Tuesday, January 19, 2010

Babies In The Sea Water

In his book, Mohnish Pabrai has discussed the cyclicality of shipping stocks, and how they might offer investors opportunities when times are tough. Last time we looked at this industry, however, it was in disarray. Companies had made purchase commitments for new ships, and so supply was going up, but demand had fallen drastically. Has anything changed in the last several months? The demand situation appears to have stabilized to some extent, with the Baltic Dry Index showing some increases from its lows. Unfortunately, many ordered ships are still on the way, as shipping companies loaded up on debt to order ships when times were good.

Value investors will often look to beaten down industries to find babies that have been thrown out with the bath water, and the shipping industry is certainly beaten down. Are there any gems to be found? Perhaps there are companies that didn't order a "boatload" of new ships, and therefore represent safe investments that can be had at a fraction of their long-term value?

To identify some companies that may be worth further investigation, consider the items that would be of interest to a value investor. First, the company should be conservatively capitalized, and therefore have a low D/E ratio. Secondly, the company should trade at an attractive level, preferably at a Price to Book ratio well below 1. Consider the chart below which shows the D/E and P/B ratios for some of the larger dry-bulk shippers:

The ones that look appealing at first glance are TBSI, ESEA and SBLK. Of course, this is only a first look at these companies, and digging much further into these companies would be necessary before making an investment. For example, this chart tells us nothing of the future commitments of these companies; if they have promised away large amounts of capital for new ships, the economic picture for these companies is not so bright (something we'll examine in a future post).

It's important to note that there are some other major differences between the companies that the chart doesn't recognize. For one thing, book value is an imperfect measure of a shipping company's fleet. The value of ships purchased will have changed depending on the type of ship and the time of purchase, and so fleets may not be comparable across companies on just their book values. Furthermore, some companies specialize in some commodities, and some companies operate in the spot market while other sign longer term contracts. Nevertheless, a screen such as this can be a good starting point in determining which companies are worth a closer look.

Disclosure: None


optionsnut said...

what about the local company ALC-T. Besides being thinly traded it seems more interesting (valuation wise) than many in this article.

Any reason why this company was omitted? One knock i had on the company was future grain shipping could go out of Churchill, but this seems to be a few years away.

any thoughts?

Anonymous said...

I looked at the shipping industry for some time, and had real hard time coming to an answer on intrinsic value. I founds that since shipping capacity is essentially a commodity, it doesn't matter if one market participant is judicious about bringing new capacity online (ie. buying new ships) if other market participants are not. I haven’t looked at the space for some time, but I recall there also being a significant capacity overhang (ie. Ships parked off the coast of Singapore).

If the industry is overcapacity, pricing will be affected for all market participants. If the industry is overcapacity, generally what you see is that freight routes get priced down to cash cost absorption (ie. fuel and headcount costs). Newer ships are generally cheaper and more efficient to run aren’t they? From a capacity utilization standpoint, the main driver is where on the cost curve you sit.

Now obviously, there are some other specific factors to consider. Companies that were smart with capex decisions will be in a better competitive position than companies with large upcoming cash liabilities and constrained balance sheets. There are also nuances around how rates get negotiated, locking in pricing, end markets that are serviced, etc.

Though the BDI is well off its lows, I don’t see how pricing improvement can be sustained until all excess capacity has come online (both from ships in dock as well as new ships being delivered) and is functioning at a relatively high utilization rate.

Again, I want to caveat that it has been some time that I really looked at the space, so I am certain that I am missing some important recent dynamics and would welcome any feedback.

Saj Karsan said...

Hi optionsnut,

I'm not familiar with the company, that's why it wasn't on the list. I just grabbed the list from Wikinvest's list of noted US dry shipping cos. I'll take a look at it and let you know if I find anything interesting.

Saj Karsan said...

Hi optionsnut,

It does look interesting, you're right. I am worried about exposure to those commodities and the commitments they have made to continue to expand their fleet along with the financing that will be required, however.

IDESS Maritime Centre said...

Good post! Hope to read even more great posts in the near future.