear whether this is sustainable.

China will most likely need to restructure their export model and this could have a negative impact on future demand projections for dry bulk commodities cargoes in coming years. Meanwhile the dry cargo orderbook is large and China has a significant share of the newbuilding contracts.

DRYS has taken large asset impairment charges for its foray into the offshore sector. It has new rigs on order that need to be financed. It also has had plans to spin off this business to a separate entity.

DRYS is facing large challenges in the present environment. Whatever the outcome, shareholders have gone through significant share dilution this year that will affect future share value. There is the issue of dry market recovery. This year things so far have gone pretty well for the sector. DRYS is completing its first round of debt restructuring. Prolonged market weakness in 2010 could lead to a much more difficult period with its senior lenders but markets may also improve and beat expectations. The main issue in the offshore side of the business is the future of the spinoff plans and its impact on DRYS shareholders. If it goes well, it could boost share value but the company is right now carrying the debt liabilities for this.

Kramer has the ease of being a pundit who can say whatever he likes without much responsibility. George Economou has a lot more weight on his shoulders. I have been critical of George for his excesses in the boom years but I appreciate his struggle in present market conditions. I think that Kramer should show a bit more generosity here. I have outlined the risks for shareholders.

Friday, June 12, 2009

Is the surge in commodities prices due to improved aggregate demand or counterproductive monetary policies?

I would be inclined to support the view that oil prices will continue to rise this year along with other commodities. The issue is whether this will be driven by aggregate demand in the underlying economy or excess liquidity from present monetary policies. We have seen huge speculative swings in commodities prices with the rise of futures markets, where there has been a decoupling with the underlying goods and services economy. So far export markets remain weak and there is a lot of excess productive capacity. Tanker markets have been terrible with very low rates, indicated little movement of physical product. As the panic in financial markets has passed, money seems to be flowing from treasuries and cash back to higher yielding assets like oil and other commodity speculation.

Since last fall as a policy response to the financial crisis, the US has adopted a 'spend our way out of the crisis' strategy based on a revival of Keynesian economics. US politicians have been massively expanding deficits and public borrowing to support these policies. They perceived the financial crisis last fall as a matter of liquidity rather than solvency. They have been socializing losses and bailing out lame duck industry. They have transferred leverage from private balance sheets to sovereign public balance sheets, trying to re-inflate asset prices rather than de-leverage.

The issue is how effective this revered 1930's economic theory will be in today's open economies and global markets as a policy response to the bursting of an asset bubble financed by high debt leverage.

The politics in the US raises the risk of debt monetization. The rise in commodities prices as well as longer term treasury yields may be driven by growing market perception of this danger. If this scenario pans out, it could lead to a very weak, sluggish recovery, plagued by commodity and asset inflation as well as renewed US dollar weakness.

It will be a very interesting fall this year!