Saturday, December 11, 2010

Genmar's scaling up proves poor timing decision

Peter G was the star of Posidonia earlier this year with his US$ 620 mio block tanker deal for the Metrostar fleet (five VLCCs and two suezmax newbuildings). He succeeded to raise US$ 195.6 mio in net proceeds from the sale of 30.6 million new shares plus allotments with a minimal 4.75% discount in a highly touted deal. One cynical hedge fund manager said at the time that the deal was a means to raise equity with minimal dilution for an already belabored operation suffering from high leverage.

The leverage reduction was only 5% with a drop from 75% to 70% by this equity raise on hyped expectations of a tanker market recovery. A number of major brokerage firms were bullish on tankers at the time. Several analysts upgraded Genmar, which facilitated the issue.

These shares represented 50% of the companies market valuation. There was both market and dilution risk in this operation, yet well-regarded analysts like Cantor's Natasha Boyden ignored the risks arguing that the acquition was accreditive and encouraged investors to buy. Unfortunately, the tanker market disappointed and Genmar's share price has been heading southwards since. Investors got badly burned.

In the fall, Genmar announced a US$ 165 mio sale and leaseback deal with Pareto for two VLCC's (Genmar Victory and Vision Dwt 312,000 both built 2001). This transaction looked like signs of financial trouble with leverage and liquidity. Genmar was facing a 15 December deadline to carry out asset sales. Pareto struggled to rally investors to put in US$ 43 to US$ 63 mio equity to close the deal.

Generally sale and lease back deals raise cash at the expense of future cashflow. In the case of poor markets, this can create further problems. On the other hand, they enhance operational leverage should there be an upturn.

Under these circumstances, it is not surprising that Standard and Poor's (S&P) has just slashed General Maritime Corp’s (Genmar’s) long-term corporate credit rating from B to CCC+. S&P cited lack of current borrowing ability, low levels of cash and significant intermediate-term debt obligations as the rationale.

Wells Fargo Securities analyst Michael Webber said: "given that Genmar's best options to avoid a covenant breach include: additional waivers, which would indicate continued dependency on its lenders and a potentially higher interest burden; asset sales, which could imply material [net asset value] NAV downside if forced on to the market; and an equity raise (which would be significantly dilutive); we believe shares could continue to face downward pressure over the near-to-intermediate term.”

Many feel that tanker markets will improve in 2011. The question is the degree of recovery since the fall in rates has been substantial and the winter season so far has had lackluster results.

Friday, November 12, 2010

QE2: Dampening shipping sector expectations from the Chinese Eldorado?

Nearly all the shipping investments made this year have been predicated on continuation of double digit Chinese growth ahead to maintain demand and soak up new tonnage coming into the market from the large orderbook overhang. Should Chinese growth rates slow to lower levels, this risks retarding market recovery and the effects of tonnage overcapacity may continue to impact the shipping markets longer than the smart money was counting on.

China reported an October trade surplus of US$ 27 billion Wednesday. This is a very big number. It will be very hard for China to credibly argue that it is trying to contribute to global growth while pulling in more and more foreign demand.

In his latest piece on the impact of QE2 on China, Michael Pettis is projecting growth rates over the next few years in the order of 5-7% if all goes well. He believes that major growth driver in the Chinese development model is low interest rates. He feels that the influx of dollar capital inflows from QE will really test the Chinese capacity to continue to keep their US Dollar peg and keep down domestic interest rates.

The Chinese appear to have thrown the gauntlet to Tim Geithner’s proposal on restricting current account imbalances directly by caps on exports as percentage of GDP, setting the stage for a potential G20 showdown. China is very dependent for its growth on widening trade surplus, and if the surplus was cut by a third in the next year or two, which is what it would take to bring it to under 4% of GDP, it would cause a several percentage point slowdown in Chinese growth, which could only be reversed by another surge in bank-driven investment.

Low interest rates (along with their cousin, socialized credit risk) are the main causes of capital misallocation and excess capacity in China, and are probably also the main forces pushing down household income and household consumption as a share of GDP.

China is very worried about the double impact of a contraction in the trade surplus and the impact of the Fed’s quantitative easing. If the former occurs, it will be almost impossible for Beijing to reduce the impact of the latter without causing a sharp slowdown in growth.

QE2 is fairly explicitly the US countermove in the great global game of beggar-thy-neighbor. It risks creating excessive monetary expansion in China because the PBoC will insist on purchasing all dollar inflows at the exchange rate set by the PBoC and monetizing them. China and other countries are right to claim that QE2 is likely to lead to asset bubbles outside the US, but only, as the US points out, in countries that intervene to prevent dollar depreciation, something the US authorities want to punish and end.

China already is experiencing a liquidity-driven investment boom, and would have already raised interest rates if it weren’t so difficult to do so (many borrowers can barely service debt even at such low interest rates). If the US continues to pursue quantitative easing, it could spell the last stage of China’s great growth spurt followed by the beginning of the big adjustment.

Shipping market expectations started with somewhat of a bang in the first half of the year with the new IPO's and renewal of large block deals. Even the container markets started to turn around with the slow steaming and renewed export volume from head haul routes. Dry bulk took the first hit in the summer with an abrupt fall in rates, for which there has been a fall recovery. Tankers have been dismal and underperformed since last winter with so far a disappointing 4th quarter.

Nearly all shipping investments at present asset price levels have very mediocre investment returns and depend on future reversion to median freight rate levels for satisfactory returns  to woo investor money. Everyone in shipping is counting on a gradual recovery in 2011 and they are all citing the China growth story in their investment thesis as a prime demand driver.

Tuesday, November 9, 2010

Profit and Growth Opportunities in Container Port Logistics Software

Goldman Sachs Infrastructure Partner's investment in Carrix, Inc signals investor interest in high-quality, core infrastructure software systems. Whilst container shipping has been suffering from overcapacity of vessels, the competitive landscape for container terminal software suppliers is limited to a select number of vendors - TideWorks, Navis, Maher, Advent Inc, Cosmos - in a growing market in the global port operations industry. Goldman saw a substantial growth opportunity in Carrix.

Container liner companies like Maersk have evolved into a highly integrated logistics services with worldwide presence. The container logistics business is moving to a manufacturing business model with forecasting and advanced planning. Often they own their own terminals and are actively investing in new terminals in key locations. The trend is to merge air freight, trucks and container services. The European Union will shortly change customs regulations such that cargo must be declared on departure to the arrival port customs authorities. This will add new demands on container port  terminal operating systems (TOS's). These systems pay for themselves quickly.

Container registration is a core task. It is simply not possible for terminal to keep track of their container cargo without appropriate software systems. Today container logistic systems are fully on line so that containers can be tracked from door to door. Once a container terminal chooses a software system, it is difficult to change and move to another software vendor. Service and backup are essential. Software suppliers compete by leveraging proprietary algorithms. As time goes on, the technology advances in computing power.

The right container terminal operating system (TOS) ensures the long-term success of a terminal by being efficient, adaptable, cost-effective and scalable. Terminal operators need an automation system that enhances container terminal operational efficiency and supports future growth while reducing operational overhead and maintaining customer-focused services. For independent terminal operators, it is essential to have reliable, accepted TOS systems to maintain competitive advantage over alternative port terminals with liner company customers.

The leader in container port software is Navis, which is owned by Zebra Enterprise Solutions, which services over 400 ports worldwide. Cosmos was started by an Antwerp services company. Carrix is the parent company of SSA Marine and Tideworks Technology. SSA Marine is the largest U.S. owned, and privately held, marine terminal operator in the world, with over 120 marine and rail operations worldwide, including 11 container terminals in LA/Long Beach, Oakland, Seattle, Panama, Mexico and Chile. Tideworks has focused more traditionally on truck warehousing and is less interesting to terminal operators than competitors like Navis.

Both Piraeus Port Authority and APM Terminals in Rotterdam use Navis software systems. Latest Navis SPARCS N4 software has integrated two previously separate systems. It is a terminal operating system that is very maintainable and adaptable over the entire life-cycle of the product while allowing customers the flexibility and scalability they need to run their operations - from a single terminal to multiple terminals across multiple geographic locations, all within a single instance. It is priced at the lowest possible total cost of ownership (TCO).  As market leader, Navis systems are sold at a premium to competitor software vendors.

The large terminal companies make annual reviews of their software systems and future needs. APM Terminals, which is one of the largest container port terminal operators in the world, has prepared a comparative report on software vendors for external use with a look into the future with a five-year horizon.

Thursday, October 21, 2010

Irish Sea ferryboat business rebounding but limited financial returns

The Irish Sea is of significant economic importance to regional trade, shipping and transport. Unlike Great Britain, Ireland has no tunnel to mainland Europe. Thus the vast majority of heavy goods trade is done by sea. Annual traffic between the two islands amounts to over 12 million passengers and 17 million tonnes of traded goods. There are five major companies who service these needs: 1) Seatruck Ferries 2) Norfolkline (now DFDS in Denmark) 3) P&O 4) Stena Line and 5) Irish Ferries.

Seatruck is a dedicated freight ferry service. They have two short sea routes and the longer Dublin-Liverpool service where they cater for trailers and unaccompanied freight. They are part of the Clipper Group. Seatruck has been growing capacity, although it has not been all smooth sailing. Its 6,000-gt ro-ro Riverdance (built 1977) was declared a constructive total loss (CTL) after grounding on Blackpool Beach in early 2008, while Spanish builder Astilleros de Huelva was very late delivering four 142-metre Heysham-max ro-ro containerships, which proved very expensive for them causing them to miss the strong markets when the Irish economy was booming prior 2008.

Norfolkline was established in 1961 but it has recently passed ownership from A.P. Moller-Maersk Group who then sold out to DFDS in which Clipper has been increasing its share lately. It operates long haul services between Belfast/ Dublin and Liverpool that are freight-oriented like Seatruck.

The other contenders, Stena, P&O and Irish Ferries focus mainly on ropax business. They also cooperate in joint services on certain routes. Stena has four short sea routes: Belfast-Stranraer, Larne-Fleetwood, Dublin-Hollyhead and Rosslane-Fishguard. P&O (now owned by the Emirates-based DP World) operates three routes: Larne-Cairnyan/Troon and Dublin-Liverpool (competing in this longer haul route with Seatruck and Norfolkline on freight and unaccompanied cargo). They sold their Larne-Fleetwood service to Stena in 2004. Irish Ferries operates two services: Dublin-Hollyhead and Rosslane-Pembroke.  They focus on short sea routes and other activities as discussed below.

These are all diversified companies. Irish Ferries - owned by the Irish-Continental Group - operate ferry services directly to Continental Europe, they have invested in terminals and are also active in the container sector. Stena and DFDS are active in the Baltic ferryboat business. Aside from being one of the world's largest ferryboat operators, Stena is also a major tanker player in bulk oil shipping.

This business has been suffering from the Irish financial crisis with reduced traffic and earnings results with some pick up this year. The crisis hit hard the more lucrative freight and car market. Traditionally the financial returns in this business have been limited. CAGR for Irish Ferries in this sector is frequently negative.

Greener pastures in liquid storage over tanker shipping

The storage industry has experienced solid growth since 2004. The financial meltdown of 2008 brought it very minimal pain. Vopak is the major independent storage operator. Stolt and Odfjell have storage subsidiaries to offer full service to their clients and strengthen their balance sheet. Others like Oiltanking are part of a trading company group (here Mabanaft).  Storage is a growing market that is part of global supply chain logistics.

The storage market benefits from four major global trends:

  • Geographical imbalances between product and consumption.
  • Countries setting individual specifications for products.
  • Liberalization of previously closed economies.
  • Growing demand for biofuels fuels.
Large multinational groups like Vopak operate terminals globally in a variety of countries. Vopak is in both the oil and chemical storage business. The oil storage business is driven by distribution needs. For example, Russian oil products are transported in smaller ships to a hub location (Rotterdam) where they are sent to the Far East in larger vessels. Vitol, a major oil trader, is building a storage facility in Cyprus as a hub for Russian Black sea production to be exported to other locations. Likewise Middle East oil products to be distributed in the Med.

The rising trend in country regulations setting individual specifications for products has been an Eldorado for this business since this creates rising demand for local blending before products can be distributed in the market place. Environmental regulations calling for greater use of biofuels have also been a boon to the storage industry with the rise of ethanol blending in motor gasoline.

One of the biggest future drivers for this business should be the Middle East refinery facilities and the shift to product of oil products and chemical feedstock at source. Production at source allows very competitive product prices for export. Whilst these facilities have been targeted for export to Far East emerging markets, there are also export opportunities to Europe and the US. Equate, a Dow-Kuwait joint venture, has been exporting ethylene glycol to the Mediterranean for some time now. The product and chemical sectors may be in the doldrums from tonnage overcapacity, but the products still need to be discharged in storage tanks.

Chemical storage is more oriented toward industrial production needs. Vopak experienced in 2009 a sharp reduction of chemical storage volume in their European chemical division, but this was made up globally by rising demand in Far East emerging markets.

The largest share of storage is booked on a fixed rental basis, providing stable income flow not subject to volume fluctuations. A large share of contracts (40% for Vopak) are long term (over four years). This trend is especially strong in Far East emerging markets. This provides stable cash flow to amortize the large capital investment in new storage facilities. Returns on capital in this business often exceed 20%.

Whilst volatility and timing can create great opportunities in the tanker market, this creates much higher risks in a capital and labor intensive business. The storage business has provided better returns over time with less risk. For major chemical parcel tanker operators like Stolt and Odfjell, their storage divisions have assisted them in providing for more stable financial results.

Wednesday, October 20, 2010

TeeKay in share buy-back

TeeKay's shares recently soared on announcement of a share buyback plan. TeeKay is one of the shipping sector's major success stories. Despite being mainly a tanker operator its share price is at record pre-2008 levels. Since early 2009, it has been making a steady recovery. The company operates a diversified fleet of Aframax, Suezmax, VLCC's and product tankers. It also has a presence in LNG and LPG vessels as well as the FSO/ FSPO market. It is a major operator of shuttle tankers.
Teekay plans to resume buying back its shares under an existing $200m share repurchase authorization. They feel that their shares are currently trading at a 40% discount. They moving into a period of excess cash flow and they see this as a compelling investment opportunity.

Teekay has a number of spin off companies in tanker and gas vessels. Its down stream company, TeeKay Gas Partners, has outperformed peer shipping shares, recovering all its pre-2008 value. It was a tremendous value play in 2009.  Just recently Teekay LNG Partners announced plans to acquire a 50% interest in two Exmar LNG carriers for an equity purchase price of about US$ 70 mio. Exmar will retain a 50% ownership stake and continue to operate the two ships.

The ships are the 138,000-cbm Excalibur (built 2002) and the Excelsior (built 2005), a specialized gas carrier which can both transport and regasify LNG onboard. The two ships are expected to generate distributable cash flow of about $10m per year for Teekay LNG Partners over the firm period of the charter contracts.

TeeKay made news earlier this year with its loan to Nobu Su's TMT for two VLCC's for which they used a pre-2008 credit facility taking advantage of the sizeable loan spreads.

Gremlins returning to haunt container market

This year market a remarkable turnaround in container shipping. In 2009, major container operators took massive losses, 10% of the global tanker fleet was laid up. Projections were for two more years of losses before recovery. Ultra slow steaming soaked up surplus tonnage capacity together with robust economic recovery in Asia. Resumption of exports to EU and US head haul trades have led to a resurgence of profits. Basic over supply of tonnage remains. Head haul routes are weakening again.

Maersk is cutting its Asia-Europe capacity by 10% for the winter period in line with changing market demand. Volumes are expected to remain weak throughout the coming four months, as the seasonally weak winter period approaches.

Conversely, Singapore's NOL Group has posted net profit of US$ 282 mio for the third quarter, turning around a US $138 mio loss last year. Revenue to 30 September grew 55% to US$ 2.4 bn. Its cumulative nine-month profit is now US$ 283 mio. It lost US$ 530 mio during the same period last year. Revenue for liner shipping improved 60% to $2.2 bn in the third quarter. Containership unit APL’s core pre-tax and interest earnings were $301 mio, compared to a loss of $130 mio in 2009. Average revenue per feu was $2,799, up 21%, while volumes grew 29% to 2 mio feu.

Container port operators in mature economies face strong cost competition from emerging markets due to excess capacity and slowing growth rates as this year's sharp rebound in container shipping cools off. Port congestion was returning in the fast growing emerging markets, but sluggish growth in the mature markets meant continued excess capacity in many ports, including New York/New Jersey and Antwerp. Customers seeking the over-capacity are starting again to squeeze the liner operators and there is increasing cost competition.

This has not discouraged more asset-oriented shipping players to move into the containership sector. A number of Greek operators like Paragon and Diana have bought container vessels at current price levels and put them on charter, looking to build up a presence in the sector. More established operators like Seaspan have continued their aggressive CAPEX plans, absorbing all newbuildings due this year, putting them on charter with increasing reliance on major Chinese liner operators.

There remains a lot of optimism in financial circles that pre-2008 growth levels will return rather than a prolonged 'new normal' scenario or at least this appears to be their story to investors in these companies to back their large deals and aggressive asset expansion financied by bank debt and plans for follow-on share offerings. They argue continued robust Asian growth regardless of Western economies. Also, attractive is the long-term employment by liner companies with strong balance sheets or sovereign risk that are considered too big to fail and unlikely to renegotiate rates downwards in poor market conditions. Tanker and drybulk sectors charters are generally for shorter period of time and more prone to renegotiation.

Seaspan's share price has outperformed this year from US$ 8 levels to the present US$ 13.20 despite the weakening conditions in the underlying container freight markets. Seaspan remains highly leveraged but it has long-term employment not subject to these market fluctuations. Still its share price remains very far from the lofty US$ 30 pre-2008 levels, but this is the same pattern for nearly all shipping stocks since the meltdown.

The basic problem is that there is still a large order book overhang of tonnage and even some new ordering. The slow steaming has been masking the existing over capacity and some are even calling for these measures to become permanent. The sector would be exposed to the effects of trade rebalancing when and if this every takes place.

Tuesday, October 19, 2010

Tough times for the tanker sector

Despite some rate improvement earlier this year and some speculative new IPO's like Crude and Scorpio as well as a large Genmar block acquisition deal; the markets have not met expectations, suffering from low rates and over capacity. Futures and inventories do not support any storage to soak up excess tonnage supply. Scrapping of single hull tonnage has been high. Even bullish analysts like Platou have revised downward forecasts. The future depends on renewed FE emerging market demand.

Recently Oppenheimer's Scott Burk and Cantor's Natasha Boyden have been downgrading major listed companies and slicing rate forecasts into 2011. Boyden reduced next year's VLCC rates to US$ 40,000 daily, some US$ 5,000 a day lower than she had previously expected. She chopped her fourth quarter Suezmax forecast from US$ 37,500 daily to US$ 22,000 daily, with projections for 2011 down from US$ 35,000 to US$ 30,000. For 2011, Burk dropped his rate assumptions to US$ 36,000 daily for VLCCs and just US$ 27,500 per day for Suezmaxes.

Whilst demand from the East has remained strong, it has not compensated for drop in demand from the major oil consumers in the west, which remains weak. The onslaught of tonnage supply has further pressured rates, with the pace of newbuilding deliveries accelerating and floating storage counts coming down. This year there has even been some resumption of ordering. The prospects of a significant rebound in 4Q look bleaker by the day.

Natasha Boyden recently bumped down Overseas Shipholding Group, General Maritime and Tsakos Energy Navigation from 'buy' to 'hold'. Share prices have taken a beating. Peter G's General Maritime, which was a star in the spring with its massive Metrostar deal raising over US$ 200 mio from the market with little or no discount to complete the deal, is currently trading at US$ 4.03 today down from a peak of US$ 8.80 at the time of the deal frenzy. Such is the fate of investors in current markets who trust their underwriters, albeit perhaps the longer-term will eventually bring expected appreciation.

Genmar recently sold two of its VLCC to Pareto. Although claiming other reasons, this may have been a financial move to get the units off their balance sheet. Their US$ 620 mio block deal was financed with a US$ 372 mio loan facility from DnB NOR bank.  At the time of the share offering, the company leverage was approximately 70%; so if market conditions continue soft in 2011 with declining vessel values, they could have loan coverage covenant problems.

Crude and Scorpio have held their share value more successfully than Genmar despite the weak spot freight rate environment. Their business model is based on less debt but Crude has substantial spot market exposure and limited operating history. Scorpio has a very strong chartering and management team providing more more inherent value than Crude, but the clean sector in which they focus has been a market laggard for some time.

Clean products have much better forward growth demand projections than the crude sector. The long term OECD trends are negative for crude oil and the only growth comes from Far East emerging markets, whereas new refinery projects in the ME will lead to structural market changes with more production at source and less export of crude oil. Unfortunately, however, the clean tanker sector order book has overshot realized demand growth and created currently a nasty over supply situation.

Scorpio's CEO Robert Bugbee, ex-OMI CFO, was one of the first major tanker executives to warn investors of coming market turbulence.

Friday, October 1, 2010

Signs of Life in Dryships Shares

Dryships recently sealed a breakthrough drilling contract that caused an 6% bounce in its share price early this week. Its share price was taking a beating this year largely due the employment uncertainty for the deep water drilling rigs on construction, CAPEX gap and the liabilities that dominate its balance sheet.

Dryship's acquisition  of OceanRig, a two-rig drilling company in Norway, back in late 2007 was a major gambit in its future. The company made a major shift into the off-shore drilling sector. As founded, Dryships was one of the most speculative plays in dry bulk. This transformed Dryships into more of a drilling play than shipping company, to which it added an additional two newbuilding deep water drilling rigs negotiated through Cardiff,  George Economou's private shipping company.

Unlike other its other Greek listed peers, Economou started with a much larger controlling share (45.5%) in the business, where he focused on somewhat older, mainly Panamax tonnage initially. His strategy was to build up the fleet in the then rising market by selling off this tonnage at profits and then using the free cash flow from operations and sale profits to buy newer tonnage. Most vessels were traded on the spot market. This strategy quickly made Dryships a market darling where its share price hit the roof with its share price rising from US$ 17.50 as an IPO to over US$ 120 by late 2008 with less than two years of trading.

The OceanRig transaction was done at the top of the market. This loaded the balance sheet with debt and the company put most of its fleet on period time charter for financial posturing. The 2008 financial meltdown hit the company very hard. It found itself very quickly with major loan asset covenant violations and was constrained to enter into a series of at the market supplementary share offering with considerable share dilution in 2009. George Economou's stake in the company plummeted. (Currently it is back to 14.5% after some incentive plan awards in his executive compensation plan.)  Economou held all the key corporate positions. There was rising criticism about transactions between his private company Cardiff and Dryships.

The loan covenant asset-debt coverage violations have taken months of negotiations to resolve. Just recently the company penned a pair of supplemental agreements with HSH on loan covenants laying the groundwork for amendments to its senior and junior loan facilities that carry an outstanding balance of US$ 520.9 mio. Last June, Economou announced that the company would do no further deals with his private company Cardiff.

The company has recently added some depth in its management team with the appointments of Ziad Nakhleh as Chief Financial Officer and Pankaj Khanna as Chief Operating Officer. Nakhleh was formerly CFO at Aegean Marine Petroleum Network Inc and started his career as an auditor at Ernst & Young and Arthur Andersen in Athens.  Khanna was the Chief Strategy Officer for Excel Maritime Carriers Ltd.  Mr. Khanna also previously served as Chief Operating Officer of Alba Maritime Services S.A.  Prior to joining Alba Maritime Services S.A., Mr. Khanna was Vice President of Strategic Development at Teekay Corporation.

The four well contract off West Africa will generate US$ 135 miio in revenue. Dryships still needs financing to cover its CAPEX for two of the four newbuild drillships. It has a US $350 mio ATM offer pending. It still needs contracts on the other three drillships to finish financing remaining payments of US$ 1.1 bn.  Originally Dryships had plans to spin off their drilling company but this has been constantly delayed. It is said that they want to realize at least US$ 400 mio from this transaction.  This may require more progress on the CAPEX financing gap and better contract cover.

Significant Changes in Chinese and Greek Ship Finance

As the Chinese local banks were used to distribute the stimulus package in 2009, local financial markets were flush with liquidity last year. Unlike Western markets, there was plenty of finance available for shipping companies. Today there is growing a shortage of US dollars in the market because China’s Central Bank is soaking up the foreign inflows from Chinese exports. Presently growing need in China for international finance sources is leveling the playing field on the finance front.  Hopes now seem frustrated that China might be a new source of senior debt finance for the hard-pressed Greek local market.

There was a big hope in the cash-starved market in Greece that China might be a new source of finance for Greek owners. The Greek public debt crisis has effectively locked up small, medium market Greek owners from senior debt financing from local Greek banks.

Chinese banks had expressed an interest in targeting more international ship finance business, even if there is not a domestic element. In practice, very little actual business has been done.

The majority of these smaller Greek shipping companies are very healthy economically with good reserves from the boom years and most of their fleet paid off, but domestic banking crisis has deprived them of bank finance for fleet renewal.

There is considerable potential in the Greek market for foreign lenders interested in medium term asset lending with attractive pricing. Also this situation makes lease financing a viable alternative. The high loan pricing makes leasing more competitive than credit conditions prior the 2008 meltdown.

Earlier this year DnB secured a Renminbi currency licence to extend their loan business to the local Chinese market. The Chinese domestic fleet is almost equal in size to the international fleet and is basically Renminbi currency dominated. DnB NOR Bank's Espen Lund recently said  "With this shortage [sic in China], we now have the big shipping companies coming back to us and our business is now back on track."

If the moribund situation in Greece prevails over time, it will result potentially in more rapid consolidation of the Greek fleet in fewer and larger companies with access to public markets and international banks. It may also lead to a longer term shift, where the Chinese-controlled fleet grows in proportion to service more of its cargo transport needs.

Thursday, September 30, 2010

Two Chinas for growth in steel demand?

Many dry bulk owners invested in Panamax and Capesize tonnage seem to expect that China will follow a path similar to Japan or Korea in terms of steel consumption per capita. The critical question to ask is whether it makes sense to look at China as an undifferentiated entity in this matter. The per capital steel consumption in the coastal regions on a standalone basis already surpasses Germany! It may be less growth potential than most observers are forecasting.

Danish Ship Funds, Christopher Rex, divides China into an urban and a rural economic zone.  He notes that approximately 650 million people, of the Chinese population of 1.3 billion people, live in the urban region. The remainder lives in rural China, where food expenditures account for a relativity large share of the disposable income. In rural China approximately 150-200 million people living are living in poverty (using the internationally accepted 1 US$ per day guideline), There is still a long way to go before these individuals increase their steel intensity to a level close to that of the urban regions.

Rex deems it unlikely that the rural regions will develop their steel intensity extensively as long as food expenditure represents a considerable share of their income. The current food inflation exacerbates the situation and suggests that it will be a long time before the rural provinces increase their steel intensity per capita.

The future potential for Chinese iron ore demand is highly sensitive to this issue. Assuming that the Chinese population, in terms of steel consumers, does not consist of 1.3 billion people but rather the 650 million people living in the urban region, this change would obviously double the Chinese steel consumption per capita from its current level of 320 kg per capita (the same as the US) to 650 kg per capita (larger than Germany).

If Chinese steel consumption per capita is 650 kg, few will expect a massive surge in Chinese iron ore imports.

The only saving grace to this situation has been the financial crisis that has limited capital and increased the cost of bank finance for owners to complete their CAPEX needs. Last year roughly 60% of the drybulk new building orderbook was deferred and there may be similar results this year.

A Chinese rebalancing agreement with its trading partners that results in a 20% currency depreciation over a several years would bring market conditions similar to the early 2000's (when China did something similar with its currency) with considerably dampened freight rates. Despite the sharp drop earlier this year in spot Capesize rates, present rate levels remain profitable for dry bulk operators and they remain in a more comfortable position than their tanker owner peers.

China bubble ahead or beginning of a new economic boom cycle?

Optimism on China and other emerging markets is a major driver in shipping markets this year in all classes of tonnage as well as resumption of new building orders. WTO's Pascal Lamy revealed global trade is now expected to grow 13.5% this year. The future depends on successful trade rebalancing, a highly complex and political issue. China watchers like Michael Pettis and Andy Xie do not believe in the sustainability of the growth model.

Pettis and Xie feel that this system is resulting in increasing asset misallocation. The growth model is based on easy money from domestic financial repression that the government invests in infrastructure projects, SOE's and real estate. China keeps its currency pegged with the US Dollar at advantageous rates to promote exports by massive purchasing of US dollar assets rather than importing their trade surpluses domestically. Internal saving rates are held at very low levels.

Xie has argued that there is no rational pricing mechanism for real estate swapped by local government entities. Pettis is worried about future non-performing loans. He cannot see how the Chinese authorities can boost consumer growth from loss-making infrastructure projects:

"But governments do not cover losses. They channel money from households to cover losses. In other words if the Chinese railroad system turns out to be economically non-viable (i.e. the true economic cost of building it exceeds the economic benefits), households will be forced pay for the net reduction in national wealth. This of course reduces future household income and consumption – the surging of which is supposed to make all these infrastructure projects viable."

Xi Li, a Consultant at State Street Global Advisors, focused in a recent article on the real exchange rate (RER), which is nominal exchange rate (NER) adjusted for inflation rate and is more important in determining a country’s current account balance with another country. China's NER, largely fixed with the U.S. in the last few years, is provoking very high internal inflation. Bubbly housing prices are due to a combination of negative real interest rates, few investment options, and extremely low carry costs in terms of maintenance fees and zero property taxes.

This viewpoint dovetails with Andy Xie's observation that the global economy is like fried ice cream, where China and other emerging markets are swallowing the US stimulus. Fed easy money policies are putting them on fire with inflation. Li feels that these dynamics will eventually put China in a very precarious position. China will become even more dependent on investments and a current account surplus to grow its economy. It is increasingly cornering itself by reducing the RER of Yuan.

Given the fixation of the current debate on adjusting the NER between Yuan and USD, one day, the continuously exploding trade deficit, coupled with the likely persistent high unemployment rate in the U.S., means that the only outcome will be the threat of trade war, or trade war itself. The U.S., controlling final demand, may finally realize that this control gives it much stronger bargaining power, may end up as the relative winner. If China has trouble, the most commodity driven economies. None of this would be good for commodity shipping.

Pettis recently wrote a lengthy piece on the politics of Chinese adjustment. He notes four ways of boosting the household income share of national income and made a list of winners and losers as follows:

Winners and losers

1.) Raise the renminbi:

Households as consumers, especially middle and lower middle classes
Service industries


2.) Raise interest rates

Households as savers, especially the middle and upper-middle classes
Service industries
Labor-intensive industries
Small and medium enterprises
Capital intensive industries
Real estate developers
Local governments

Capital intensive industries
Real estate developers
Local governments

3.) Raise wages:

Households as workers, especially lower middle classes and urban workers
Consumer and retail businesses
Capital intensive industries with domestic customers
Employers, especially low-income labor intensive companies

Employers, especially low-income labor intensive companies

3.)Transfer state assets:

Households, with the distribution depending on the form of privatization
Government, especially local officials

Government, especially local officials

He notes that the trick for any of the first three adjustment measures (which are the necessary ones for a sustainable adjustment) is to adjust just fast enough so that the employment created by the rise in household consumption offsets the unemployment created by financial distress among the relevant losers. He stresses that Chinese adjustment must be slow because in the short term the negative consequences for employment can overwhelm the positive consequences.

Pettis feels that the pace of China’s adjustment will in large part depend on the pace of the external adjustment. Its trade surplus depends on the ability and willingness mainly of the US and trade-deficit Europe to absorb them. He does not think that the rest of the world is able (especially in the case of trade-deficit Europe) or willing to wait long enough to allow China a relatively easy adjustment.

Accordingly, Pettis interprets the China optimism of commentators like the Sydney Morning Herald's Michael Pascoe and the Financial Times's David Stevenson as the final stages of a bubble. Both Pascoe and Stevenson see a huge rising consumer market in China in the coming years as a major driver in world growth.

The shipping community seems to believe strongly in the robust growth school with Peter G's block vessel acquisition deals earlier this year, Navios's foray into tankers and Evergreen's new order of post-Panamax tonnage. From 10% of the world container vessel fleet in layup in 2009, pundits are now concerned about a future shortage of boxships in view of this massive new growth ahead. All this is all based on continued robust demand growth in China and other emerging markets.

Thursday, September 9, 2010

The Eurozone pact with the Devil and its risks

Peripheral Eurozone countries effectively made a Faustian pact with the Devil foregoing their economic freedom in exchange rates and monetary policy tempted by easy credit and EU transfer money that resulted in consumption and real estate bubbles. The Euro was always a political tool to force European integration rather than sound economics. The EZ created structural distortions increasing divergences. Without an exit mechanism, "Abandon every hope, ye who enter here" as Dante would put it....

The Trilemma in international economics suggests that it is impossible to have all three of the following at the same time:
  • A fixed exchange rate.
  • Free capital movement (absence of capital controls).
  • An independent monetary policy.
A flexible exchange rate and independent monetary policy are means to manage trade balances and promote growth, which is critical in an open market environment and free capital flows - something that EU periphery politicians sadly overlooked.

These hapless countries were reduced to the status of US state governments but without any equivalent of the US Federal redistribution system. EU members in the north like the UK, Denmark and Sweden prudently passed on these risks, preferring their independence. They were unjustly and ruthless maligned by the Brussels elite, but today time has proven the wisdom of their judgement.

Unlike sovereign governments, who can create monetary reserves through their central banks, the peripheral Eurozone members unwittingly exposed themselves to the risk of insolvency and bankruptcy with the illusion of a sovereign guarantee from Brussels that allowed them to rake up public debt in amounts and at rates that they would not normally be entitled. Once the bond vigilantes moved in and popped this illusion, credit spreads started to widen with restoration of proper risk pricing and crisis broke out.

The Brussels elite initially compounded the crisis with their very poor management, blaming the markets for their own shortcomings and policy failures. They were only bailed out with the tacit cooperation of the US, who winked at the unprecedented expansion of the IMF charter by facilitating  them with a financial backstop because the Americans feared the systemic risk. The ostensible mission of the IMF is to support individual countries in trouble, not a badly constructed and questionable currency union. This should have been the sole responsibility of the European Union, not other IMF members collectively.

The unsustainable trade imbalances that this currency union has created have in no way been addressed to date. It is virtually taboo in the EU even to raise the subject. The reason for the lack of demand-side adjustment is that much touted Europe’s internal market is not fully functioning, certainly not at the consumer level. As FT's Wolfgang Munchau points out, Germany entered the Eurozone at an uncompetitive exchange rate and embarked on a long period of wage moderation where it benefited from a real devaluation against other members.  Meanwhile southern European industry lost competitiveness and withered.  Consumption soared and real estate bubbles were fueled by the cheap credit until the bond vigilantes spoiled the party. A large part of the German trade surpluses are reflected in peripheral member deficits.

Over time, these intra-Eurozone imbalances will not only persist, but probably increase. This will make the economic adjustment for Spain, Portugal or Greece even more difficult than it already is. Those persistent imbalances, as well as the alarming build-up of debt, raise cause of concern about the long-term health of the Eurozone. Solvency is defined as the ability to finance debt in a sustainable way, and is affected both by the amount of debt, and future income through which the debt is repaid. Already several EZ members like Greece, Ireland and Portugal are bordering on insolvency.

For the Greek austerity plan, it hard to imagine a realistic estimate of a trajectory that foresees a stabilisation of the Greek debt-to-GDP ratio at tolerable levels. Optimists like Olli Rehn in his recent article 'Greek Renaissance' tend to pull the joker of some massive above-average growth forecasts for the future without explicitly stating where this growth is coming from. Normally in these IMF work-outs the growth comes from exports spurred by devaluation and structural changes. Even Swedish restructuring in the late 1990's resulted in currency devaluation. In Euro Hell, Brussels will not give Greece this option in defense of their sacred cow, the Euro.

The other side of the German exports to weak peripheral members and the resulting trade deficits is the mounting debt crisis. The austerity measures of 'infernal' devaluation is largely a Brussels concoction of untested crank economics that in practice downsizes GDP and deprives the failing country of tax base and income needed to repay and reduce its debt. Coupled with the 'pretend and extend' debt pyramiding of the IMF/ EU 'bailout' facility for insolvent borrowers, this risks bringing the whole Euro currency union down like the Tower of Babel. In the case of defaults, other weak EZ members will be liable for the backstop facility, pulling them under as well.

To guarantee the solvency of the Eurozone’s periphery would require not a few quarters of solid growth, but an entire decade. Where is this joker of massive above-average growth going to come from? Who is going to accept the trade deficit rebalancing?

Presently the Brussels elite seem very much in self denial. They remain unwilling to accept that one day a Eurozone state might either default, or, more likely, be forced to restructure its debt. Not only do they adamantly refuse to accept the principle, but also stubbornly insist on avoiding any institutional preparations for an orderly default of a Eurozone member or departure from the currency zone.

It is as if the Devil has possessed their minds in the hell (with no exit) that they have created with their currency union.... Is it a coincidence that the Faustian legend came from Germany? Can purgatory bring salvation?

Wednesday, September 8, 2010

Chemical war of attrition

The chemical sector experienced some revival earlier this year, but rates softened again during the summer and there remains a great deal of uncertainty yet about the time of a market upturn. Financially weaker operators like Eitzen and BLT continue their optimism, the more established major operators like Stolt and Odfjell remain cautious and see a longer market recovery period.

The chemical tanker sector was badly hit by the 2008 GFC. Cargo volume dropped dramatically in nearly all trades. Markets during 2009 were sustained mainly by US chemical feedstock exports to China, with tonnage swelling in the FE struggling for return cargo. This year after a stronger first quarter, the chemical tanker market saw a pullback. The transatlantic trades slowed, not helped by continued weak petroleum product markets. Reduced requirements for aromatics from China, which sustained the market in 2009, led to less demand for larger commodity parcels (above 5,000 tons) and with plenty of available vessel space as a result. The biofuel market withered with the US putting a 54 cent/gallon import tariff on most foreign ethanol supply and Brazilian ethanol production has been hurt from high sugar prices and heavy rains in 2009.

Stolt has been outperforming its peers with its solid contract base, diversified income from storage and other activities, and its sound financial position with moderate leverage. Stolt was very fortunate in its CAPEX obligations because delays at the SLS Shipyard allowed them to renegotiate price and delivery of their Dwt 44.000 coated newbuildings placed in 2005 for ME commodity chemical trading and they eventually secured full refunds for their Dwt 43.000 stainless orders. STJS cargo volume transported was up 7.6% from 1Q10 albeit freight rates remaining flat. Stolt finished its 2Q2010 with US$ 27.5 mio net profit.  

Stolt's main competitor Odfjell finished its 2Q2010 with a net loss of US$ 64 mio, but much of this was due to their decision to enter the new Norwegian tonnage tax system at a total cost of USD 42 million. Time-charter results per day increased by 2% compared to first quarter. Odfjell is not running any cash losses, but its balance sheet is somewhat weaker than Stolt with higher bank leverage.

Stolt expects a continued weak market for the rest of 2010 and 2011. Odfjell reports falling cargo volume in 3Q2010 accompanied by weakness in outbound voyages from US and Europe. They see increased competition for cargoes.

Ailing Eitzen Chemical with the recent exit of its CEO Annette Malm Justad and failure of its much touted merger with BLT gained reprieve by selling off its 74.3% stake in Eitzen Bulk, which brought a total profit of US$ 60.7 mio for the 2Q2010. Total freight income in the quarter dropped from US$ 31.03 mio to US$ 29.03 mio as the ethylene market remained weak and there were a number of drydockings. Eitzen has had extensive loan restructuring with its senior lenders and has extended its covenant waivers for several years, but it is far more dependent on a quick market recovery than financially stronger competitors. All the more so because it has a weak contract base, more dependence on the spot market and clean petroleum products.

The most optimistic and aggressive chemical operator, Berlian Laju (BLT), was recently down graded by Fitch, who cut its rating on the tanker owner from “B” to “–B” with a negative outlook. It also dropped its tag on BLT’s $400m unsecured notes from “CC” to “CCC”. Its Indonesian management believes fervently in rapid return to bull market conditions and it maintains a very aggressive new building program. This is an unlimited growth mentality similar to that of Seaspan's Gerry Wang, but without the support of long term SOE charterers to underwrite the business. BLT derives less than 10% of its revenues from Indonesian business, although lately it has shown interest to diversify into Indonesian FPSO and more domestic tanker cabotage business.

The weight of the shipowner’s significant capital expenditure requirements led Fitch to concerns that it may breach certain covenants if current market conditions persist. BLT leveraged up its balance sheet in 2007 when it purchased Chembulk from AMA at the peak of the market boom with a sizeable markup from the price that AMA had acquired this Connecticut-based chemical tanker operator from its founder Doug MacShane just a few months earlier in the beginning of the year. Having paid a premium price, the company strained considerably to raise the cash to complete the deal with AMA, selling and leasing back existing vessels in its fleet as well taking on heavy bank debt.

Eitzen and BLT have smaller vessels than Stolt and Odfjell. Particularly, the Eitzen fleet is concentrated in Dwt 12.000 stainless units and also has a fleet of coated chemical tonnage. BLT has some larger stainless tonnage in the Dwt 20.000 range, but this has come from their acquisiton of Chembulk, left largely with the US management. Their Asian fleet are smaller units. Both companies have smaller contract books than Stolt and Odfjell.

The future depends on how the markets play out. A V-recovery and bull market would greatly benefit BLT due its very high operating and financial leverage. A prolonged slack market will benefit Stolt with its resources to pick up distressed opportunities. Clearly Stolt and Odfjell with their stronger balance sheets and customer bases have more staying power than Eitzen and BLT. Eitzen needs very much a quick market recovery before its lenders become restless again and BLT could face loan restructuring with its senior creditors or even worse, be forced to sell off its Chembulk acquisition to raise cash.  

Tuesday, September 7, 2010

Seaspan's China gambit

Seaspan is a non-operating containership owner with a very ambitious fleet expansion plan. They have been struggling since the 2008 GFC to finance their aggressive CAPEX program. Their business plan is highly dependent on continued Chinese export growth. The two top customers are Coscon and CSCL  (70% total revenue) both Chinese state owned enterprises.  90% of their contracted revenue is from China and Japan. The company is highly leveraged and has recently filed a shelf registration for a new share issue.

Seaspan is a vessel provider business model. It owns and operates container vessels with long term charters to major liner companies. It has no container logistical system of its own as do the major liner companies like Maersk, CSCL, MSC, CMA-CGM, Neptune Orient and Orient Overseas. It is largely an asset play backed by long term charter parties with substantial rate discounts and subject to earnings margin pressures over time from inflation, currency fluctuations and increased repair costs as the fleet ages.

It has a very impressive Board of Directors, including Graham Porter (Chairman of the Tiger Group), John Hsu (partner of Ajia Partners, one of Asia's largest privately-owned alternative investment firms), Peter Lorange (former President of IMD) and Peter Shaerf (managing director at AMA Capital Partners). Seaspan's CEO Gerry Wang appears to have very good personal contacts with the Chinese SOE's in shipping. He is always been extremely bullish on Chinese growth prospects.

The container sector was one of the most sharply hit by the sudden and deep economic slowdown in 2008 GFC. The major liner companies suffered heavy losses in 2009, with aggregate industry losses running into tens of billions of dollars. As an effect of industry wide losses, the liner companies heavily cut capacity, idling their own capacity and returned the chartered tonnage to non-operating owners. Normally, most liner companies own approximately 50% of their tonnage and charter in the remainder to cover their cargo volume projections.

These major operators made substantial adjustments in terms of order cancellations and deferrals of newbuilding deliveries well into 2011-2013. There was probably more speculative vessel ordering in the container sector than any other sector of the shipping market. A very large part of the orderbook are the large post Panamax size vessels for long haul routes.

The great attraction for non operating owners' investment has been the term charter cover from the liner companies. The current order book stands at 30% of the current fleet, down from about 55% at its peak in mid 2008. It is important to understand the current order book mix in terms of the owners.  The German KG market and asset providers in non-operating owners like Danaos Shipping and Seaspan constitute greater than 50% of the current order book, remaining is covered by the liner operators like Maersk, APL, and CMA CGM etc, who actually control the underlying commercial business with end-users in the sector.

Seaspan fared well in 2009 closing the year with record profits of US$ 145 mio as opposed to the losses of the two prior years: 2008 (US$ 199) mio and 2007 (US$ 10) mio. They reported no charterer default or renegotiation problems. This year for the 1 H, Seaspan is again in loss position, but due to sizeable changes in fair value of financial instruments resulting in a loss of $223.2 million for the six months ended June 30, 2010 compared to a gain of $92.5 million in 2009. The change in fair value loss for was due to decreases in the forward LIBOR curve and overall market changes in credit risk.

As of their annual report filed last March, Seaspan had contractual CAPEX obligations on an additional 26 containerships over the next 30 months over an in addition to the existing fleet of 42 vessel in operation. Whilst there have been rumors of possible new order cancellations, Seaspan so far has maintained its orderbook.  It appears that they are highly dependent on COSCO in chartering this new tonnage. The employment contracts with their two Chinese SOE charterers are subject Chinese law and dependent ultimately on the Chinese legal system for enforcement. Indeed, this year, they turned aggressive and also added one additional new acquisition chartered to United Arab Shipping Company for two years and Gerry Wang has made statements about opportunities to pick up units in the troubled German KG markets.

Considering the industry environment with the major liner companies cancelling orders and lately reletting larger post-Panamax tonnage, this represents a remarkable contrarian business strategy with backing from a BoD of major industry figures, who apparently believe strongly in a robust world economic recovery with shipping markets bouncing back to former levels in the near future, ostensibly driven by renewed Chinese export growth and internal infrastructure development as a return the pre-2008 GCF situation.

Financing this program has not been easy. The total purchase price of the 21 vessels was estimated to be approximately US$ 2.6 billion. The remaining five units were covered by leasing arrangements with Peony Leasing Limited, or Peony, an affiliate of Bank of Scotland plc and Lloyds Banking Group. As these units were contracted during the market boom, Seaspan faces a valuation problem with the decline in prices for new orders today. They have "gearing” covenants in their senior debt that prohibit them from incurring total borrowings in an amount greater than 65% of our total assets. Further they were blocked from drawing the remaining approximately US$ 267 million available under their US$ 1.3 billion Credit Agreement on which they were relying heavily to support their CAPEX program.

In May 2010, Seaspan issued 260,000 Series B Preferred Shares for US$ 26 million to Jaccar Holdings Limited, an investor related to Zhejiang Shipbuilding Co., Ltd. of China ("Zhejiang"). These preferred shares are perpetual and not convertible into common shares. They carry an annual dividend rate of 5% until June 30, 2012, 8% from July 1, 2012 to June 30, 2013 and 10% from July 1, 2013 thereafter and are redeemable by the Company at any time for US $26 million plus accrued and unpaid dividends. This appears to be a shipyard-extended credit facility for their reported two orders in this yard.

Compare this to established liner-owner operators like Neptune Orient Lines (NOL) and Orient Overseas (OOIL), integrated logistics players with proven container shipping capabilities available at attractive valuations. For example, OOIL's three principal business activities are segmented under International container transport and logistics services (OOCL, OOCL Logistics, and China Domestic), Ports and Terminals (Kaohsiung and Long Beach) and Property Investments (Wall Street Plaza in New York and Beijing Oriental Plaza in Beijing). OOIL’s container shipping operations is amongst the most cost effective in the container shipping industry with the Company consistently outperforming its peers with the highest profit margin among major container line operators.

OOIL has always had one of the most conservative and strongest balance sheets in the container shipping industry and has consistently kept the net gearing to the lowest. The company has no major issues in meeting its capital commitments and capital expenditure. At the end of FY 2009, OOIL had vessel capital commitments of US$ 712 mio and US$ 1.27 billion in free cash. It's capital gearing is 58%.

Seaspan's second quarter earnings conference presented a very rosy picture of a company with a low debt ratio, impressive built-in future growth revenue of US$ 7 billion and fantastic compound annual growth rate (CAGR) of 40%. Suffice this to be based entirely on their assumptions of a V-shaped world economic recovery and deeming their situation a few years ahead. . Their present leverage is very high and they would be not going through the trouble and expense of a shelf registration if they were not concerned about the need to raise equity to maintain their covenant obligations and cover their CAPEX needs. Indeed, one can presume it likely that this is an exercise to woo potential interest for a possible IPO offering.

The issue is whether peer companies like NOL and OOIL offer more value to investors because of their integrated logistics business models, their diversity of revenues sources, and their stronger balance sheets. All this is in the context of an uncertain environment in terms of economic recovery and rebalancing of trade flows. All these companies are dependent on continued emerging market growth in the Far East.

Sunday, July 18, 2010

Is the Chinese eldorado that fuels shipping investments coming to an end?

This year has seen considerable new investment in large block speculative shipping deals. Peter Georgiopoulos did a US$ 886 mio deal in May to buyout the Metrostar fleet, and now a US$ 545 mio deal for 16 bulkers from Bourbon. Metrostar paid a record price of US$ 180 mio for five container vessels. The driver is anticipated economic recovery driven by Chinese export growth. Good times again as if the 2008 meltdown never happened. Yet already there are signs of a slowdown. Will China save the day?

Global growth since the 1980's has depended increasingly on monetary easing to induce asset inflation for stimulus, each dose of monetary stimulus resulting gradually in weaker recoveries with increasing joblessness. Wages in Western countries have remained fairly static and the government authorities have encouraged consumer lending to prime consumer spending with households becoming increasingly indebted. As an example, much of the growth in the US since the meltdown of 2000 was due to easy money that fueled a real estate bubble and led to the subprime mortgage crisis and massive foreclosures. The housing market in the US remains moribund.

The Asian emerging market countries since their financial crisis in the late 1990's moved to a neo-mercantilism whereby they kept their currencies undervalued to generate large trade surpluses through aggressive export policies. They recycle the money into developed western countries keeping down their exchange rates and financing their trade partners' deficits. One of Ben Bernanke's major speeches a few years before he become FED chairman was characteristically entitled "The Global Saving Glut and the U.S. Current Account Deficit" as a sign the times.

Eerily reminiscent of the defunct investment craze, China has become the rage with investors as an eldorado of unlimited growth potential. This optimism fueled interest for shipping issues on Wall Street, especially for dry cargo vessels to transport iron ore and coal for the steel production with the increased demand created by the real estate boom in coastal areas. Likewise investors went wild over the container sector where the only concerns of Seaspan (SSW) CEO Jerry Wang were whether Los Angeles could expand its port facilities to cope with the insatiable demand for Chinese goods.

Since the 2008 meltdown, there has been a modest recovery in both the US and EU but there remains a huge sovereign, corporate and household debt overhang in a balance sheet style recession. The most robust growth has been in emerging markets where there are much lower sovereign debt levels. The Chinese could finance their stimulus out of their trade surpluses, but there is growing evidence that the stimulus money has resulted in commodities inventory stocking as well as an over-heated housing market that is causing a serious real estate bubble.

Growth in the US seems to be slowing now that we are moving to the second half of the year. The EU has been confronted with serious sovereign debt problems in their weaker members of which Greece is now under a joint IMF-EU workout. Bad management of the Greek crisis and serious structural deficiencies in the Euro system resulted in contagion in other member countries, which led to a massive emergency EU bailout facility funded by member states and IMF participation. The ECB balance sheet is filled with toxic EU government securities.  It even suspended minimal ratings standards for Greece. The weaker PIIGS members are all under strict austerity programs. The UK, whilst in a somewhat better position free of the Euro albatross, has also voluntarily started an austerity program to address its fiscal and debt problems.

In this environment, Chinese capital surpluses are becoming harder to export. The weaker EU members were the second largest importer of these surpluses, but now austerity programs make this unsustainable. There is is already evidence of falling trade volume on western bound container trade lanes from the Far East. Meanwhile dry cargo freights as represented by the BDI have plummeted to levels not seen since the fall of 2008. The dry cargo pundits feel that the drop in dry bulk rates is only temporary due to Chinese contract renewal negotiations with producers. Likewise, container operators like Maersk, euphoric over recent transpacific rate increases, are projecting a surge in profits that match 2008 levels. External signs, however, are troubling.

What we see is that China has an increasingly volatile economy with large swings. The real estate is showing signs of decline. Non-performing loans are on the rise. Dependence on the US to export trade surpluses has risen since EU sovereign debt problems and austerity programs. The next tension is likely to be between the US and China on trade surpluses, especially if US unemployment remains at present levels. The last thing that China wants is to import the surpluses domestically because this would lead to currency appreciation and risk bankrupting the exporting companies.

All hopes at present are on another Chinese stimulus program to shore up the output gap. There appears a growing internal debate on how to manage their housing bubble and overheated economy, but the other major issue is the sustainability of the export model and how to deal with the shock from the EU and US taking measures to address defensively their large unemployment problems in a time span that is out of their control.

As FT's Walter Munchau put it:

The pessimists believe that a strong global recovery is unlikely given the persistence of financial stress, and the deleveraging of the private and public sectors across the industrialized world.

The optimists divide into two groups. There are those who have difficulties counting to zero, who cannot add up the global private, public, and foreign balances, which must equal zero by definition.

And then there are the rational optimists, whose expectations of resurgence in private sector demand must surely rest on the assumption of a return to even greater global imbalances than before the crisis, to which the eurozone will this time contribute actively. But this is surely not a sustainable position.

The pessimists would argue that global demand growth will not be sufficiently strong to support a selfsustained recovery in the eurozone. Even the rational optimists, who believe that this is possible, would probably conclude that these imbalances are not sustainable, and may trigger another financial crisis down the road. And if that is what you expect, you are not really an optimist.

What we know is that some of our societies are deeply over-leveraged, and that de-leveraging them means running trade surpluses, not deficits. That is not good for China nor the 'smart money' in shipping!

A prolonged, sluggish global recovery with high levels of unemployment in Western consumer economies and possibly a series of sovereign defaults of which the restructuring of the Greek public debt is high on the agenda would lead to renewed stress on the banking system, particularly in Europe. Overleveraged companies having already negotiated covenant extensions with their banks may be forced to sell assets at distressed prices that everyone has been trying to avoid the last few years.

We see a lot of 'smart money' in shipping assets. The new IPO's earlier this year like Baltic (BALT), Crude Carriers (CRU) and Scorpio (STNG) are all trading at discounts.  Albeit these companies have bought marked down assets and have low leverage, it is unlikely there will be appetite for further issues unless the discount is closed. It will be interesting to see what levels, Genco (GNK) obtains in raising equity and debt funding to close the 16-vessel Bourbon deal. Generally, Wall Street remains soft and shipping issues have generally never recovered to pre-2008 levels. Many of them are trading below US$ 10.

Is the container sector really out of the woods yet?

Investors have been euphoric over the rate increases in transpacific annual contracts. The container sector attracts keen investor interest due the long term employment with large liner companies like Maersk (OMX: MAERSKB) considered too big to fail. As a result, the sector has been plagued by huge order book overcapacity. The demand driver is the proverbial Chinese export machine. Yet container earnings may be peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

The global financial crisis hit Maersk and other liner operators very hard. They had aggressively ordered new tonnage as well as chartered in vessels from non-operating owners like Seaspan and Danaos , who had order books as large as their existing fleets. 

Maersk sank to a loss of US $1.02 bn in the historically low rate environment of 2009, overturning a profit of US $3.46 bn a year earlier. The liner operation fell to a $2.09 bn loss for the full-year as income from its containerships collapsed by nearly 30%. Aside from the container losses, Maersk also made a dreadful timing mistake in acquiring the Broström tanker fleet at top of the market prices shortly before the 2008 meltdown.

In this difficult environment, the liner companies fought back earlier this year by slow-steaming to try artificially to reinflate demand and reduce their losses from the dramatic drop in cargo volume. Industry consultants AXS Alphaliner estimate 78% and 53% the Asia-Europe and Transpacific routes strings are still running in slow steaming mode currently. Maersk also became a leader in cost cutting.

During 2010, the container shipping market was been positively affected by growing demand, primarily due to inventory restocking in the US and Europe and, to a lesser extent, growing consumer demand. Growth was seen mainly on the head haul routes and Intra Asia, which increased by 18% and 70%, respectively. Average rates in the first quarter were $2,863 per FFE, up by 18% compared to the same period of 2009 as a result of improved market conditions and higher bunker surcharges.

Maersk banked US $639 mio in the first quarter, overturning last year’s US $ 372 mio loss and smashing the US$ 225 mio consensus among analysts.

Citigroup analyst Ally Ma feels that the return to profitability for many lines may mark the beginning of renewed capacity woes as they begin taking delivery of deferred new building orders placed prior to the global financial crisis, against a backdrop of weakening demand. She reckons that the 3rd quarter rate hikes may indicate that container earnings are peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

Most new building deliveries to date are directly being employed in strings running on slow steaming effectively dampening the supply growth. The German KG market has for the past decade been a major asset provider to the container operators, owning the vessels and chartering out to the liner companies. KG participants are still facing insolvency issues and despite the recent market surge in charter rates, payments are insufficient to cover the payment of interest and principal in 2010 and 2011.

Non-Operating owners to continue facing financing issues as bank credit remains tight. Danaos Shipping (DAC) announced cancellation of three new buildings of 6,500 TEU which were ordered at Hanjin Heavy Industries and initially expected to be delivered in the first half of 2012. Seaspan (SSW) in a filing to the stock exchange stated funding shortfall for its remaining capex commitments and hinted at further cancellations on the cards.

The future of the container industry hinges on the quality of the economic recovery ahead. The US recovery seems to be slowing down and the EU is facing a serious sovereign debt crisis where austerity measures in Southern European countries are likely to dampen severely demand.

The temptation to buy speculatively container tonnage today has led to a rise in asset prices as each new deal brings new highs. Indicatively, Metrostar is said to have shelled out some US $180 mio to buy five 10-year-old 3,500-teu ships from German owner Claus-Peter Offen. This is double what the vessels might have fetched at the start of the year.

This is driven by the expectation that container rates will soon regain historic norms and present rates are closer to 50% of this level leaving room for improvement. Yet this counter-cyclical investment could prove self defeating in dealing with the overcapacity should the recover stall and we face a longer period of sluggish growth as opposed to the forecasts of politicians and pundits.

Wednesday, July 7, 2010

Peter G's big gamble

Peter Georgiopoulos has been aggressively scaling up his 3 publicly listed companies: Baltic (BALT), Genmar (GMR) and Genco (GNK) with massive block vessel acquisition deals. Whilst asset prices are down from boom year levels, bulk carrier prices have risen considerably off the meltdown lows. Bulk carrier freight rates have fallen sharply. Economists like Nouriel Roubini predict a weaker 2H 2010 and a sluggish recovery ahead, with potential public debt defaults ahead. Does Peter G's timing make sense?

Baltic was conceived in late 2009 as a pure dry cargo play based on opportunistic vessel purchases, spot employment and low leverage with a high dividend payout. Baltic's IPO was successful, but at a larger discount than anticipated. It was priced between US$ 13-14 but it is currently trading at US$ 9-10. It is a captive company of Genco (GNK) who manages the vessels and earns commissions on its fixtures and S+P transactions.

Genco (GNK) crashed in 2008 to US$ 6,50-7, but then made a modest recovery in 2009. Lately it has been under pressure, trading around US$ 14-15.

Genmar (GMR), the oldest Georgiopoulos company concentrating on tankers, is trading around US$ 5,40, which represent new lows for the year. In 2009, it underwent debt restructuring with its senior lenders, which it partially refinanced by a bond issue that cost more than originally anticipated. The successful US$ 200 mio equity raise for the Metrostar 7-vessel block deal was priced at US$ 6,75, only a modest discount. Investors are presently under water, but the increased equity strengthened the company balance sheet by lowering the leverage to 70% down from 75%.

The latest Platou market reports makes subdued projections for the drybulk sector that would indicate that Peter G's timing may not prove to be the best in making his bulker acquisitions. The tanker market is looking better, but Genmar remains with fairly high bank leverage. This would generate exceptional returns if the tanker markets continues to improve, but it also means further covenant violations with senior lenders in a poor market.

The investment thesis depends on China and emerging market growth. China slowdown in construction has sent dry bulk rates southwards lately. Supply-demand conditions and cyclicals are more favorable for the tanker sector but projected demand growth in crude oil transport is low in coming years.

Time will tell whether Peter G's was overly aggressive in his massive block deals of 2010. I think that analysts may have been overly optimistic on the timing. At least, the market has been pricing the shares differently from the analysts.  The next test will be the forthcoming equity raise for Genco to support the 16-vessel Bourbon block dry bulk acquisition deal.

Tuesday, February 16, 2010

Kabuki theater reigns in Brussels and Athens before the deluge

No one in Brussels or Athens really seems to know what they are doing outside of Kabuki theater. Plans are made hastily and revised on a daily basis. Like the Titanic, they continue to insist that their ship is unsinkable (and there will not be any financial losses) but there are clearly not enough lifeboats for all the passengers to escape alive.

Today’s European Union does not seem very far from Thomas Mann’s masterpiece "Magic Mountain" depicting pre-WW1 Europe in an allegory of self-denial prophetically in Davos, Switzerland where there is now an annual world economic forum.

Kabuki ritual inhibits EU members from engaging in any frank and substantive discussion over the dysfunctionality of their Euro currency union. Despite their LSE credentials, George Papandreou and George Papaconstantinou give the impression of showmen rather than economic literates in terms of their performance over the past few months in the handling of this crisis, first promising expanded entitlements by soaking the rich to win the October elections, then temporizing over the debt refinancing problems until Davos and finally capitulating to the EU demands whilst feigning that they were not asking for any help. Mind you that whenever economics is laced with politics, the results are nearly always toxic no matter who are the actors involved.

Since the 2008 meltdown, it was always difficult to fathom how the remedy of socializing private losses on public balance sheets made any sense. This strategy always seemed like pushing the problem around rather than addressing the issues of overleveraging and cleaning up balance sheets in the financial industry. It was built on a wall of hope that financial engineering would lead to a robust recovery and in time, the losses would disappear like a bad dream without any pain or consequence.

Europe, overtaxed and overleveraged, is one of the most exposed regions with the slimmest means to hold out until better days. The Euro system was badly constructed on inflexible rules that Milton Friedman once called the equivalent of “locking yourself in a room and throwing the keys out the window….” It is not surprising that Eurozone is becoming a leader in sovereign debt crises and this is putting the currency union to test.

Greece was an accident waiting to happen. The last time there was productive investment was back in the 1960’s when there was a policy of balanced budgets, strict control over entitlements and major projects in refineries, shipyards and aluminum production. The Military Junta, black-listed by Western governments for loans, openly solicited private investment, with a vision to develop Greece as an offshore center for the Middle East. Greek construction companies expanded abroad in Middle East infrastructure projects. Piraeus was filled with new shipping companies. Major corporations established marketing offices in Greece and foreign banks queued to open branch offices. Greek per capita income increased three fold over a short period of time. Greece seemed a fledging emerging market economy with a GDP larger than Turkey at the time.

When the politicians returned in 1974; seething with resentment and bitterness after years out of power, they started to settle accounts with the business community who had prospered in this period. Socialism and transfer of wealth become the predominate development model and the private sector was to service the state. Onassis was driven out of Olympic Airways, the Andreadis businesses were confiscated. They created a web of laws and regulations that forced many businesses into debt and bankruptcy. This unfortunate climate was escalated by the Socialist triumph of 1981. The Socialists massively expanded entitlements, extending them to many who had never paid any contributions. They moved to socialize failing businesses, transforming them into loss-making state owned enterprises staffing them with party cronies. Public deficits soared and public debt rose rapidly. By 1986, Greece was forced to devalue the drachmae and declare the first of a serious of austerity programs. Interest expense soaked up public budgets and it was in part monetized by double digit inflation.

It was in this climate that the Socialist Party back in power after a brief hiatus in the early 1990’s decided to make entry into the Eurozone a national priority. They were enticed by the benefits of low interest rates to relieve their financial woes from their mounting debts and stagnating economy without a stable tax base. Their concept of development was use of EU transfer money for large public infrastructure projects. They used the privatization allegedly to enrich themselves on the Athens stock exchange by rampant insider trading, playing musical chairs taking positions through state-controlled corporations. They shunned arms-length professional management preferring control through union-affiliated pension funds.   Brussels welcomed them in open arms because they wanted as many countries to participate as possible in the new currency union and this was a means for them to expand their markets into southern Europe. Indeed the relations between Brussels and Athens seemed almost symbiotic at the time. This EU culture of corruption is partially borne out by the Siemens trials in Germany where Siemens top management allegedly bribed Greek officials of the two major parties to obtain contracts for security equipment required for the Athens Olympics - indicative of the times.

As Simon Johnson elegantly points out in his recent WSJ piece “The Greek Tragedy That Changed Europe”:

If Greece (and the other troubled countries) still had their own currencies, it would all be a lot easier. Just as in the U.K. since 2008, their exchange rates would depreciate sharply. This would lower the cost of labor, making them competitive again (remember Asia after 1997-'98) while also inflating asset prices and helping to refloat borrowers who are underwater on their mortgages and other debts. It would undoubtedly hurt the Germans and the French, who would suffer from less competitiveness—but when you are in deep trouble, who cares?

Indeed prior 2002 when Greece abandoned the Drachma, the Bank of Greece had a policy of slow depreciation against the US dollar. Inflation was higher than hard money countries but prices were lower. People sheltered themselves by investing in real estate and holding foreign currency. Interest rates were as high as 20% at times on Greek government obligations so savings was rewarded. Consumer credit was limited. Euro entry created enormous distortions. Local prices started to rise to EU levels but salary levels lagged, putting considerable pressure on the middle and lower classes. Interest paid on savings became negligible. People turned to consumer credit to cover their diminished purchasing power. Banks prospered with enormous spreads. The Greek state was able to borrow with hard money credit ratings so the public balance sheet grew. The commercial deficits soared. Greek domestic production was replaced by EU imports. This credit expansion fueled the price increases. The Greek government was lax to take restrictive measures fearing a popular revolt since the population was under increasing economic pressure, unemployment remained high (especially youth unemployment was at disastrous levels) and they feared the bursting of the domestic credit bubble.

Brussels offered them no solace because as Simon Johnson puts it: ECB policies have been overly contractionary—resulting in a strong euro and very low inflation—and not appropriate for member countries in the midst of a financial collapse. Milton Friedman said that putting your money in the hands of others was bound to lead to conflicts.

Indeed it was the ECB according to Simon Johnson – not “speculators” - who initiated the crisis in Greek spreads when on German prodding they decided to cut off the special credit windows that they had opened to support the weaker members like Greece by buying their government bonds. This lead to higher spreads on Greek bonds, albeit 6-7% pa pricing can hardly be considered usury when credit card interest rates in Greece have been 18-20% pa on consumers. The ECB was suddenly confronted with the specter of a possible Greek sovereign debt default that was leading to massive shorting of the Euro. Fearing contagion to other weaker EU members, Brussels went into panic. Immediately all fingers were pointed to Greece to extract a ‘pound of flesh’ by the concept of an ‘internal’ devaluation whereby all salaries are cut and taxes are raised. In other words, the EU is asking Greece to massively curtail demand, lower wages and reduce the public sector workforce. It interesting to note that the last time we saw this kind of precipitate fiscal austerity—when nations were tied to the gold standard—it contributed directly to the onset of the Great Depression in the 1930s.

Unfortunately, it is almost taboo to open substantive issues on the imbalances in Euro system, which is considered virtually a ‘sacred cow’ ; much less question the wisdom of the proposed EU remedies on their weaker members. The Russian dissident Vladimir Bukovsky has said that political system in the EU resembles in many ways the former Soviet Union. Whilst the normal path for a country like Greece would be to go to the IMF for assistance, Brussels appears to see this negatively. They do not seem to want to see Greece to take an IMF credit facility and Greek politicians are too beholden to take any actions of their own. Brussels is concocting their own aid package but no one is permitted to discuss the details. Greece is obliged to say that are not asking any aid and they do not need it. Simon Johnson points out some of the reasons for this Kabuki theater:

Many in Europe view the fund as an American-influenced institution—located three blocks from the White House for a reason—that would be invading Europe's territory. My personal experience is that Eurocrats become livid whenever any critical discussions on the Euro system by outsiders and tend to lose any sense of reason.
French President Nicolas Sarkozy has serious personal reasons to push the IMF away. Mr. Strauss-Kahn is a serious potential challenger in France's upcoming elections; Mr. Sarkozy would hate to see the IMF play a statesman-like role on his home turf.
Chancellor Angela Merkel, currently maneuvering to ensure a German is the next head at the ECB, is also concerned. The IMF might ask for a revision of ECB policies and request structural reforms. This would challenge the prevailing ideology among Frankfurt-dominated policy makers and reduce their power over weaker EU members.

I believe that the Greek debt crisis is really two crises: a crisis of a failed economic and political system in Greece and a failed Euro system. Indeed Greece sought refuge in the Euro because their system was a failure. I do not think that the Greek government’s stability plan has any connection with reality and I do not see it as feasible. Of course, the Greek government is hoping that Brussels will give them an ‘E’ for effort along with substantial discounts as has always been the case in the past. This will not do anything to resolve their ‘Ponzi’ public deficit pyramid. No one in Brussels seems to want to revise the Euro system albeit there is considerable academic ink being currently spent on possible alternatives such as the recent piece: “The Option of Last Resort: A Two-Currency EMU” by two Greek economists Michael G. Arghyrou and John Tsoukalas, proposing some relief for the European south.

Nouriel Roubini feels (and I concur) that things could get considerably worse:

In the end, if Greece is politically unable to do enough fiscal adjustment to forestall unsustainable debt dynamics – i.e., if it turns out to be insolvent and not just illiquid in spite of a partial financial support from the IMF and/or or the EU/ECB – one solution that is one step short of default (that occurred in Russia, Argentina and Ecuador) may be a coercive restructuring of its public debt – under threat of default – along the lines of what was done in Pakistan, Ukraine, Uruguay and the Dominican Republic. In effect, this would entail a coercive lengthening of the maturity of the debt without face value reduction of the debt (no formal haircut) together with a coercive reduction of the interest rate on the new debt at below markets levels. Such surgical solution would imply some losses for creditors on a NPV basis but much smaller losses and less systemic disruption than an outright default. As the experience of past emerging market crises suggests such coercive restructuring can be designed – even in the absence of collective action clauses – via exchange offers that bypass the need for unanimity in changes in the terms of such public debt.

Still, such a coercive restructuring of the debt would resolve – or push to the longer future – the issue of public debt sustainability. But it would not resolve – in the absence of structural reforms or outright exit from the monetary union – the problem of the loss of competitiveness and the unsustainable external balance. That is why default (or coercive debt restructuring) without devaluation may not be possible and devaluation (exit from EMU) without default may not be possible either.

Having lived though this problem in Greece, I believe that coercive restructuring of Greek public debt is the only realistic solution for Greece. Given that much of this debt is held by other EU countries, this would inflict considerable pain, especially on Germany and this is probably one of the major reasons why they appear to be so reluctant for IMF involvement.  I do not see Germany, however, without responsibilities for the failed policies in the EU.

Many economists like Nouriel Roubini and Simon Johnson are making constructive suggestions to the EU on the management of this crisis. Simon Johnson even goes to far as to call for intervention of the US government to press Brussels to bring in the IMF and to cooperate assertively to help reduce the risk of further collapse in Europe.

I think that that is a fair view of the stakes involved in this matter. Neither Brussels nor Greece is really capable of resolving this complex matter on their own and the stakes are too high for failure.