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GNK: Genco Shipping & Trading Ltd.

Recs

26

July 27, 2010 – Comments (12) | RELATED TICKERS: GNK

The original pitch can be found here

I originally intended for this to be a 5 minute quick pitch, but it ended up taking a few hours. 


Business:

Genco Shipping & Trading owns a fleet of drybulk ships consisting of various sizes. As of the last annual report, GNK’s fleet consisted of 9 Capesize, 8 Panamax, 4 Supramax, 6 Handymax, and 8 Handysize drybulk carriers for 35 total ships. The ships are mostly under time charter contracts of various lengths that expire in a laddered fashion. These 35 ships have a total capacity of 2.8M dwt (dead weight tons).

Many drybulk shippers have traded way below book value and have been considered potential value traps the entire time. There has been constant mention over the past few years of an oversupply of ships in the industry. Moreover, the BDI (Baltic Dry Index), which measures rates for drybulk shipping, is wildly volatile and goes up and down often, pumping up and dragging down the shipping stocks’ prices along with it. A decent strategy in 2009 was to rollercoaster shippers. I was in and out of ESEA, PRGN, and TBSI several times in 2009, most of the time for 5 to 15 percent gains.

I became interested in GNK after hearing that the BDI had slumped for 31 straight days. That slump went on for 4 more days, falling an absurd 35 days in a row. Shippers, whether good or bad, were dragged in the mud this entire time. The recent shipping slump has created an excellent entry point to buy a shipping stock. At the time of my CAPS green thumb, GNK was trading at 4 times trailing earnings, which is ridiculous for a profitable company making moves to make more money in the future.


Growth Strategy:

GNK operates a fleet of relatively new ships compared to the industry average. As of the 2009 annual report, its ships had an average age of 7.2 years, compared to the industry average of 15 years. Its oldest ship was built in 1997, making it 13 years old. It’s pretty nice to consider that GNK’s oldest ships are still younger than the average age for the industry. For reference, the average lifespan of a ship is expected to be 25 years. That can be lengthened or shortened based on maintenance and modernizing practices, I’m sure.

GNK has been acquiring new ships since its inception. Check out the growth of its fleet over the last 5 years:

2005: 17 ships
2006: 20 ships
2007: 27 ships
2008: 32 ships
2009: 35 ships
2010/2011: 53 ships

The acquisitions of new ships have, however, caused long-term debt to balloon. For the most part, companies seem to use financing and capital market offerings to acquire new ships. Currently, GNK’s long-term debt as of the Q1 2010 balance sheet was $1.264B. That debt is almost entirely due to a line of credit from 2007 used to acquire 9 Capesize vessels, which are pretty large vessels.

There is a plan in the works to acquire 18 more ships, 13 Supramax and 5 Handysize vessels. These ships will put the new capacity of the fleet at 3.8M dwt for about a 30% increase. The 13 Supramax vessels will be paid for using a combination of bank debt, senior note and equity offerings, and cash. I figure the 5 Handysize vessels will be paid for using bank debt and cash. 14 of the 18 new ships will be delivered in Q3 2010 and the rest will be delivered in 2011. The acquisitions should put the average age of the fleet at 6.2 years, down from 7.2 years. As far as industry oversupply goes, I don’t think GNK’s nice new ships will be vulnerable to being discontinued.


Earnings Discussion:

Here are the EPS numbers for 2005 through 2011:

2005: $2.90
2006: $2.51
2007: $4.06
2008: $2.84
2009: $4.73
2010 (19 analysts’ avg. prediction): $4.27
2011 (19 analysts’ avg. prediction): $2.87

As you can see, earnings have been positive and pretty strong for a sub-$20 stock. Before discussing the above numbers, let’s talk fleet utilization. As of 12/31/08, fleet utilization was 98.9%. As of 12/31/09, fleet utilization was 99.0%. As of 3/31/10, it was 99.6%. There are contracts set to expire from 2010 to 2012, but I’d say GNK is doing a rather fine job finding ways for its ships to make money. I’m not sure I expect such stellar utilization numbers going forward, but I believe it’s pretty safe to say GNK’s management is no slouch and utilization rates will not be falling off a cliff anytime soon. I’m sure it helps also that GNK’s ships are relatively new.

I find it curious that analysts are expecting earnings to plunge so much in 2011. I’ve looked up estimates on other shippers and almost every other shipper is expected to increase earnings from 2010 to 2011. I saw that the low estimate for GNK in 2011 is $0.54. Based on the fact that the fleet will have 50% more ships, 30% more capacity, and an impressive track record of achieving high fleet utilization, I find it hard to believe the $0.54 estimate. I personally believe GNK’s numbers should be more in the $3.00 to $4.00 range in 2011. If GNK can continue to grow and keep fleet utilization high, I believe it can achieve $5 or more in EPS within 5 years.


Financial Health:

GNK makes plenty of money and has increasing long-term debt. $37.5M of the $1.264B is due in 2010 as of the Q1 2010 report, with most of the rest of the debt due in 3+ years. The company shouldn’t have problems making debt repayments as necessary as long as it makes money, which I see continuing.

The dividend was cut as a result of a stipulation stemming from the 2007 credit facility that was used to purchase the 9 Capesize vessels. Certain financial criteria must be met before the dividend is reinstated. I’m guessing that once GNK is done purchasing ships at a rapid rate, it will start to make moves to pay down debt. Based on the size of its debt compared to its equity, I believe future dilutions may occur. Still, the P/E multiple assigned to GNK is alarmingly low and would still be acceptable even after a good amount of dilution.

Based on its relatively new fleet and strong earnings numbers, I believe GNK is looking okay going forward.


Risks:

There are contracts expiring from 2010 to 2012. Also, 18 new vessels are being acquired and only 6 of those have long-term contracts attached. There’s always a risk that fleet utilization will go down. Analysts certainly seem to be forecasting a drop in EPS from 2010 to 2011 for GNK but not for other shippers.

Debt levels are quite high. I wouldn’t be surprised to see a good bit of dilution in the future.

I’m not convinced of an all-out recovery anytime soon, so shipping rates could remain flat or even crash (even despite recent events). Management tries to reduce the impact of short-term fluctuations, but that’s not always possible.


Conclusion:

I’ve seen that the market is quite short-sighted and will often bid a stock to lofty levels based on one or two good years. Based on the current situation, I believe that a company earning over $4 TTM and still making major moves to grow should not be valued under $20. Its stock is mispriced in the short-term, likely caused by the 35 day slump in the BDI.

Longer term, an eventual recovery should see GNK exceeding the $4.73 EPS from 2009, especially with 30% more tonnage capacity in the future. If GNK can pull off $5 in full year earnings in 2012 or 2013 and the market assigns a multiple of only 7, that’s more than a double from current levels. Assigning a multiple of 7 to TTM earnings of $4.48 gives us a value of $31.36 per share.

Three to five years from now, I expect a better economy than we have right now. I expect EPS to exceed $5 at that time. If people are more bullish then, a P/E multiple of 10 would see a price of $50 for GNK. That’s not unfathomable considering the high of $84.51 in May 2008 (more than 29 times 2008 earnings). I know that was during the commodity boom, but I’m only asking for a multiple of 10 instead of 29, which I believe is quite reasonable. A multiple of 12-15 is still not unthinkable and would put it in line for considerably more than a triple from the current level.

I believe GNK is both a solid short-term and long-term play. Both profitable and unprofitable drybulk shippers have been slammed with the recent slump in the BDI. I expect a short-term bounce of 20% to 50% and a possible triple or more within 5 years. Management has done a good job with fleet utilization, achieving almost 100% as of Q1 2010. The growth is quite aggressive, but I believe the acquisitions will contribute nicely to future earnings as long as the debt level is contained.


Disclosure: Long GNK

12 Comments – Post Your Own

#1) On July 27, 2010 at 11:43 AM, TigerPack1 (97.90) wrote:

GNK is my top pick in the international shipping group, from a risk-adjusted basis, considering the management team, balance sheet and valuation metrics.

I do, however, expect it to remain quite volatile in terms of stock price moves the next 6-12 months, as the economy slows and a real oversupply of ships wreaks havoc with shipping rates.

I would not be a surprised by a dive into the US$10-$12 range between now and the end of the year.  Eventually in 3-5 years, I expect the stock price to be well above $30 a share or nearly double the $17 price today.  Mathematically, if you can pick up shares closer to $10 each, your long-term upside, and percentage gains will be even higher!

-TigerPack

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#2) On July 27, 2010 at 2:27 PM, outoffocus (22.83) wrote:

In honor of your recent Top Fool pitch. 

All Glory to the HypnoToad

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#3) On July 27, 2010 at 2:29 PM, TMFUltraLong (99.95) wrote:

You won't catch me touching shipping with a twenty foot pole but good luck!

UltraLong

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#4) On July 27, 2010 at 6:49 PM, JakilaTheHun (99.94) wrote:

I like shipping, too.  GNK is one of my picks in that sector.  TBSI is probably my favorite.

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#5) On July 27, 2010 at 6:51 PM, MegaEurope (21.45) wrote:

Any thought on EXM babo?  I think they might edge out the others as the cheapest - perhaps correspondingly higher risk though.  Analysts expect earnings to collapse starting this quarter.

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#6) On July 27, 2010 at 10:51 PM, TMFBabo (100.00) wrote:

@TigerPack: I'm not ruling out a drop to $10 because we saw $9 in March 2009 and lower in 2008, but I don't think it's guaranteed.  I've decided in RL to jump in while I like the recent price, the lowest since March 2009 levels.

@outoffocus:
TV Announcer: "We now join America's most popular show already in progress: Everybody Loves Hypnotoad."
Fry: "The show has been going downhill since season 3."

@UltraLong: Not a bad idea, but it's hard to stay away every 3-6 months when drybulk shippers' prices crash again.  For what it's worth, I'm pretty bearish on many shippers because of aging fleets and time charter contract uncertainty going forward.  I find DSX and GNK to be intriguing plays even long-term, however.

@JakilaTheHun: I saw on TBSI's Q4 2009 earnings call transcript that TBSI's average fleet age is 23 years.  Considering GNK's discussion of 25 being the expected lifecycle out of its own ships, that number scares me a bit.  Sure, better maintenance practices and more modernization can get more useful life out of these ships, but that's quite capital intensive.

The other long-term shipping play I'm considering is DSX, with low debt and an even newer fleet than GNK.  DSX only has Capesize and Panamax vessels, however, while GNK has pretty nice fleet diversification.

@MegaEurope: EXM has impressive current and past earnings, but I think I prefer GNK for the newer fleet and more balanced fleet diversification (which helps fleet utilization).  EXM has more of its fleet exposed to the spot market (I think) and more time charter contracts expiring this year.  I will say, though, that it has a larger fleet than GNK and more impressive current earnings (which will be less impressive if it drops).

Some of EXM's Panamax ships are starting to get a bit old and 3 of its 5 Handymax ships are at 22+ years of age.  Its new vessels being built are all Capesize, which are already pretty new compared to its other ships.  I think maybe they should've started building Handymax ships to replace the 22+ year ones, or some Supramax ships (they only own two of these).

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#7) On July 27, 2010 at 11:07 PM, TMFBabo (100.00) wrote:

Regarding the oversupply of ships, I regard that to be a similar position as the steel mills of the world.  Steel mills are massively underutilized as well.  Many blast furnaces in the US are currently idled, with capacity utilization rates well below the "norm" for many companies.  I'm sure there's a similar story in the rest of the world. 

Still, I'm guessing there are more new mills being built each month.  Since all this capacity can't possibly survive, the older mills must either invest tons of money to survive and compete.  In the process, the weakest will surely die off.  I think it's not that different with shipping.  

As far as shippers go, I still like DSX and GNK with their new fleets.  I only like GNK more because I think DSX is trading at a higher premium because it's obviously the safe play in the drybulk industry.

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#8) On July 27, 2010 at 11:09 PM, TMFBabo (100.00) wrote:

Oops, I originally had "older mills must either invest tons of money to survive or die off" but I forgot to remove "either" when I changed the rest of the sentence. 

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#9) On July 27, 2010 at 11:38 PM, dgoldenz (26.40) wrote:

In for a real life pick at $17.10, don't fail me now!  Thanks for the write-up.

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#10) On July 28, 2010 at 2:14 PM, CPACAPitalist (63.22) wrote:

Got in at $15.55 and think i'll stick around for a while.  Nice write up.  Let me know when you catch wind of the Slurm IPO.

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#11) On July 30, 2010 at 10:49 AM, bricks79 (54.46) wrote:

You want to wait up to five ears for a non-dividend paying stock in a slow growth economy? Maybe it works, but it's a long shot.

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#12) On July 30, 2010 at 11:58 AM, TMFBabo (100.00) wrote:

@dgoldenz: You're welcome.

@CPACAPitalist: Thanks.   

Fry: Outlaw slurm? Don't listen to grandpa! He's crazy!
Farnsworth: I'm not your grandpa, you're my uncle from the year 2000!
Agency Guy: Ooookay grandpa, we'll fix your worm problem.

@bricks79: I respect quality dividend payers (PG is my biggest holding), but I don't think that's the only "correct" way to invest in the market.  Even in slow-growth times, there will be opportunities that crop up from time to time.  I'll be dead wrong on some of them, but that doesn't mean I'm going to stop looking.

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