Monday, October 31, 2011

Capital profit disappoints, so why is Evercore pushing this stock?

Since Jonathan Chappell moved to Evercore from JP Morgan, he has been touting the virtues of Capital Products Partners and the management of Evangelos Marinakis. Chappell even went so far as to replace Teekay Tankers in Evercore Partners' conviction buy list. Despite my high personal regard for Chappell as an analyst. I find this viewpoint to be misguided. Recent financial results seem to corroborate my reservations.

Stripping out all of the noise, Capital’s bottom line stood at US$ 1.7 million, well short of the US $6.6 million the market was expecting from vessel operations. Most of its profit was made up of an accounting gain on the takeover of Crude Carriers.

Capital’s CEO Evangelos Marinakis holds the conventional view that the products market is amongst the most attractive in shipping right now. The theory is that this class of vessel, especially MR (medium range) tankers, has less of an order book overhang and will see more demand growth from new refinery projects than the crude sector.

Not everyone shares this viewpoint. DvB Bank, a transportation specialist, warns that product tanker values could fall by a fifth if the European sovereign debt crisis negatively affects all global economic markets and creates a significant drop in demand to ship refined oil products. DvB expects product tanker fleet utilization to remain less than 90% until 2013. Platou Markets - who normally have a fairly positive bias - also do not see relief in tanker markets until 2013. Recent large losses of TORM, an established top tier product tanker operator are ominous for this sector.

What confounds me is why Chappell sees Capital in a more favorable light than methodical players like TeeKay or Scorpio which both have greater depth of management? Compared to these peers, Capital is a relative newcomer without much intrinsic value. It was only last year that Capital began its foray as a listed pure play product tanker company.

By contrast, TeeKay has a proven track record and has made every effort to build intrinsic value in its business. It has a strong presence in higher margin niche businesses like shuttle tankers and LNP and in its cargo book operations where it has built up tanker pools. Scorpio invested in an exceptional chartering brokerage team as well some ex-OMI senior management. It also built a cargo book before entering into capital markets to acquire tonnage.

Marinakis has been more of a Greek wheeler and dealer with his Olympiakos football team involvement. I do not see the same management depth at Capital. Does it belong in the same league as the above mentioned peers? Marinakis tends to be very mercurial in his decisions. After launching his pure product tanker play, he then used company funds to buy a bulk carrier that he chartered to Cosco. A year later, he decided to merge his crude tanker listing into this venture, adding VLCC’s and Aframaxes with significant spot exposure.

Although Chappell is cautious in his market projections in both dry and tanker sectors, there seems some irrational exuberance in betting on Capital over other peer companies with more solid management.

Tuesday, October 25, 2011

Major Chemical Tanker Operators continue to expand in liquid storage with new acquisitions and innovative financial partnerships

Both Stolt Tankers and Odfjell AS continue to leverage their considerable franchise in chemical transportation expanding in the chemical storage business. Both have a chemical logistics operation with sizeable cargo books. They control a major share of the chemical transport market. Liquid storage is a healthy growing business with good return on asset and attractive risk profile. This diversification enhances bottom line results, provides increased earnings stability and gives them competitive edge over peer competitors.

The chemical sector is traditionally a very low margin business with high operating costs and asset values, suffering from poor returns on investment. These companies have created a valuable franchise in chemical transportation, but they need earnings stability and improved returns on investment for their investors.

They have built up a global presence in chemical storage facilities that assists in meeting these goals. Sometimes, they have gone into new facilities alone like the recent Stolt acquisition of Den Hartogh Holdings bulk-liquid storage terminal in the Netherlands, other times in partnership with peer storage operators like VOPAK, Oiltanking and Vitol in select locations.

Odfjell chose a novel approach to finance the expansion of their terminal business in Europe and North America: a strategic partnership with Lindsay Goldberg LLC, a U.S.-based private equity firm. This firm has been involved in chemical projects in the past with their holdings in PL Propylene LLC (an evolution of an earlier Lindsay Goldberg sponsored venture, PetroLogistics). PL Propylene is now constructing the largest propane dehydrogenation plant in the world to service Gulf Coast propylene consumers. Lindsay Goldberg first entered the PetroLogistics venture by supporting their purchase of an ethylene pipeline.

It will be interested to see how the Odfjell-Lindsay Goldberg partnership evolves in the liquid chemical storage business.

Thursday, October 6, 2011

Eagle Bulk once a Wall Street darling now facing forced sales

At the outside of the 2008 meltdown, Eagle Bulk with its emphasis in handymax tonnage was considered one of the safest bets of shipping stocks. Sophocles Zoullas was well-regarded in NY financial circles. Kelso, who originally banked the venture, had made very good money. Yet the business model had flaws and this is now coming to light.

Eagle Bulk concentrated on supramaxes, where there has been excessive ordering. The smaller vessels in handy sector with more flexibility in port access and variety of cargoes are outperforming.

It was a start-up company with little initial intrinsic value. It has been heavily dependent on charterer counter parties for fleet employment. Only recently has it been developing a commercial department for a contract base. Eagle has always been very secretive about its management, vessels and employment compared to peer companies. Early this year Eagle received considerable adverse publicity when it was discovered the company had significant exposure to Korean Lines, a major charterer who went bust, declaring reorganization.

Shipping is a capital and labor-intensive business with basically low returns on asset. The historical benchmark has been between 10-15% with leveraging. The challenge is how to bring this up to acceptable levels for investors, who are looking for 20-30%. Since shipping is a cyclical business, this can be done in part with timely investment and divestment decisions.

Capital cost is very important. These dry bulk issues, however, were structured with generous dividend payouts, precluding significant reinvestment of free cash flow. New business had to be financed by costly new equity raises. Eagle had few options but a large block purchase strategy to scale up and claim accretitive returns on multiples from a rapidly growing fleet.

The company chose to buy the business from another owner who had ordered a large block of vessels and wanted to resell them at a considerable premium for profit. The expectations from the transaction propelled Eagle’s share price to new highs. This was very good for Kelso, the private equity firm, which sold off shares in timely fashion; but not very good value for investors who bought into low margin business with marginal returns on residual value.

When conditions changed from fall 2008, Eagle had a high cost asset base and too much debt. This precluded any bargain hunting for vessels at lower prices. They put their efforts trying to rearrange and rationalize their order book, where they were over exposed. They had the financial capacity to do new business only through a joint venture through Kelso.

Eagle has a high break-even for its vessels due mainly to very high administrative expenses and interest cost. Executive compensation has been lavish over the years. Despite this, the Group managed to stay in the black until recently. The bad market conditions this year have depressed asset values leading to loan covenant violations. At present, their net worth is close to negative. Presumably the pressure from lenders is to encourage timely recapitalization or asset sales to reduce debt. Oaktree recently bought a small share. Eagle has got a long and risky road ahead of them for recovery.

General Maritime close to filing for Chapter 11 for reorganization

For some time now Genmar has been an ailing company, suffering over indebtedness, high interest expense and cash flow problems with a large portion of its fleet without contract coverage and dependent on a weakening tanker market. The issue now is what stand its distressed asset private equity investor, Oaktree Capital, will take in this situation. Will they eventually take full control of the company, seek fresh management to recapitalize like they did with Beluga? Meanwhile, unsecured bondholders are in a parlous situation.

The Group was not well positioned for the 2008 meltdown. It had just absorbed Arlington Tankers, acquiring some attractive assets but at a high price and it was already carrying too much debt. When the window opened in early 2010 on Wall Street for seasoned equity, Peter Georgiopoulos gambled on a large block tanker acquisition deal from Metrostar.

The proved a bad timing decision and a misread of the tanker markets. Georgiopoulos paid a premium for the vessels over the market, but thereafter tanker rates started to plummet, triggering loan covenant violations and even compromising liquidity. Investors, who had bought into Genmar’s deal in the capital raise without discount, have literally lost their shirt with a penny stock today.

Genmar is hemorrhaging with a second quarter net loss of US$ 24 mio lifting losses for the first half to more than US$ 55 mio with time charter cover for the second half of the year falling to 42%. The “too big to fail firm” is funded through two bank facilities totaling US$ 850 mio at Libor plus 400 basis points and two bonds totaling US$ 500 mio with minimum interest rates of 12%. This does not even include the heavy cost of the US$ 200 mio Oaktree facility on top that is being capitalized. Interest costs were seven times higher than the firm’s earnings before interest, taxes, depreciation, and amortization for 2012!!!

Needless to say, Moody’s rating agency cut Genmar's rating three notches to Caa3 with a negative outlook.

Genmar has a young and attractive asset base. If “marked to market” and recapitalized, this would make an attractive investment with a position on eventual improvement in the tanker market. Currently tanker market dynamics suffer from an excessive order book overhang with three new deliveries for every ten existing units. The main demand driver is Asia emerging markets, but there are also adverse structural changes in the US because of increasing use of domestic tar sand and shale gas resources for energy needs as well as ethanol in gasoline blending. It more likely than not another year of miserable rates before a possible recovery in 2013.

It seems difficult to foresee how Genmar will survive in its present form. Oaktree is an experienced distressed asset investor. They might well be better off running their own show with fresh management of their choosing for better value creation and strategy than the past. On the other hand, bondholders may be in for a very big potential ‘haircut” under Chapter 11 proceedings. The bond payments are not sustainable and they’re sucking up value.

To his credit, Peter Georgiopoulos, who secured a stake in a limited partnership related to the Oaktree investment, will assign his interest in the vehicle to Genmar.

Greece should default and restructure but the EU prefers a debt prison and the Greeks suffer Stockholm Syndrome

It is pretty obvious that Greece is insolvent, the EU/ IMF bailouts are increasing debt and the fiscal imbalances are deteriorating with the austerity measures that are pulling the country into a deep depression. The shrinking GDP reduces capacity to repay debt, so why these self-destructive policies and Greek government capitulation?

Rationally the Greek government would have long ago followed the road of Iceland, defaulted, abandoned the Euro and restructured its public debt in drachma. This would have facilitated necessary structural changes by creating favorable economic conditions for a recovery so everyone in Greece would have something to gain in rationalizing the public sector and opening up closed professions. This process would require reasonably five to ten years.

External devaluation is far less socially destabilizing than horizontal wage cuts and bilking pensioners, which is the infernal EU/ IMF remedy of ‘internal’ devaluation. The new currency would remove the vicious circle of the Euro and EU monetary policies that benefit the Core by undervaluation and gut the Periphery economies by bloating their trade balances.

What is unique to the Eurozone is that it employs deliberately deflation as a means of becoming 'competitive', considering flexible exchange rates as démodé. Conventional currency devaluation makes foreign imports more expensive, but local goods with high domestic content remain at same prices. Nobody has a direct salary cut, etc. It can be done overnight and immediately, there are results. It fosters domestic production and exports.

Admittedly devaluations do not address underlying structural problems, but they buy time for correction without undue social disruption. The EU system of 'internal' devaluation creates immediate social disruption, but actual improvement in competitiveness may take years. An insolvent member with a high debt load may collapse in the process.

Greece has a disproportionately large number of self-employed people. These people like their counterparts abroad tend to hold on to their income and under report for taxes. Choking these people to death economically not only destroys the heart of the Greek economy, but also Greek social fabric. Whatever income squeezed out of them is lost from other taxes like VAT in the deflationary spiral. Today these hapless Greeks face a similar fate of the Kulaks in Stalin’s farm collectivization.

The Eurozone has grave structural problems making it very unattractive for its members. Unlike the United States and England whose central banks were founded to facilitate the government debt, the European Central Bank serves the commercial banks, making government dependent on them for their debt operations. Basic criteria of statehood are the powers to create money, levy taxes, and declare war. Written by EU bank lobbyists, Europe’s constitution deprives Eurozone members of the money-creating function.

The locked up currency parities led to huge trade imbalances between the Core and Periphery, bankrupting a large part of the Periphery. The EZ economy is shrinking, and its own commercial banks are close to insolvency thanks to these foolish EU policies. This is creating a horrible train wreck. Even the US is heavily involved through the derivatives markets that cover sovereign default risk to backstop these weak EU banks.

The EU has been bailing out Greece to cover their commercial banks as a policy response to buy time for an elusive recovery. This also gets the US investment banks off the hook for the derivative default risk. The IMF/ EU/ ECB will eventually become the sole creditor buying out all the commercial bank debt.

The dilemma is that they will be holding worthless paper of countries that are totally barren economic landscape and perhaps even failed states from social disintegration. This why Victorian debt prisons were eventually abolished. History repeated is often a farce!

Lessons learned from this:

1.) Eurozone membership comes at significant social costs: less economic and political freedom for its members.

2.) Permanently lower living standards at least for the EZ periphery countries.

Generally the whole EU system suffers from chronically high unemployment and economic stagnation from the sovereign debt overhang that it generates. It is one of the worst performing regions of the world. It cannot compete either with the Far East nor the US.