GENCO SHIPPING & TRADING GNK S
May 26, 2011 - 7:09pm EST by
bafana901
2011 2012
Price: 7.09 EPS $90.00 $77.00
Shares Out. (in M): 36 P/E 7.9x 9.2x
Market Cap (in $M): 260 P/FCF 0.0x 0.0x
Net Debt (in $M): 1,394 EBIT 0 0
TEV ($): 1,654 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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Description

 
There are five reasons I am recommending Genco Shipping (GNK) as a short.
 
1) A wall of new buildings is about to hit the capesize and panamax fleets in 2011 and 2012.
2) The first of 36 Chinamaxes has just been delivered. These ships, owned by strategic players, are expected to disrupt business for traditional ship owners on the important Brazil China iron ore route.
3) GNK's 2h2011 earnings will be hurt as a results of a large portion of GNK's fleet rolling off high earning time charters into a depressed spot market.
4) GNK is highly geared and is in danger of breaching more debt covenants.
5) Finally, GNK trades at a premium to it's npv and my dcf models show that it is easily the most expensive drybulk shipping company listed in the US.
 
 
 
 
BRIEF DESCRIPTION
 
 
GNK's in-the-water fleet consists of 9 capesizes, 8 panamaxes, 17 supramaxes, 6 handymaxes and 10 handysizes. In addition, three handysizes are expected to be delivered in Q2 2011.
 
GNK also owns 25% of Baltic Trading Limited (BALT US) and 16.3mil shares in Jinhui Shipping (JIN.NO) listed in Oslo. GNK's share in BALT is worth $35mil and $50mil for JIN.NO. 
 
 
 
 
ENTERPRISE VALUE
 
 
I have adjusted the traditional EV for BALT and JIN.NO as well as for the $90mil that will be paid upon the delivery of the 3 handysize ships.
 
 
Price                              $7.20
No Shares                       35.95
Mrkt Cap                  $    259mil
Cash                         ($   282mil)
Debt                           $1 671mil
EV                             $1 648mil
Debt(acquisitions)     $      60mil 
Cash(acquisitions)    $      30mil 
BALT                        ($      35mil)
JIN.NO                     ($      50mil)
EV                            $1 653mil
 
(Net Debt = $1 394mil)
 
 
Looking at the second hand values of the fleet is the first indicator that GNK is overvalued. The second hand values are a good proxy of GNK's value as a large portion of the fleet is currently trading on the spot market. Also, many high earning time charters end in 2011. This means that the adjustment to second hand values for "above/below market charters" will be limited.
 
 

Second Hand Prices

 
 
                   NoShips      AveAge             Price              Value 
Capesize          9                    3                   $46mil           $414mil
Panamax          8                  10                   $28mil           $  224mil
Supermax       17                    3                   $28mil           $  476mil
Handymax        6                  13                   $22mil           $ 132mil
Handysize      10                  13                   $19mil           $  247mil
                                                                   Value            $1 493mil
 
 
Subtracting net debt of $1 394mil from the $1 493mil estimated value of the asset implies a market cap of $99mil or $2.75 per share. (Current Price = $7.20)
                                                                                                                                                       
While it is difficult to argue with the second hand values of the fleet the imminent launch of the chinamaxes and the the well publisized over supply of capesizes will put further pressure on the earnings power and values of capesize and panamax fleet. GNK is the most vulnerable to these forces as unlike the other listed dry bulk shippers GNK has not fixed long term time charters for their capesize and panamax fleet.
 
 

GNK's EMPLOYMENT PROFILE

 
In this write-up I am only going to focus on GNK's employment profile for the capesize and panamax ships as this is where GNK is the most vulnerable. For the smaller ships I have asumed that the current level of earnings is maintainable. 
 

Capesize Fleet

Of the 9 capesizes 3 are currently trading on the spot market where capesize rates on certain routes are as low as $6000 a day. With cash operating costs close to $6000 a day times are tough for capesizes in the spot market.
 
In June 2011 a time charter of $36 000 a day ends for one of GNK's capesizes and in September 2011 another 3 capesizes earning on average $36 000 a day roll off their time charters. This means only 2 of the 9 capesizes will be on time charters in Q42011. Luckily these two ships are earning $59 000 a day until Q32012.
 
The bottom line to the expiration of the four 2011 time charters is that the revenue stream from the capsize fleet will fall from $26mil in Q12011 to $16mil in Q42011 and EBITDA will fall from $21mil to $11mil assuming charter rates remain at the current depressed levels.
 
 
Panamax Fleet
 
Of the 8 panamaxes only 2 are trading on time charters. A $55 000 time charter on one of the vessels ends in June 2011 leaving only one panamax on time charter of $53 000 per day. Current panamax spot rates are actually above capsize rates at $11 000 per day. With daily running costs also averaging $6 000 revenues fall from $16mil in Q12011 to $12mil in Q42011 and EBITDA falls from $11mil to $7mil.
 
 
Effect on Total EBITDA
 
The Q12011 income statement (excluding BALT) is shown below
(Note that BALT, which made a loss gets consolidated by GNK.)
 
Revenue                                                $91.7mil
Vessel Operating Expenses                   $ 20.9mil
Admin Expense                                      $   7.1mil
EBITDA                                                   $ 63.7mil
Depreciation                                          $ 29.5mil
EBIT                                                       $ 34.3mil
Interest Expenses                                 $ 19.1mil
PBT                                                        $ 15.2mil
 
EPS                                                           42c
 
Assuming spot rates remain at current levels the rolling-off of high earning time charters could see GNK's EBITDA fall to $50mil in Q42011 and EPS to 14c.
 
As stated above the decline in earnings assumes that spot rates will remain weak until Q42011. As I will describe below the prospects for these fleets are bleak and it is difficult to forecast any recovery in capesize and panamax shipping rates.
 
 

CAPESIZES SUPPLY

 
Capesizes are on average 180 000dwt. 80% of their cargo is long haul iron ore and the remaining 20% coal. The main iron ore routes are
  • Brazil to China and Europe
  • Australia to China and Europe
 
Although the over-supply of capesizes is well known what is less well publisized is the arrival of the chinamax.
 

The Chinamax (400 dwt)

 
Before the GFC Vale, the biggest exporter of iron ore, were selling iron ore for $60 per ton and paying the drybulk shipping companies $60 a ton to ship the coal from Brazil to China. Feeling ripped off and to quash Australia's competitive advantage from a shorter shipping distance Vale decided to buy their own fleet of ships.
 
 
To benefit from economies of scale and to lower the volatility of their iron ore price Vale placed a $2.5bil order with a Chinese and a Korean shipyard for 19 Chinamaxes in 2008. At 400 000dwt these will be the largest dry bulk vessels and will be delivered between 2011 and 2012. Vale has just received the first chinamax (Vale Brazil) and it's about to take it's maiden voyage from Brazil to China. (Use this link to track the voyage http://www.marinetraffic.com/ais/default.aspx?mmsi=564905000&centerx=-44.37971&centery=-2.5677&zoom=10&type_color=7)
 
 
The Vale order ignited interest in this new category of ships known as VLOC's and today there are currently 104 VLOC's (>230 000dwt) on order (30mil dwt) of which 36 are chinamaxes. The expected delivery schedule is
  • 2011 38 ships (11.9mil dwt)
  • 2012 35 ships (11.0mildwt)
  • 2013 19ships (6.3mil dwt)
  • 2014 12ships (3.7mil dwt) 
 
Estimates are that the 36 chinamaxes alone can displace 150 capesizes which will hurt the economics of the capesize fleet. More bad news is that the acquisition of a fleet by Vale and other strategic players obviously marginalizes independent ship owners such as GNK.
 

The Capesize Fleet

 
In addition to the threat of VLOC's disrupting traditional long haul capesizes routes, capesizes face challenges from a large order book. The order book consist of 566 ships to be delivered over 4 years. This is just over 50% of the current fleet of 1 116 ships (191mil dwt).
 
The expected delivery schedule is
  • 2011   286 ships (49mil dwt) (44 already delivered)
  • 2012   199 ships (35mil dwt)
  • 2013     69 ships (12mil dwt)
  • 2014     12 ships (2mil dwt)
 
Optimists are banking on two safety valves that they believe will limit the expected growth in the fleet.
 
Slippage: In 2009 there were only 112 actual deliveries out of 181 expected (62%). For 2010, 214 (68%) of the expected 313 capesizes were delivered. If these delivery trends persist the order book shrinks to 366 capesizes.
 
Scrapping: Only 20 capesizes were scrapped in 2010. The low scrapping rate is because the capesize fleet is fairly young with only 156 ships (14% of fleet ) over 20 years old.
 
Assuming slippage of 30% and scrapping of 40 ships per annum implies that the capesize fleet will grow by 160 ships in 2011 (14%) and by 100 (9%) ships in 2012.
 
If one adds in the VLOC's, where there is no evidence of slippage, the combined fleet grows by 38mil dwt (20%) in 2011 and by 29mil dwt (15%) in 2012. There is no chance that demand (expected to grow at 7%) will plug this gap and with stats like this it is not difficult to predict trying times towards the end of 2011 when the full force of the new supply hits the market.
 
 

PANAMAX FLEET SUPPLY

 
I don't want to spend as much time on the panamax fleet as the economic threat to GNK's is not as severe. As was pointed out above current  spot charter rates for panamaxes are above capesize rates ($11 000 vs $8000) because their smaller size (75 000dwt) allows them to enter more ports which means that their routes and cargos are more diverse.
 
 
I also don't expect panamax rates to recover for the following reasons
  • The over supply of capesizes will put pressure on panamax rates.
  • The order book (870 ships) is close to 50% of the 2010 fleet (1 826ships)
  • Similar to the capesize fleet expected deliveries are front end loaded with the majority delivering in 2011 (360 ships) and 2012 (383 ships). Simplistically, without adjusting for slippage and scrapping, the 2010 panamax fleet is expected to grow by 40% over the next two years.
  • Panamax slippage is a little higher with an average of 60% of the order book being delivered in 2009 and 2010. (2009: 86 ships, 2010: 186)
  • Scrap rates may be a little higher than capesize rates as 22% of the fleet are over 20 years old.
 
The above supply fundamentals indicate that the supply of panamxes over the next 2 years is going to swamp the demand which also makes a sustained recovery in panamax rates unlikely.
 
 

GNK DEBT AND COVENANTS

 
Net debt after paying for the 3 handysizes on order is about $1 400mil.
 
The banks have already waived their maintenance covenants requiring GNK to pledge vessels with a value of at least 130% of current borrowings. In return GNK have had to suspend the dividend and agree to an accelerated repayment schedule.
 
The repayment schedule for the next five years is as follows:
  • 2011 $ 53mil
  • 2012 $180mil
  • 2013 $216mil
  • 2014 $216mil
  • 2015 $216mil
 
To meet the 2012 repayment GNK will have to generate EBITDA of $316mil per annum or $65mil per quarter. If shipping rates remian at these levels GNK will struggle to meet this payment.
The maximum leverage covenant which limits the ratio of net debt to EBITDA to a maximum of 5.5 to 1 is still in place . With net debt of $1 400mil this requires GNK to generate EBITDA of at least $254mil per annum or $63mil per quarter. Q12011 EBITDA was $63mil and given the expected roll-off of time charters it seems likely that this covenant will be breached if shipping rates remain at current levels.
 
I must emphasise that GNK does have some wriggle room as JIN.NO is "available for sale".
 
 
 
 
GNK IS OVERVALUED
 
Below is a sample of US listed shipping companies with a significant exposure to the capesize sector.
 
               DWT(Capesize)          DWT(Total)          %Capesize       Premium to NPV
SBLK        1.2mil                          1.6mil                      75%                    1%
OCNF       1.7mil                           1.9mil                      90%                  -9%
DSX          1.8mil                           3.0mil                      60%                 -28%
NMM        1.1mil                           1.8mil                      60%                   52%
SHP           0.6mil                           1.3mil                      50%                   48%
GNK          1.6ml                            3.8mil                      42%                   77%
 
The "Premium to NPV" column compares the NPV per DCF models to the EV of the companies. Using current one year time charter rates
(capesize=$18000, panamx=$16000) the DCF model shows that GNK is the most overvalued shipper in the sample trading at a 77% premium to it's EV. The model also shows that to justify the current valuation GNK would need to earn $30 000 a day on their capesize and panamax fleet.
One reason for the premium could be that the market is valuing GNK as a call option betting that shipping rates will rise. This is effectively the bet that managment have been communicating. It seems they have been reluctant to fix ships at these levels as they expect higher rates in the 2H2012 which can used to lock in rates.
 
The high exposure to the spot market is confusing as historically GNK communicated that there strategy was to fix a large portion of the revenue stream in the time charter market. I am not sure what happened to the strategy and have been surprised that managment have left many ships whose charters finsished in 2009 and 2010 in the spot market even though attractive charters were available.
 
While management continue to be on a recovery I cant see this as supply will easily swamp demand in 2011 and 2012. Sure I may be wrong, but, given the large level of debt and prior issues with the debt covenants it seems reckless for management to be taking on so much operational risk in addition to the high level of financial risk.
 
 

CONCLUSION

Bloomberg reports that 141 capesizes are currently on anchor (http://www.bloomberg.com/news/2011-05-23/u-s-commodities-day-ahead-copper-drops-on-china-manufacturing.html) and with the chinamaxes starting to deliver the odds are that GNK's high risk bet and stock price are about to be tested. GNK should be a good short because my models show it is overvalued and the most vulnerable to a weak charter market. It also runs the risk of breaching it's debt covenants.
 
A word of caution. Capesize rates have moved by more then 8% in 11 of the last 21 weeks so I expect this to be a rocky ride. For those who want to eliminate some of the volatility I suggest going long DSX which is trading at a discount to it's npv. In addition, DSX has no debt.
 

Catalyst

- The growth in the capesize and panamax fleet in 2011 and 2012
- The delivery of capesizes
- The roll-off of high earning charters
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