Thursday, July 30, 2009

Is Wall Street optimism over reaching rational expectations?

PIMCO's Bill Gross argues that median GDP and capital stock returns have been based on 5% PA whereas the government policy efforts to re-inflate the economy have hidden costs and restraints that will reduce median GDP and capital stock returns to 3% PA. This means a new period of sluggish growth and high unemployment where people will have less disposable income.

I have argued in the past that we risk a period of prolonged sluggish growth with high levels of public debt that become a permanent drag on the US economy. The major ideological battle of the new Obama administration is over ultimate control of the US economy between government and the private sector. President Obama is committed to government control as the superior solution. I believe that these policies will result in a poorer country than Americans have been accustomed in the past with lower competitiveness in global markets.

The stimulus plan is based largely on government programs. Efforts to promote 'Cap and Trade' policies and universal Health Care represent the transfer of an increasing share of the US economy to the US government. Already a large share of the banking industry and the US auto industry has been transferred to the government. The FED has a vastly expanded balance sheet.

All these programs are rife with hidden costs and restraints. Further the expansion of US sovereign debt has been substantial. There are rising risks in currency devaluation and higher interest rate exposure. Little has been done to address the problems of over-leveraging . There is no additional resources to assist the underlying goods and services economy.

As Mr. Gross puts it:

"Investment conclusions? A 3% nominal GDP “new normal” means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector, which substantially changes the character of the American capitalistic model. High risk bonds, commercial real estate, and even lower quality municipal bonds may suffer more than cyclical defaults if not government supported. Stock P/Es will rest at lower historical norms, and higher stock prices will ultimately depend on tangible earnings growth in the form of increased dividends, not green shoots hope. An investor should remember that a journey to 3% nominal GDP means default/haircuts for assets on the upper end of the risk spectrum, as well as extremely low yielding returns for government and government-guaranteed assets at the bottom end.

A corollary of this is that the US financial sector is far larger than warranted and needs considerable downsizing.

Financial instruments turn a first half loss into a large profit for Exmar

Exmar is battling drooping revenues from waning freight rates to post the healthy result in poor market conditions. Earnings have fallen the most in the VLGC sector and less sharply in midsize gas carrier.

Exmar has three 150,900-cbm LNG newbuildings under construction at Daewoo shipbuilding & Marine Engineering (DSME) for which financing is yet completed.

LPG export volumes from the Middle East have declined sharply and the lack of long-haul trading opportunities resulted into a substantial fleet surplus. Overtonnaging in the VLGC sector has been evident for a number of years.

The midsize gas carrier fleet is also hurting with substantially reduced ammonia movements gradually increasing pressure on this segment during the first half of the year.

Exmar hopes to secure financing the first two vessels on order fairly shortly and will begin working on the financing of the third vessel in the course of the fourth quarter 2009 with an objective of securing commitment by the first quarter 2010.

It is not clear when market improvement in the gas sector is likely to come in the current economic environment.

Sunday, July 19, 2009

Energy player inks 10 bulkers/ Exporters and steel mills seek long charters

With the fall in dry bulk vessel asset prices, Chinese players have been avid buyers, looking to take a larger share in Chinese-related transport trades. In this case, coal player Lanyue Energy Development signed up for 10 supramax bulk carriers at Xiamen Shipbuilding. This trend is likely to put Western competitor companies at a disadvantage.

Lanyue is one of the top coal transporters in Guangdong province. As aChinese company it benefits from advantageous domestic financing as well as preferential connections for employment contracts. Major London brokerage firms have been saying for sometime now that they feel the Chinese will be moving closer to the Japanese system of covering their transport needs by long-term contracts of affreightment with their own domestic shipping companies.

Notably, Vale's recent deal with NYK comes amid a rush of fixtures by iron-ore exporters and steel mills looking to secure tonnage long term ( Will the Chinese start to follow suit?

NY-listed dry cargo operators will find this tough competition in the future. Many of these companies expanded in large block deals at top of the market prices and leveraged senior bank debt. They have both higher capital and operating costs in comparison to their Chinese competitors.

The issue in the future is the quality of the recovery in shipping for which the dry bulk sector - especially the larger Capesize units - seems to be taking the lead so far.

Is the Handymax sector as good as conventional wisdom claims?

From the outset of the crisis in shipping markets, conventional wisdom has praised companies in the Handymax/ Supramax sector and castigated the Capesize sector. Analysts based their arguments on the record order book for larger bulk carriers and the high age profile of the smaller sizes suggesting need for fleet replacement. Yet the smaller sizes have not been immune to decline in asset value. On the other hand, the recovery in cargo demand this year has favored the Capesize sector.

Secondhand Handymax-bulker values have fallen between 70% and 85%, according to a review of the market by DVB Bank. Shipowners who invested in Capesize bulkers got the best value for money last year, according to research from a top shipbroker, Lorentzen & Stemoco ( and are likely to keep the lead this year.

Whilst most shipping analysts remain focused on supply and demand, they tend to overlook matters like operating margins and leverage as well as investment returns. The larger-size units benefit from lower unit costs. For example, crew cost for a Capesize unit is far less analogous to a Supramax or Handymax on a per Dwt basis, but the freight market for the larger sizes is a lot more volatile with significant profit potential.

Of course, the order book situation for the larger sizes is troubling, but the higher age profile of the smaller sizes is due to the traditionally lower investment returns for the smaller sizes whereas the money for new tonnage follows the higher investment returns.

So far Far East demand has once again smiled on the larger bulk carriers despite order book concerns. The question is whether this is sustainable over the long run? The debate between the smaller and larger bulk carriers is a bit like the Tortoise and the Hare.

Will the analysts backing the smaller sizes laugh last and best?

Tuesday, July 7, 2009

Diana Shipping is upgraded

I have long been a fan of Diana Shipping because of its restrained expansion policy in boom times, strong balance sheet with low leverage and good liquidity and its conservative chartering policy. This was very unfashionable in boom times and some felt that CEO Simos Palios was a poor steward for his shareholders. They found the block deals at record prices and substantial debt leveraging of its peers more exciting. They discounted asset impairment charges and loan restructuring as of no consequence to shareholder value. In these times of crisis, however, Diana is well placed to survive and profit.

Natasha Boyden lifted her rating on the NYSE-listed bulker owner from "hold" to "buy." "We believe [Diana's] healthy balance sheet, high charter coverage and strong free cash flow generation puts the company in a position of strength to potentially expand its fleet by buying vessels at what we view as potentially distressed asset values," she wrote in a note to clients. She said Diana's share price offers an "attractive entry point" for investors.

I do not always agree with Natasha, but I think that she taking a reasonable position here. Others have complained about the company's brokerage commissions levels and practice to put their vessels on charter to operators. The company's relative openness and transparency gave them some room to make such comments because many peer dry bulk companies keep private their chartering details. There is little evidence that Diana is out of line with peer performance in these matters and openness on these matters with investors is to management's credit.

These are challenging times and Diana is one of the few listed shipping companies with a genuinely strong balance sheet to create substantive shareholder value.

Is TOPS still a going concern?

After recently publishing a piece on Top Ships (TOPS) signing a deal with Yorkville Advisors to sell up to US$ 200 mio in new shares as part of a US$ 500 mio shelf registration, Tradewinds is now reporting that the company auditors - Deloitte, Hadjipavlou, Sofianos and Cambanis - have raised "substantial doubts" about the ability of Top Ships to continue. They point to the company's negative working capital position, minimum asset cover ratios and other loan covenants on more than $342 mio in debt, nearly US$ 290 mio of which has been declared current because of the covenant breaches because the breaches impact other loans with so-called cross-default provisions.

TOPS has been one of the weakest Greek listed shipping issues and the worst performer in the tanker sector. Last year, QVT - the leading institutional shareholder in the group - filed an activist petition, calling for the nomination of two independent BoD members. TOPS management strongly objected and prevailed over them.

At the time, TOPS was overextended in a diversification into bulk carriers that they booked in 2007 at top of the market prices. They had hoped to finance this operation by raising additional capital and took out bridge debt financing that was to be repaid by the new equity money. As the subprime crisis broke out, the capital markets turned against them, so their attempts in December 2007 and spring 2008 did not lead to anticipated results. This resulted in share dilution and they made some asset sales to complete the operation.

QVT was unhappy with company performance and rebuffed by TOPS management, but it has held on to its holdings, taking even deeper losses. During the winter this year, TOPS shares were briefly at penny levels, but since then they have improved and are trading at US$ 1.90 - US$ 2 range.

To the credit of TOPS management, they subsequently did some timely and substantive restructuring in 2008, unwinding onerous ship leases and de-leveraging by selling most of their aging Suezmax fleet to Frontline (FRO) shortly before all hell broke loose in the fall financial crisis. Earlier in the summer, they covered their newbuilding commitments for a series of Dwt 51.000 product carriers by leasing them out on bareboat charter to the D'Amico group for seven years. TOPS carries the counterparty default risk on this operation, but they have covered their operating risk.

The issue is whether TOPS has sufficient investor credibility to pull off their plans to raise fresh capital in current market conditions. They seem wary of an ATM issue - perhaps in part because of their experience with activist shareholders - and the climate has hardened recently on ATM operations. So perhaps they are hoping for a private placement. The pricing is open question as TOPS investors were badly burned in a discounted PIPE placement in the spring last year at US$ 7 per share.

I would not rule out success at this point. TOPS has proved resourceful in the past and management has managed to turn around recent company performance to a profit position from previous losses. The auditors' comments apply to many shipping companies these days, but other companies like DRYS have raised capital whilst in senior lender negotiations on technical default.

TOPS remains a speculative play and possible future takeover target.

Sunday, July 5, 2009

End of ATM private bail-outs for troubled shipping companies?

Rewarding failure and value destruction has lately been the fashion on Wall Street. A number of troubled shipping companies with massive losses have been raising new capital at market prices to investors in order to restructure their senior debt and recapitalize from massive losses. Hedge funds and institutional investors have shown remarkable tolerance to loss-making companies in the shipping sector, where they have taken big hits themselves in their holdings. American business culture seems to take losses with relish as if they are only imaginary and cannot not have forward impact. This week Dahlman Rose's Omar Nokta made a tepid protest at this share-issuing practice, saying the boutique New York investment bank has found investors reluctant to buy shares in any owner with a pending ATM programme because of dilution concerns.

The dean of this technique is without doubt George Economou of Dryships (DRYS). Largely through the use of ATMs, DryShips has gone from a shares count of 40 million last autumn to 258 million today, raising over US$ 1 billion in fresh capital whilst in restructuring discussions with his senior lenders and posting massive losses

Investors gobbled up the DRYS shares with enthusiasm. It almost became a self-fulfilling pyramid with shares rising daily at double digit figures, reaching over US$ 10 per share until reality finally set in about expanded share count. Certainly Economou cannot be blamed for the 'get-rich quick' mentality and blissfulness of US investors.

Other companies like OceanFreight have followed suit with this technique. It is been an important source of fee income for Wall Street brokerage houses since the meltdown last fall.

The results will depend on the future of shipping markets, especially in 2010 and further out. If there is a robust recovery, everyone will win. If it is a poor market where many of these companies may be obliged to undergo a second round of debt restructuring with their senior lenders, things may start to get dicey.