Sunday, January 6, 2013

Greek listed shipping companies have a competitiveness problem with their peers in terms of investment returns

One of the biggest problems in Greek-listed companies is that many have been trailing on profitability. This was recently brought home in excerpts from Fearnley report tracing these companies from 2000 onwards that was recently published in the Tradewinds.

Vancouver-based TeeKay LNG (TGP) delivered a 10% return for its investors but Livanos-controlled GasLog (GLOG) late in the game is presently at -3% returns. Tsakos (TEN) with scant returns of 5% against TeeKay (TK) overall at 14%. Peter Georgiopoulos (GMR) went into Chapter 11 largely wiping out common shareholders.

The same goes for dry bulk company listings. Palios-controlled Diana Shipping (DSX) with negative returns as opposed to Danish-based Norden (DNORD) with 38% returns. Fredriksen’s Golden Ocean (GOGL) secured a 19% return for its shareholders, whereas Panayotides’s Excel (EXM) and Zoullas’s Eagle Bulk (EGLE) have lost money for their shareholders with negative returns. Both companies have had serious financial problems.

Why have so many of these Greek-controlled listed companies delivered such poor results for their shareholders?

Admittedly, the shipping industry as a whole has been under a lot of pressure lately with difficult market conditions. This has placed management under stress with extraordinary challenges. Greek shipowners are relative new-comers to capital markets. Traditionally, Greek companies have been closed private family businesses. Most privately-held Greek shipping businesses have been performing well in current difficult market conditions.

The Greek listed companies were mainly start-ups. The only case of a mature company was the Angeliki Frangou’s acquisition of Navios as a platform and she has since managed the business well, outperforming her compatriots. The start-up companies were all on the vessel provider business model, providing ships and crew for charter employment. They had no cargo books. Conceptually, they were cyclical asset plays with high dividend payouts to entice investors. This situation was fueled by the remarkable rise of China with its double-digit growth rates, insatiable appetite for raw material imports and its burgeoning export market to the EU and US in finished goods.

The challenge for these newly-listed companies was that shipping is an old-fashioned labor and capital intensive industry with relatively low returns on assets. The traditional benchmark for a good ship acquisition deal is 15% return on asset on the basis of 60% leverage with cheap bank finance. This is not a big margin to cover the unforeseen if results do not work out as well as planned nor would this satisfy normal institutional investor return requirements of 30% returns for start-ups and 20% returns on existing businesses. Covering the risk profile with longer term employment from charterers entails a discount on the charter rate for the counter party risk transfer. This sort of arrangement creates additional challenges, capping further market upside in a rising market where there is premium on vessel values and lowering financial returns.

Capitalizing on magic of the China growth story for cargo, these companies could only entice investors on rising earnings multiples from fleet expansion. The concept was double the fleet with large block vessel acquisition deals. Presto: double the profits! Most of these companies expanded their fleet by buying fleets from existing private shipping companies. Peter Georgiopoulos was a forerunner with his tanker deal with privately held Metrostar in the early part of the Millennium. Indeed for some private Greek shipping companies like Metrostar, it became a lucrative business to sell their tonnage to listed shipping companies at premium prices. Eagle Bulk, for example, expanded in the same fashion in the dry cargo Supramax sector, doing a large block deal from another Greek private company rather than building the business themselves.

Ironically, this concept with investors came to a halt two years ago with a repeat deal that Peter Georgiopoulos did with Metrostar to expand and renew his Genmar tanker fleet. Investors loved the deal and gobbled up the supplementary share offering at par with no discount for the risks involved. Unfortunately, the tanker markets came under pressure shortly thereafter. General Maritime strained to secure bank finance to complete the deal. Ultimately, GMR went into Chapter 11 and investors literally lost their shirt. This debacle was a cold shower for institutional investors in shipping deals. Criteria for new money became more demanding. Institutional investors started to press for deep discount entry prices. The best placement source shifted to day-trader retail investors who, could care less whether their stock picks were solvent or their business strategies made any sense. 

All these deals were cyclical asset plays. No one cared about earnings margins or value creation from competitive advantage other than a large fleet. Profits were generated from rising freight market expectations. If you were lucky, you would sell the assets down the line to another shipping company in a game of musical chairs. Excel Maritime (EXE), for example, bought out Quintana in a merger shortly before the 2008 financial meltdown. Excel was obliged to raise a great deal of bank finance to complete the deal. Stuck in the chair when the music suddenly stopped after 2008, Excel has been reeling with liquidity problems and bank covenant violations ever since. The main shareholder was obliged put in additional cash from his personal money for recapitalization to keep his lenders happy and at bay. It is no surprise that Excel Maritime has been for its shareholders neither a profitable Norden nor Golden Ocean, but rather a source of painful disappointment.

An unfortunate derivative of these asset plays is that they distracted Greek managers from moving into other more profitable growth areas like gas shipping and offshore. Peter Georgiopoulos (and his investors) missed out entirely entirely these opportunities.  Instead Georgiopoulos moved into similar dry bulk asset plays in Genco and Baltic with poor investment returns. This ultimately ruined his tanker business where other competitors like TeeKay Shipping comfortably trumped him in the tanker markets with their franchise in shuttle tankers and nice play in LNG shipping, rewarding their investors handsomely.  His management team involvement in Aegean Marine Petroleum (ANW) (albeit his personal role here may be more of a figure-head position) does not appear to be getting any better results in the fuel supply business where competitors like World Fuel or Glencore-controlled Chemoil have much better share performance for their investors.  (See the below article with comparative stock charts and discussion of business strategy)

The future of Greek shipping lies in regaining competitive advantage and better earnings margins. Greece entering the Eurozone was a big structural setback for its shipping industry. It put its management and ship repair companies in a high cost, slow growth currency zone with a 30% premium over the US dollar. Shipping industry revenues and customer base are mainly with emerging market countries with exactly the opposite strategy of cheap currencies following the US dollar to foster their export markets in goods and services.

Greece is tied to the mill stone of a low-growth economic zone that is getting progressively poorer as time goes by.  It is also facing significant fiscal drag from massive barrage of taxes due to an unsustainable debt overhang held by EU government creditors in debt peonage.  The PSI+ debt restructuring bankrupted local Greek banks, severely limiting bank credit for small-medium Greek shipping companies.  The aggressive high tax environment may even ultimately eliminate the tax-free offshore status of Greek shipping companies. A Eurozone venue means continued higher administrative and crewing costs for Greek seamen than Far East competitors. Greek companies will struggle to compete with peer vessel management companies in business friendly places like Singapore free from these issues.

Given erosion of their cost structure, Greek shipping companies may have to focus more and more on niche markets and new growth areas to make up for their higher operational cost structure and sharp competition from foreign competitors with more disciplined growth strategies with emphasis on earnings margins, investment returns and risk profile on the business that they develop.

It is fair to say that this cyclical downturn in shipping markets will also open new opportunities in asset play strategies for those who have the wallet, financial backing  and patience. In these cases, the first-ins and early-outs are generally the most fortunate. The last-ins get caught when the music stops. Too many Greek listings proved to be in this category.

Aegean Marine Petroleum Network: lagging competitors with low return on investment and mounting financial expense eroding earnings margins

Aegean Petroleum (ANW) has an unusual business model compared to its bunker supplier competitors.  Its sole focus is the low margin marine fuel business.  It prefers expansion in physical assets and shuns derivatives to hedge fuel purchases. This asset heavy business model means that expanding bunker sakes put pressure on its receivables financing, resulting in breached loan covenants. Mounting financial expense is eroding profit margins. Sales volume has lately been flat.  Aegean has been consistently behind its competitors in share price and financial performance.

Many investors confuse Aegean for a shipping company. In effect it is a commercial trading company focusing solely on the marine fuel market. This is highly competitive market place with margin pressures. Marine fuel market is less profitable business than aviation or land fuel markets. The shipping industry as a whole suffers from over indebtedness and over investment. Aegean rather than diversifying into more profitable fuel markets is investing heavily in new marine fuel supply points, mainly on the basis of local start-ups as well as building storage facilities for a bigger share in the marine fuel market despite eroding margins, poor shipping industry fundamentals and larger competitors, who are stronger financially and diversified in other more profitable fuel markets.

It is hard to see any coherent strategy for competitive advantage. The original concept of gaining market share from a fleet of double hull bunker tankers scarcely made any sense for a company, whose main activity was buying fuel from major oil companies and selling this to shipping companies at a mark-up for the service. The delivery service with the bunker tankers is included in fuel price and is a cost, not a source of revenue. Fuel oil supply is a highly competitive business, where price and bunker quality are the main customer concerns. Whether the fuel is delivered by a fancy new bunker tanker is not a major factor in choice of supplier.

Aegean, moreover, contracted its bunker fleet prior 2008 at top of the market yard prices. This strategy may actually in retrospect be putting Aegean at disadvantage with competitors, who chartered in tonnage avoiding long term involvement in costly physical assets as well as those who waited and are now covering their needs with tonnage at present lower yard prices. In fact, Aegean has been lately selling off older tonnage to rationalize its fleet at tell-tale vessel disposal losses.

The latest strategy for competitive advantage seems to be investment in storage facilities. This does not seem in concept very different from the old strategy of the bunker vessel fleet. The new storage facilities are not primarily to be rented out to 3rd parties for a new source of revenue, but rather to be used to accumulate fuel for flexibility in customer sales. Note that Aegean’s larger, more sophisticated competitors make use of derivatives desk in managing their customer commitments at lower cost and more efficiently. Some like Chemoil are even divesting of their storage facilities for better asset allocation.

Expanding fuel sales puts pressure on working capital because suppliers must pay in advance for the fuel that they supply to their customers, who then pay later for the purchases. For this reason, bunker suppliers often factor their receivables for cash. Aegean lacks free cash flow to facilitate larger receivables because so much of their free cash flow goes to investment in physical assets and debt service. Their bunker fleet is mortgaged, which entails debt service and interest costs to their bankers. Their quarterly earnings reports demonstrates higher interest expense than competitors like Chemoil, even though Aegean is a smaller company with lower sales turn-over. Larger competitors like World Fuel are much stronger financially with very little debt and their receivables factoring is on much better terms. They have better earnings margin from their fuel sales and more free cash flow available with very little encumbrance for debt service.

Aegean was obliged to state in their 2011 financial report that they had covenant violations with their lenders from their receivables financing. This year a major loan facility is up for renegotiation with lenders. It is hard to see how Aegean will manage lower finance costs than their competitors. This puts Aegean at disadvantage with them, so it is hard to see why Aegean is so interested in expanding when the additional market share is at diminishing financial returns.

Unlike competitors, Aegean also has an unusual management structure. Their management team is from Peter Georgiopoulos, who sits as Chairman. No one in the Georgiopoulos management team has a history in oil trading or bunker supplier business and the Chairman role appears to be largely a figure head position. The major shareholder in ANW owns Aegean Oil, a Greek-based domestic oil retail business, which is their sole physical supplier in Greek ports and has acquired land for envisaged ANW storage facilities in Dubai. Perhaps the shipping background biases this management team toward physical asset plays, albeit the main shareholder has a history of developing a successful retail fuel business in Greece.

The management depth of competitor bunker suppliers is formidable. Chemoil after the founder’s tragic deal was acquired by Glencore a major commodities trading house with enormous financial strength. Its present CEO, Tom Reilly was the former head of OceanConnect Holdings, Inc - an innovative company combining state of the art on-line technology as well as 24/7 traditional expertise to provide global energy and risk management products and services. He also held a major management position in a Texaco Chevron joint venture in bunkering and fuel trading. Michael J. Kasbar, President and CEO of World Fuels has worked in the fuel business all his career and was the driving force in World Fuel’s proven strategic acquisition record in diversified fuel markets.

Aegean stock performance in comparison with World Fuel speaks for itself in terms of the results of its strategy in a striking way as seen in the adjacent stock charts.

Whilst Aegean has fallen significantly since its initial IPO and stagnated with low volume, World Fuel has significantly outperformed and rewarded its investors.

Even Chemoil stock despite the succession turmoil has also outperformed Aegean and it has been improving lately after being acquired by Glencore with revamped management.

Given such dismal share performance with peer companies, what does Aegean management have in their heads using surplus company funds to repurchase shares?  Would not the interests of Aegean shareholders be better served by merging Aegean with a bigger, financially stronger and better managed fuel company like World Fuels in return for INT stock?  Indeed such has been the fate of many a marine fuel supplier company in this highly competitive sector!