Shippers are Sinking

The transportation sector may be entering another period of consolidation and bankruptcy restructuring. The airlines did it shortly after the aftermath of the 2008 financial crisis. Freight shipping companies could be next.

“Genco Shipping & Trading moves forward with previously announced restructuring support agreement,” reads Genco’s (NYSE: GNK) press release issued yesterday.

Awash with debt and hemorrhaging money since 2012, Genco may well be the first major bulk dry goods shipper to succumb to the tempest that has been ravaging commodity producers and shippers since the commodity bubble burst at the end of 2011.

Does this bode an ominous warning of other bankruptcies to come in the international shipping sector?

The Sinking of Genco

“Genco Shipping & Trading Limited [yesterday] announced that… it and certain of its subsidiaries have filed voluntary Chapter 11 petitions to implement a prepackaged financial restructuring that is expected to reduce the Company’s total debt by approximately $1.2 billion and enhance its financial flexibility,” the company’s press release summarized.

Yet the company is not a total write-off. It will “continue normal operations” and will “continue to support its employees, customers and vendors during the financial restructuring process”.

All it needs is a little help to clear out some debt. With a market cap of just $74.07 million and total debt of $1.61 billion, the company posted a net loss of $145 million in 2012 and another loss of $148 million in 2013 – nearly double its current market cap each year. As such, Genco reported a profit margin of negative 64.95 percent, an operating margin of negative 29.47 percent, a return on assets of negative 1.44 percent, and a return on equity of negative 12.22 percent. Its debt is a crippling 707 percent of its latest revenues.

The deal with creditors allows for the following key provisions:

• Converting $1.1 billion of a 2007 secured credit facility into “81.1 percent of the equity of the reorganized company”,

• Replacing another $353 million in obligations with “new senior facilities with extended maturity dates through August 2019”, and

• “The cancellation of all equity interests in the Company, with such equity interests receiving seven year warrants for 6.0 percent of the New Genco Equity struck at a $1.295 billion equity valuation”. Not much gain is expected for common shareholders, as the last price of $1.70 per share is some 8 percent of book value.

What broadsided Genco’s business was another one of those perfect storms of falling prices and rising costs.

As for costs, Wikinvest explains that “drybulk commodity transportation is a capital-intensive business; ships are expensive and the payback period can be lengthy”. Moreover, fuel prices have been on the rise for years, with crude oil up more than 100 percent from the $50 area at the end of the 2008-09 financial crisis to over $100 per barrel today – about where they were in 2007 before the crisis.

Meanwhile, shipping prices as gauged by the Baltic Exchange Dry Index tracking global ocean shipping rates are still at their post-crisis lows, and at just 20 percent of their 2007 pre-crisis levels, as noted in the graph below.

Source: InvestmentTools.com

The demand for dry bulk shipping is completely dependant upon global economic expansion which consumes materials, ores, and grains, driving freight prices up and keeping shippers in business. It was inevitable, then, that a global economic slowdown would strike shippers more severely, especially as the world’s largest consumer of dry goods – China – is still slowing. Wikinvest goes so far as to say that “the health of the dry bulk shipping industry, and all companies within it, are tied to the health of China’s economy”.

With China’s productivity expected to remain on the decline for at least another year or more, the dry goods shipping industry may be in for a period of consolidation and restructuring similar to what the producers of metals and other commodities experienced in 2012. One way or another, debt must be written off, with Genco perhaps being the first of a long procession into bankruptcy courts.

Prominent Shippers in the Same Boat

Genco is not the only shipping giant being ravaged by the relentless global economic tempest, with at least three others listing dangerously toward unprofitability themselves.

• Dryships Inc (NASDAQ: DRYS) – One of Genco’s largest competitors, this $1.38 billion small cap reported at least 3 consecutive years of losses of $74.5 million in 2011, $246.7 million in 2012, and $223.1 million in 2013. The company’s recent profit margin is negative 14.95 percent, with a return on equity of negative 5.14 percent. Its total debt of $5.64 billion is 378 percent of its revenues.

DryShips charters its 40 vessels to other companies that pay a contracted daily rate on shorter-term contracts based on spot freight prices. This gives the company greater exposure to rising and falling cargo prices which should benefit the company when the global recovery finally picks up, lifting freight prices.

• Diana Shipping Inc. (NYSE: DSX) – This $971 million small cap’s profits have been on the decline as well, reporting a profit of $107 million in 2011, a profit of $54.6 million in 2012, and a loss of $21.2 million in 2013. It too is taking on water with a profit margin of negative 12.89 percent, an operating profit of negative 5.68 percent, a return on assets of negative 0.34 percent and a return on equity of negative 1.68 percent. It’s total debt of $431 million, however, is a much better proportioned 263 percent of revenues, though still quite high.

Diana also charters its 23 vessels to other companies, but on two to five year contracts, forgoing revenue growth if freight prices rise for the duration of the terms. Another hindrance to profit is the company’s practice of replacing old ships by commissioning new ones, instead of purchasing existing ships – a strategy which Wikivest believes will “become prohibitively expensive as steel prices continue their rapid ascent”.

• Eagle Bulk Shipping, Inc. (NASDAQ: EGLE) – A micro cap of $62 million, this shipper has likewise been crippled by the global slowdown in commodity consumption, posting three consecutive losses of $14.8 million, $102.8 million, and $70.5 million from 2011-13. With a profit margin of negative 34.84 percent and a return on equity of negative 12.53 percent, the company will likely be unable to support its $1.17 billion debt measuring 578 percent of revenues. Look for a possible restructuring here too.

Eagle charters its vessels to other companies on short-term one to three year contracts, a shorter lock on prices which will allow it to benefit from rising prices more quickly than some of its competitors. Part of the cause of the company’s high debt is the commissioning of several new ships. Fortunately these were ordered before materials prices began rising.

• Navios Maritime Holdings Inc. (NYSE: NM) – The best performing stock of those listed here, this $894 million small cap stands out as the only solid profit generator, posting at least three consecutive profits of $145.7 million, $40.8 million, and $175.4 million from 2011-13. Yet, it too has a negative profit margin of 21.29 percent and a negative return on equity of 8.38 percent. Even so, the company’s $1.49 billion debt is only 291 percent of its revenue, one of the lowest proportions in the space.

A comparison of these four shippers to the bankruptcy-protected Genco in the graph below shows how Navios (yellow) is the only one to outperform the broader S&P 500 (black) over the past five years. Yet Navios only recently surged above the S&P since the middle of last year.

Source: BigCharts.com

Investors May Want to Abandon Ship

With fuel and shipbuilding costs still elevated, and shipping prices still depressed, it is doubtful shipping companies can weather the global recession without requiring protection similar to Genco.

The industry has been commissioning new ships in earnest in preparation for the global recovery, which will undoubtedly come at some point in time. But as Wikivest explains, “expecting an oversupply of ships in the next two to four years, rates for new long term contracts have begun to fall. The question for the future is whether [prices] continue along their descent, or whether unexpected growth in Asia will shore up slack demand and cause prices to reverse.”

It all hinges on the outlook for China, by far the world’s largest single consumer of bulk materials, which the dry shippers rely upon so heavily. Since recent economic reports out of China point to a continuing slowdown, dry goods shippers ought to drop anchor and do their best to weather the storm.

Investors holding these and related stocks may enjoy a sizable jump in value once global shipping picks up. But in the meantime, you may want to abandon these ships, as there are better alternatives that are delivering profit even now.

Joseph Cafariello