Greeks face loss of competitiveness with Asian Peers

Keynote Speaker at Hong Kong Shipping Forum on Business Models and Strategy in the Shipping Industry

Why not a derivatives market in vessel asset values?

Shipping investment projects have always been mostly asset plays rather than new business models to serve customers more efficiently in the transport of cargo. The Greek shipping industry craves for investment in physical assets as opposed to the Norwegian asset-light cargo operator model with chartered-in tonnage often on purchase options. Profits are generated from moving in and out of assets in the shipping cycle. Cargo transport operations remains secondary in the process mainly to keep holding costs down. Lately investment firms have also gotten into the game, teaming up with operating companies to acquire shipping assets.

Would not it be easier and more efficient to develop a derivatives market for this process rather than taking on all the headaches of physical asset ownership?

The latest version of this asset play concept is the Oceanbulk Carriers partnership between Petros Pappas and Oaktree Capital with the purpose of picking up distressed dry cargo shipping assets and eventually making profits on market recovery. Petros Pappas has an excellent record as one of the most successful asset players in the Greek shipping community, having sold off most of his dry cargo fleet in the heady boom years of the late 2000’s to the point of even moving out of basic ship management and operations.

There is no doubt that the dry cargo business is currently under severe stress. The sector has been plagued for years with a historically high vessel order book on expectations of infinite Chinese growth with their insatiable appetite for commodities imports and incessant speculation in commodities resources. The Chinese themselves have become major shipbuilders with huge expansion of yard capacity, mainly for dry cargo vessels. It did not take much of a drop in Chinese growth rates in 2012 and some inventory destocking to send dry cargo freight rates tumbling.

As this point, several high profile listed dry cargo companies like Genco (GNK) and Excel Maritime (EXM) are on the verge of bankruptcy, plagued by asset prices falling below loan outstandings and cash flow problems to service the debt payments. Unlike Asian competitors like Pacific Basin with large cargo books, these companies themselves started as asset speculations. They leveraged up with debt to expand their fleets in large block purchase deals, playing the market cycle.

Excel Maritime went to the extreme of merging very unwisely with another asset play, Quintana (QMAR) shortly before the 2008 global financial crisis and reportedly taking on US$ 1 billion additional debt to finance this transaction. The motive to merge for the Quintana stakeholders backed in part by First Reserve private equity was to realize their asset position for profit because their operating profits were restricted by long term time charters and this kept their stock price from appreciating as much as they would have liked to see. Just the announcement that they were planning this move caused a bounce in their share price.

Contrary to their mission statement to focus on distressed assets, the Oceanbulk-Oaktree venture recently decided to place new orders rather than to wait for opportunities in existing tonnage. At the same time, their new business development director and former investment banker, Hamish Norton, recently gave a dry bulk presentation at an industry forum in Athens where he sagely noted that the continued drybulk order book risks putting off any market recovery for another year yet in the sector. So ordering additional dry cargo vessels would at least appear to be contributing to more industry distress and counter-productive in hastening any market upturn in rates.

Perhaps a vessel asset futures market – if feasible – would be a more efficient tool for these cyclical asset plays. The ship derivatives could be based on standard type bulk commodities vessels, just as the Baltic Freight index is based on standard voyage routes. Banks could use the derivatives in order to hedge their loan exposure, reducing their credit risks to shipping companies. Shipping companies could hedge their asset purchases against fall in value and impairment charges. Hedge funds and institutional investors could take speculative positions on rising and even falling asset prices.

The beauty of a derivatives market for ship values is that it would not entail any ship ordering. Shipping companies could go back to the fundamental business of transporting cargoes for their customers. Because the derivatives market would allow for both long and short positions on vessel values, it might even assist in providing a reduction of vessel asset price volatility. Positions could be taken and unwound very quickly.

All this would relieve investors from the trouble for these cumbersome partnerships to buy physical assets, the need for bank finance, the travails of ship management and needs to charter the vessels with risks of charterer default, etc., only to lead to a game of musical chairs on market recovery to sell the assets or the shares in the company to the next guy with a mark-up.

Of course, the last guy in the chain like Excel Maritime in the Quintana merger or Berlian Laju (acquiring Chembulk from AMA at a sizeable mark-up), is invariably left holding the candle, facing bankruptcy as the market sours.

The shipping industry would become more of a logistics business, but is it not what it was supposed to be in the first place?

Eurozone politicians face growing credibility problems from angry European voters

The European Union project is one of the biggest attempts in history to change the geopolitical status quo in Europe and eventually abolish the nation-state with rule from a supranational entity in Brussels. A principle mechanism for this unification is the Eurozone currency union, where 17 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender. Monetary policy of the zone is the responsibility of the European Central Bank (ECB) which is governed by a president and a board of the heads of national central banks. There is no common representation, governance or fiscal policy for the currency union. When rarely taken to plebiscite as in Sweden or Denmark, rank and file voters have rejected the concept, preferring to remain with national currencies. None of this has much broad public support or popular legitimacy in Europe beyond the European political elite.

Since 2008 an increasingly larger number of Eurozone Periphery countries have been facing national bankruptcy with high levels of public debt, trade imbalances and loss of market access to issue debt. The bailout programs have put the EU Periphery in deep recession with loss of output at levels similar or in excess of the Great Depression with very high levels of unemployment in excess of 20%. Last year the World Bank cited the Eurozone debt crisis as a major threat to the world economy that could lead to a renewed global financial crisis. We have not seen such an attempt at internationalization since the Soviet Union in the 1920’s and 1930’s at such heavy human cost with presently millions of Europeans out of the work and economically marginalized. The rise of broad-based popular discontent with the economic hardship is now challenging this new status quo in Europe.

Recent Italian elections results have reopened the Eurozone debt crisis with a majority of Italians voting for anti-Eurozone Beppe Grillo five star movement and the increasingly Eurosceptic PdL/ Legha Nord coalition. The pro-Eurozone Socialist PD and Monti parties had disappointing results. There are three basic dimensions to the Eurozone debt crisis:

• The EU political elite are locked into the concept of the Eurozone monetary union in which they have staked their careers as a new economic Utopia.

• The Eurozone area is mired in a deepening recession with a growing divergence between the Core members setting the policies and Periphery countries suffering by these policies severe loss of GDP, massive unemployment and permanent damage to their economies.

• The currency union is a powerful tool for forced political integration, but it was not founded on sound economic fundamentals nor the broad consent of European voters.

The severe economic dislocation with resulting social turmoil is discrediting the EU political elite and unleashing new political forces of renewed nationalism that may in the end result in a breakup of the currency union if the growing divergences cannot be resolved.

The purpose of the Eurozone was to enhance the single market and move the member states to political union. European policy makers frequently cite the United States as a proto-type with optimism that they will achieve the same political union under a single supra government. Of course, they overlook the fact that even today there exists considerable political tension between the US federal government and the various states. There is a continuing debate about the size and role of the US federal government – issues taboo for open discussion in Brussels. Further, it took a long and bloody civil war for the union to prevail in the US.

The challenges in Europe for union are much larger. European countries are nation-states with different languages and political cultures. European societies like Greece and Italy have no wish to become multicultural melting pots. The Greeks, for example, revolted from the Ottoman Empire with the concept of a homeland for all Greeks - both living in Greece and abroad – to be free, not terribly different from the more recent case of Israel.

The currency union was sold to the smaller EU countries as a road to prosperity because they would not have to worry about future currency devaluation vis-à-vis the other members and they would benefit by credit enhancement with lower interest rates and more credit availability.

The EU political elite discarded from the outset any trade flow criteria that would justify rational participation in a common currency zone. Instead of starting with a small and sound base of core members, they tried to get the maximum number of EU members to sign up for the project at the outset with the aim of using this currency zone as a lever for greater political union. Frequently, Eurozone entry - as in the case of Greece - was finessed by use of credit derivatives and accounting tricks with the collusion of the Brussels policy makers.

The Eurozone set-up lacked a central bank lender of the last resort. The commercial banks were to supply credit to member state governments. The ECB, moreover, operates under rules that the Germans insisted for their participation to mimic the German Bundesbank. The rigid monetary policy favored Germany and its exports over the other member states. This led over time to asset bubbles in the Periphery and created chronic import dependency in the Periphery countries, devastating local production. The growing trade imbalances left the Periphery country members with the dilemma of increased public indebtedness or deep recession and unemployment

Perhaps the most poorly understood aspect of a currency union is that by giving up national currency, basic social contracts like social security systems as well as commercial banking system were put in jeopardy.

Member countries no longer had any control over monetary policy, money creation or interest rates. They faced severe spending restraints.

They could no longer fund via their central banks their social security systems nor could they bail out their banking system in their local currency when under stress. Their heavy reliance on local commercial banks to finance their deficits starved their private sector from credit and ultimately led to the insolvency of their banking systems.

In financial crisis, they were totally beholden to the ECB, Brussels policy makers and the mercy of other member states for any assistance in a cumbersome, interminable and dysfunctional resolution process. In effect, Core members – namely Germany –dictate their terms on the weaker members in the workout programs with entire brunt of the adjustment process and pain falling on them. They suffer unwittingly a severe loss of their national sovereignty.

The Bank of England foreseeing these factors in their risk assessment blocked the UK from entering the Eurozone. The UK has its problems but its fate is in its own hands.

Eurozone members lack defacto the right to request IMF assistance without the consent of the other Eurozone members and then with heavy EU involvement with EU officials often at loggerheads with the IMF staff.

Normally for a sovereign nation under a bilateral IMF workout, the IMF would propose structural reforms along with a currency devaluation. The devaluation is meant to produce a boost in exports making immediately all goods and services cheaper whilst leaving wages, salaries and pensions intact. This primes the period of structural reforms making up for the lost output and unemployment in the restructuring process. The adjustment is less economically painful and socially destabilizing.

The Germans view EU periphery countries in terms of their unification experience with East Germany, where they developed their theories of ‘internal devaluation’ now used in all EU workout programs for debt-ridden EU periphery countries. Contrary to current US thinking to avoid recession and deflation, the EU/ German process purposely provokes deep recession and high unemployment to drive prices levels down through deflation in place of currency devaluation.

In the case of German reunification, it took over ten years for these structural reforms to have a serious impact. The cost for this process was a permanent population loss of 12% with chronic unemployment and low wage levels that remain today. This has been the pattern in all EU workouts, with severe GDP loss and high unemployment.

The countries under these EU/ German-style workouts are left with permanent economic damage from the severe deflation. Aging, shrinking European societies like Greece and Italy, simply cannot afford permanent population loss much less a prolonged period of lost growth. The severe loss in GDP is almost impossible to recoup. Chronically high unemployment, low wages and living standards remain for years.

The countries under these EU/ German workouts are invariably left with very high levels of debt as the relative value of debt increases in the deflationary environment whilst the capacity to pay it down diminishes with the shrinking economic output and population loss leading to an outbreak of private and public sector bankruptcies together with ensuing debt restructuring.

If bilateral IMF workouts left scars from the experience of pain and humiliation in South Asia countries, which led to their adoption of export policies to run trade surpluses for more financial independence, the severely harsher EU/ German method of ‘internal devaluation’ constitutes a highly explosive political time bomb in Europe.

The present European climate where EU periphery countries are mired in deep economic depressions with GDP compression and unemployment in excess of 20% has become surreal. EU governments promise a future nirvana of European unification with prosperity just around the corner. The Greek government, for example, is currently betting the house for economic recovery latter this year to buy time with increasingly violent protest.

The European electorate is rapidly discovering that the utopia of the Eurocurrency zone is a nightmare of economic pain and social marginalization. There is a growing sentiment that the EZ workout programs with constant creditor pressure for harsh measures for the next bailout installment and heavy-handed interference in local elections for a government of EU approval are an exhibition of tyranny and coercion. Voters increasingly feel that their political elite have not been truthful with them. Political rage is leading to the collapse of the traditional party systems and to creation of new anti-EU/ Eurozone protest parties that are growing rapidly in ranks.

This was the message of the recent Italian elections. Now the EU elite is currently searching desperately for a solution that they managed last June to achieve in Greece with the present docile, compliant pro-Euro government to continue the same highly unpopular policies. Italy as opposed to Greece is a larger country with considerably more debtor leverage. Should the EU/ Germany ultimately be obliged to consent to the growing demands in Italy to jettison austerity and higher taxes reversing the Monti government; then they risk a rebellion of the smaller Eurozone members, who are increasingly desperate.

The issue remains whether the EU elite will be able to put the genie back into the bottle and regain control as happened in the 1848 European unrest or this protest momentum will ultimately lead to their overturn and disgrace of the existing European Union status quo with the emergence of new political and social order in Europe.

Greece in the position of Oliver Twist under supervision of the EU in the role of Mr. Bumble could potentially get swept up in the Italian protest if it grows and spreads to other Eurozone member states.

Greek Competitiveness II: the tax man cometh. End of the era of Law 89 offshore shipping?

Greek shipping is not only facing difficult freight markets and lagging in investor returns in the face of competitors; but now due the Greek debt crisis, the Greek government is beginning to abrogate its offshore status by imposing a new onslaught of taxes as well as threatening to regulate office practices like domestic industry.

Already, the Euro has been hardening this year against US Dollar, the shipping industry base currency, making office costs and salaries more expensive.  Now the Greek shipping industry will have to pay Greek flag tonnage tax level on all foreign flag vessels managed in Greece.  The shipping services offices in brokerage and crewing were slapped with a ‘temporary’ retrogressive special tax of 10% on all foreign exchange that they bring to Greece starting last year for the next four years.  The golden years of Law 89 offshore shipping seem to be coming to an end.

Being locked into a heavy (quasi-Deutschmark) currency zone never seemed a sustainable policy for an industry based on the US Dollar and emerging market cargo demand such as Greek shipping. Eurozone entry has destroyed already a number of traditional Greek industries such as ship repairs and textiles. Will ship management be added to the list of bygone traditional Greek business, no longer competitive and be forced to move abroad?

As opposed to cautious distance from the Eurozone by the UK financial industry in the London City , Greek ship owners warmly embraced Greece in the Eurozone. They never considered the long term implications of this on their industry in Greece with the higher costs from unfavorable currency parities, the risks of encroaching EU regulations and the potential tax liabilities that would eventually render Greece an unattractive jurisdiction for shipping offices. Greek owners and managers are losing their structural competitive advantages, without even thinking about it.

Already Greek crews are largely a thing of the past with most of the sea academies closed and Filipino seamen manning a large portion of the Greek-controlled fleet. The middle management of port captains and engineers that run the ships and serve as the link between the office and the vessel remain predominately Greek. Many are retired seamen. Now their jobs are at risk because of new, heavy-handed government policy that would restrict them from working as a second career in offices.

The new tonnage tax agreement was negotiated by the large Greek ship owners, where there is the biggest concentration of Greek flag vessels. The smaller Greek shipping companies simply cannot afford to operate under Greek flag with its higher costs. This agreement permanently extends the same Greek flag tonnage tax rates to all foreign flag vessels. It makes the operation of foreign flag vessels more expensive in Greece as opposed to other jurisdictions. The rate increase more than doubles the tonnage taxes for medium size tonnage. The money involved is not large prima-facie amounting to approximately US$ 5.000- 7.000 per vessel per annum, but it can be even more onerous for companies managing very large vessels like VL’s or large numbers of vessels.

It is a direct threat to third party management in Greece because foreign principals will be loath to accept the extra cost for management with venue in Greece and may likely prefer to change management venue to more competitive jurisdictions like Dubai, Monte Carlo and Singapore, without these charges. These alternative jurisdictions are not heavily burdened with high public debt, keep taxes low and are generally business friendly without the Greek uncertainty.    

Already foreign ship management firms are seriously considering curtailing their activities in Greece or moving out. One major foreign management firm with over fifty employees in their Greek office called on the Greek government in protest. The Greek official in charge reportedly told them that he could care less if the people were laid off and the closed office was closed. It was also reported that the Greek tax authorities invaded the offices of a major Greek ship owner and manager. The owner was compelled to fire a large part of his staff of port captains and engineers. Greek politicians have always been indifferent to Greek jobs in the private sector.  

Shortly after the Greek ship owners thought that they had resolved their problems with the tonnage tax agreement, they were suddenly confronted with a new special ‘temporary’ tax that amounts to 10% on the foreign exchange brought into Greece starting retroactively in 2012 for the next four years. The owners reportedly sent a high profile law firm to the Greek government, protesting and threating litigation if the law were passed. At the last minute, just prior the vote of new draconian tax laws in January, the ship owners escaped these special taxes through amendment, but the law still stands for all the Greek shipping services offices under Law 89 such as brokerage firms and crewing offices. Ironically, these are smaller firms, who have also been suffering in difficult market conditions. They are less able to cover the taxes than their ship owner/ ship management brethren, but generally seen with complete contempt by the Greek political class.

Just as there is no guarantee that the tonnage taxes may be increased in future years, neither is there any guarantee that this ‘temporary’ tax may become permanent.  These new tax laws are going to put a lot of pressure on the smaller service firms, forcing them to close or curtail their activities. The larger firms are already considering changing venue and reducing their staff in Greece. Foreign firms may prefer to move out of Greece and service Greece via more business friendly jurisdictions.

There is no doubt that the current climate of taxes and government heavy handedness means that unemployment will rise in the Greek shipping industry. Greek shipping jobs are among the best paid in Greece. These people will be joining other social groups in unemployment in the general mounting social misery that prevails in Greece.

Added to these issues is the reorganization of the domestic Greek banking system and question marks on availability of credit for Greek shipping companies. Eurobank, for example, is going to be merged into the National Bank of Greece. Commercial Bank of Greece is being absorbed by Alpha Bank. We still do not know how the new Basel regulations as well as the EU overseers of the Greek banks will view shipping credit, moving forward.

All indications are that Greece is not going to be a place for small companies, entrepreneurial startups and innovation in the shipping space. Industry consolidation seems far more likely with fewer and larger shipping firms across the board. Larger firms may prefer to move out and downgrade their Greek presence to representative or technical offices It remains to be seen how this traditional Greek franchise will evolve; but the creative, expansionary phase of offshore Greek shipping under Law 89 seems over.

Greece like most of the EU has become a high tax, big government, heavily regulated jurisdiction that simply cannot compete with the Far East or the US, either on innovation, costs or low energy prices. The EU has lagged for many years on growth rates compared to other parts of the world. The EU is probably unique in terms of favoring very high unemployment and severe recessions as affirmative public policy choices to make its member states more ‘competitive’. It seems likely that these policies will continue to kill more jobs than they create.  This is the dismal track record of European policy makers for many years now.

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!