Shipping A Big Mess

By Stephen D. Simpson, CFA | November 27, 2011 AAA

This isn't the first time, nor likely the last, that I've written about the tough conditions in the shipping industry. A combination of high capacity, high fuel prices and inconsistent emerging market demand, has led to low rates and high operating costs and numerous struggling companies. With the recent bankruptcy of General Maritime (OTCBB: GMRRQ) and the warnings from Frontline (NYSE: FRO) management about its own potential liquidity difficulties, it seems pretty clear that the reckoning has come for many of these companies. (To know more about bankruptcy, read: An Overview Of Corporate Bankruptcy.)

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General Maritime Goes Down

General Maritime was not the first, nor will it likely be the last, shipping company to declare bankruptcy, during this downturn. There's not a lot that really needs to be said about this situation; the company had a great deal of debt, which is true for many shipping companies, and a dismal operating environment, which, again, is true for pretty much all shipping companies.

Ultimately the second-largest U.S. oil tanker owner had to bow to the inevitable, as oil tanker rates, outside of Very Large Crude Carrier rates which have recently bounced strongly, have been unsustainably low. General Maritime is not going away, though. The company has arranged financing for its reorganization process and it will apparently continue, as a going concern, and will likely return to the public markets once rates and market sentiment improves, as those debt holders will want an exit strategy.

Is Frontline Next?

As Frontline management highlighted in their recent earnings presentation, oil tanker rates have been sinking for two years. Things have gotten so bad in recent quarters, in fact, that rates have actually dropped below the operating cost levels for many shippers. To wit, for the trailing nine months, Frontline's operating revenues have only just barely covered its operating expenses, excluding impairments, and have left the company unable to make its interest payments from its operating earnings.

Not surprisingly, then, the company has had to issue a warning about its ability to comply with its debt covenants. With about $2.7 billion in debt, about a half-billion of net purchase commitments, and a negative net asset value based on current ship values, clearly this company has some challenges.

Unfortunately, there are no easy answers. VLCC rates nearly tripled their quarter-to-date averages, but still stand just below the company's estimation of cash breakeven. Worse still, the Suezmax and OBO rates aren't where they need to be either.

Still, management is not throwing in the towel yet. The company and Ship Finance (NYSE: SFL) terminated some contracts and the company has additional levers to pull, in terms of asset disposals, sale/leasebacks and equity offerings. Unfortunately, they're a weak seller selling into a depressed market and the company is likely going to incur some serious pain, in the course of avoiding bankruptcy.

Any Safe Harbor?

There's never a market so miserable that some investors won't approach in the search for value. To that end, Diana Shipping (NYSE: DSX) may be a good starting point - the company has a relatively clean balance sheet and has been doing fairly well, on an operating basis. Ship Finance, too, is well worth a look; although the company is ultimately vulnerable to prolonged shipping rate weakness, it has a different operating structure than most shipping companies.

Elsewhere, while Nordic American Tankers (NYSE: NAT) has slipped into the red, it at least has a clean balance sheet and a real focus on operating efficiency. Scorpio Tankers (Nasdaq: STNG) also has a relatively healthy balance sheet and while it is extremely risky to run an all-spot market fleet, the company does have low operating costs and low distillate inventories suggest higher spot rates, in the near future. Last and not least, Golar LNG (Nasdaq: GLNG) recently beat estimates, posted excellent fleet utilization and is actually considering reactivating more old ships.

Dry bulk shippers, like DryShips (Nasdaq: DRYS), Safe Bulkers (NYSE: SB) and Excel Maritime Carriers (NYSE: EXM), look more dangerous. There are a few apparent bargains here and there, such as Diana and Paragon (NYSE: PRGN) for instance, but rates are still pretty unappealing and the market is very worried about the state of China's appetite for raw materials, as the government tries to stave off inflation.

The Bottom Line

Right now shipping is a market only for the crazy-brave. There will be survivors and those survivors will live to see strong stock rebounds from these levels, but as the banks have proven over and over again, things can always get worse before getting better. Investors who feel that they must nibble in this territory may want to go with names like Ship Finance or SeaCube (NYSE: BOX), a container company, not a shipper, but there are no sure deals out there today. (For additional reading, check out: Turnaround Stocks: U-Turn To High Returns.)

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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