Monday, July 20, 2009

Shipping Your Dollars Away

While a company may appear undervalued on an earnings basis, this does not mean the company has cash to distribute to shareholders. A quick way to help determine if a company has the cash flows needed to pay shareholders is to compare its depreciation expenses with its capital expenditures within the context of its operating income. For StealthGas (GASS), a provider of carriers and tankers for the oil and gas industry, the comparison is as follows:

Unfortunately, this profile is not dissimilar to that of other companies in the shipping industry. Clearly, it is unlikely that there is any cash left over after these massive capital investments are funded. Rather than using earnings to pay shareholders, the company has needed a source of financing to fund an expansion. That source has been debt financing, as the company has increased its D/E from a more reasonable 65% to its current 90%.

As this company has ramped up its expansion, it has put itself as risk. Despite what the growing earnings record may show, this company is in no position to reward its shareholders.

The high debt levels combined with the fact that the company is in a cyclical industry suggests trouble is ahead, especially if the industry is expanding while the economy is not. While in other industries capital expansion can be cancelled and in some cases capacity can even be cut, this is not the case in shipping. Due to high manufacturing lead times, GASS is contracted to buy several more ships through 2012! These contractual obligations will require another $135 million in financing!

Since other companies in this industry are in the same position, supplies of ships will continue to increase in the next few years, while goods that need to be transported are slowing. This leads to lower revenues and reduced fleet values...a situation investors should be wary of entering, despite the earnings growth profiles these companies have shown in the last few years. While stock market values of these companies are depressed (GASS' P/E is less than 5, and its P/B is .33), long-term investors should ensure their company is not too laden with debt and expensive commitments to outlast what could be a rough few years for this industry.

Disclosure: None


edpin said...

Very good post, Saj. NAT is a better company, and one I've been monitoring closely. However, I'm afraid of the 36% or so extra shipping capacity coming online from now until 2012. That's something you mention as a problem for GASS (by contract they have to buy ships until then), but it's also a problem for everyone else, including NAT (who buys second hand ships) because there will be more shipping capacity out there and hence lower shipping rates. What's your opinion on NAT? I've passed for now, but watching it closely.

Saj Karsan said...

Hi Edpin,

NAT has a solid balance sheet, especially after their recent share issue. But the company is dependent on the spot market, and so commodity prices and shipping capacity will play a big role in the success of this investment. As you said the industry may suffer from overcapacity, so I'm not sold on it right now but it may be worth a closer look.

PlanMaestro said...

There are cheaper plays than NAT with strong charters. You really have to pick up your spots in this sector. It is in in disarray but there are good opportunities.