Saturday, September 19, 2015

Is the Greek dry cargo business model now obsolete?

Of the 700 odd Greek shipping companies listed in Greece, the majority are in the dry cargo sector with small fleets of three to ten units, mainly smaller and older vessels.  Apart from the ubiquitous handy size bulk carriers, Greek shipping is also heavily invested in Panamax bulk carriers. Will these companies survive this current freight market crisis?  Will the crisis result in consolidation?  Is the business model sustainable or will it have to change for the times?

Many of the publically listed dry bulk companies ranging from the smaller ones like Free Seas, Hellenic Carriers and Globus to the larger ones like DryShips and Paragon are suffering from legacy debt problems and weak earnings.  The smaller private companies are at the mercy of the local Greek banking system with its insolvency and capital control issues.  The best off are the cash rich, mature private Greek owners like Eastern Mediterranean or the Angelicoussis Group.

The predominate business model in Greece is vessel provider.  The Greek shipping companies are long in shipping assets, but generally weak in commercial platforms.  The majority of the companies are small and lack scale efficiencies.  This is particularly true for the smaller listed companies with fleets too small to support the high administrative expenses for the public listing. 

This business  model is entirely to be expected for historical and structural reasons.  Greece is a major maritime nation. Greek seamen were the backbone of this system.  The biggest strength and competitive advantage of Greek owners was the link between their offices manned by former mariners and chief engineers and their vessels.  They offered low cost, high quality shipping services to charterers and end users.  Greeks unlike their Scandinavian rivals were never big in cargo operations or freight trading, a particular strength of the Danish shipping industry historically.

The nature of the Greek shipping  business model leads to asset arbitraging as a major means of enhanced earnings.  Freight markets in bulk commodities shipping is highly commoditized with low earnings margins from vessel operations.  This waxes and wanes with the shipping cycles, but historical mean averages have been low.

The dry cargo markets in particular are very fragmented with low entry  barriers.  Shipping companies have no market pricing power.    Vessel values rise exponentially on future earnings expectations in good markets, making vessels sales a highly lucrative business over vessel operations.  It was Greek historical acumen in these skills of sale and purchase profits that has made Greek shipping so enticing to US Capital markets over the last ten or fifteen years. 

Major US institutional groups like Oaktree saw the same US real estate paradigm in the shipping markets.  They were attracted to Greek shipping for a similar sort of play. This led to investor partnerships pioneered by Peter Georgiopoulos and more recently by Petros Pappas both very close to Oaktree Capital.  This also extends to non-Greek groups like Scorpio Bulk, a highly speculative dry cargo asset venture on new building contracts, close to a futures market play.

This sort of play to be effective depends on the right kind of financial and freight market conditions. These conditions were at their prime thirty years ago in the heady days of petrodollars, high inflation and eager banks with abundant credit facilities for shipping companies.  Since the 2008 Global Financial Crisis, with ZIRP (zero interest), QU (quantitative easing) and the end of a globalization super cycle, the environment for asset arbitrating on cyclical freight markets is becoming more and more problematical.

There is a glut of overcapacity globally and a dearth of demand.  Banks has weak balance sheets and limited credit availability.  There is enormous shipyard overcapacity.  The Chinese infrastructure boom is over.  Speculative investment money in shipping has more than often been a godsend to cargo interests, providing ample ship supply to service their transport needs, but it has not been kind lately to investors in the underlying shipping assets. 

With the credit crunch is a limited number of buyers for shipping assets compared to prior years, limiting the potential for mark up in prices.  With the general weakness in commodities prices and ship yard over capacity, shipping assets are exposed to deflationary effects and fall in value over time with lower replacement cost.  Falling scrap prices means lower residual values.

The most successful and resilient business models are the cargo operators of which the Navig8 Group has been an industry leader.  They serve end users customers with chartered vessels.  They are popular with ship owners, hungry for employment in weak markets.  Their business has small margins and depends on  high volume for profits. It is an asset light trading model.

These businesses can go both long and short in shipping assets.  They do not carry long term exposure in shipping assets or bank leverage.  For larger vessels on standardized voyages, they can hedge their positions with freight futures desks.  They can adapt quickly to sudden market changes, adjusting their cargo books and positions in vessels.  These are the flourishing businesses of the times as opposed to the suffering Greek vessel providers.

Institutional investors have been lately turning to partnerships with cargo operators like Navig8 to adopt to the times.  Oaktree and Peter Georgiopoulos incorporated this model in the restructured Genmar from the ashes from Chapter 11 reorganization proceedings, by merging with the Navig8 VLCC venture and renamed their company Gener8.  This ties vessel owning long in assets with a lighter more agile trading model including chartering in vessels.

The question for the Greek dry cargo owners is whether their business model is obsolete and they will have to consider moving into cargo operator business models on a hybrid basis like a Norden or a Pacific Basin with mixed fleets or owned and chartered vessels..  Companies heavy in shipping assets but weak commercially lack economies of scale in the market and are weaker in understanding the freight market risks.  They are overly oriented to asset arbitraging, which in present market and financial conditions is a backwards-oriented business strategy of yesterday, not effective in the present environment.  Chartered vessels would create needed fleet scale for companies with smaller fleets

These Greek companies are facing survival risk and becoming dinosaurs.  They face a double whammy of violent changes both domestically in Greece with the failure of the Greek state as well as external forces in the aftermath of the globalization super cycle of the past century.

Greek Shipping and EU revisited

The third Greek bailout program has now been passed by the Greek parliament and at least the basic tax increases on Greek shipping have become public.  We can now begin to take stock on the damage done to the Greek shipping community by the SYRIZA government and the EU/ Eurogroup bureaucracy.

The tax increases are hardly helpful for a business under a great deal of stress due the very poor dry cargo markets, where the majority of Greek shipping companies in Greece are concentrated.  None of this is positive for the increasing unemployment in the Greek maritime sector. There are 4% tonnage tax increases each year for the next three years.  There is also a continuation of the 'extraordinary' (now becoming permanent) levy on Greek maritime service businesses on the foreign exchange brought in to Greece for covering their office and administrative expenses.  Already tonnage taxes in Greece are much higher than other jurisdictions. 

This makes third party ship management in Greece problematic given that ship managers in major jurisdictions like Cyprus, Dubai, Singapore and Hong Kong do not have this burden.  Ironically, the EU approved the low rates in Cyprus, whilst insisting on rate hikes in Greece.  The other jurisdictions are blessedly outside the Eurozone, without fiscal problems or over indebtedness. There is little prospect of their hunting down their businesses and citizens by repressive taxation as happens in Greece and the  EU as a whole to cover their political mismanagement and losses from repeated  policy failures. 

The only positive thing to be said in terms of advantage for Greek offices is that rents and salaries in Greece are extremely low compared to rival jurisdictions.  The other places are economically healthy, Greece is in a deflationary spiral with massive unemployment and falling real estate prices.  The tax increases are offset by lower personnel and administration costs in Greece as opposed to the other rival jurisdictions.

There are, however, other negatives in Greece beyond these new EU tax measures on the Greek shipping industry.  The two most serious negative factors are the broken local banking system with capital controls and the general uncertainty of the future, including exposure to further tax hikes and erosion of offshore status of Greek shipping in Greece.  All this creates a bad business environment for an industry that is facing a lot of structural problems due changes in world trade and a particularly bad situation in the dry cargo sector, where the majority of offices in Greece are exposed.

The most unpleasant aspect is the situation with Greek banks and capital controls.  The Greek banks are now facing new stress tests and recapitalization issues.  Lending has been at a standstill for months now. The small and medium Greek shipping enterprises dependent on the local Greek banks for the financing of their fleets are suffering the consequences.  The capital controls extend to their US Dollar accounts in complete contrast to the situation prior Greek entry to the Eurozone and the drachma.  In those days, US Dollar accounts were considered freely convertible foreign exchange and there was never any issued about the solvency of the local Greek banks.  Bank finance for vessel purchase to rollover and renew their fleets is now again on hold.

Ship owners like most of the Greek bourgeoisie cling to the Eurozone.  This is becoming more and more problematic as the political and economic situation continues to deteriorate in Greece and the process of the Greece state insolvency takes its course without any debt relief in sight. 

The broader fundamentals internationally are not good.  The EU is unstable with mounting sovereign debt, very poor growth and defective, dysfunctional institutional structure.  The US is entering the last year of a two-term Presidency, where historically there have been major market meltdowns in US equities markets.  The most important of all for shipping, global trade patterns are now changing because the China story is over with falling GDP growth rates and instability in Chinese financial markets, which have caused recently  fall-on turbulence and volatility in US financial markets .  

The China situation has had already a strong effect on dry cargo markets. The tanker markets are still buoyant with the low oil prices.  With the end of the current globalization super cycle, production in the coming years may become more localized and this would have a profound impact on the shipping industry.