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.