Shares of marine shipping and small-cap energy services stocks have been hammered over the past week for reasons that have more to do with profit-taking than anything fundamental.
Of course, when your stocks go down in value you sometimes don't really care if it's due to something wrong with the business or the fact that recent momentum traders are exiting. It all feels the same.
No one has a perfect view of the future, but it sure looks to me like this is a great opportunity to pick up shares of leading dry-bulk shippers like
Genco Shipping & Trading
while they endure this rough spot.
Let me give you a quick update on the marine shippers, and then introduce
( OKN), a risky but promising new name that even longtime followers of the group may not know about.
Whenever stocks have violent shakeouts while perched materially above long-term support, as these have, they become very vulnerable to panicked selling by momentum traders who know nothing about their business. But ultimately investors with more knowledge about the real worth of the companies step up and support the stocks by taking advantage of substantial dips, and that is what should happen in this case.
According to analysts at Jefferies and Cantor Fitzgerald, the spot charter rates of Capesize dry-bulk ships fell last week as the amount of space available on ships grew. The supply increased because Chinese steel makers have begun to draw down their iron ore inventories rather than bring in more supply while they initiate annual negotiations with miners over 2008 prices.
Jefferies and Cantor both believe that charter pricing will get back on track and move higher again once the negotiations mature, as the Chinese cannot pull down their inventories very long.
Lazard Capital Markets analyst Urs Dur told me Monday afternoon that the volatility at this time of year might be news for new investors in the group, but anyone who has been around dry-bulk shipping for a few years knows that this type of gamesmanship on pricing, both by Chinese buyers and the Chinese media, is typical and not indicative of deals that will ultimately be struck. Dur noted that the Chinese ore buyers whined about pricing last year but acquiesced in the end.
The key is to watch not what the Chinese are doing, but what the actual charterers of ships are doing. He said that the iron ore miners like
of Australia are trying to lock in charters at today's prices for three to five years. Given that charter rates are now at their highest point in history, when you see smart cargo owners are willing to pay a lot for a long time it tells you that they think rates will be higher next year.
To put a number on it, Dur said that in 2007 through last week, ore shippers finalized 451 charters of over one year in length. In all of 2006 the number was 246, and in 2005, the number was 176. "Companies with major mining commitments need capacity to move their cargoes to a very hungry China," said Dur. "China saying that they are going to stop consuming iron ore is like America saying that they are going to stop consuming McDonald's hamburgers."
Not gonna happen, in other words.
So demand for dry-bulk ships isn't deteriorating, so don't get spooked out of the industry. All the stocks in the group are buys, though my favorite is Genco due to its superior management, youthful fleet, long-term focus and charter coverage through much of next year.
Genco and Diana have gone up fourfold and sevenfold since 2005 as the cost of shipping raw materials across the world's oceans has barreled steadily higher. The average price of chartering a big freighter to carry raw materials from Brazil to China has nearly tripled to $180,000 a day from $65,000 a year ago.
In many cases, the cost of ocean shipping is pricier than the cargo itself. Iron ore costs about $60 a ton, but its shippers charge $88 per ton to ship it across the Pacific. Likewise, coal runs about $45 a ton but Europeans are willing to bring it in from the United States for $48 per ton.
Even though shipping rates are on the rise, a lot of the dry-bulk shipping companies are still cheap as they sport low
price-to-earnings ratios, like cyclical stocks in midcycle. The peak of the cycle is likely a year away because there just aren't enough new ships coming into play to change the profit dynamics of this business.
The Baltic Exchange Dry Index, the key indicator of freight rates for commodities like coal, iron ore and grains, hiccupped last week a touch but has still advanced 170% in the past year.
The Wall Street Journal
noted in a recent article that shippers and commodity merchants "are braced for higher rates" next year and possibly through 2009, as shipyards are not able to build enough new freighters to relieve the shortage until around 2010. Keep in mind that there was little investment in this business for decades, so you don't just snap your fingers and produce a new fleet of boats.
So in this context, now let me tell you about Oceanaut, which is sort of a spin-off of industry titan
. In a phone interview from Athens, Christopher Georgakis, who is chairman of both firms, told me that back in 2006, before investors had discovered the supply/demand imbalance of the industry, he and his team were looking at ways to diversify Excel into other parts of the dry-bulk industry and take advantage of the potential for longer charter rates.
They didn't want to sell EXM shares to buy more boats because they believed that their stock was severely undervalued, but they also did not want to unbalance the company's capital structure by taking on long-term debt. Instead, they came up with the idea of starting a "blank check" company, which is an unusual but totally legitimate method for starting a new U.S.-listed public company: You sell shares of a separate entity with the stipulation that you must use the proceeds to invest in something within 18 months.
To do this, Excel created Oceanaut, which had its IPO in March 2007 and raised enough money to buy a fleet. It took a while to figure out how to put the money to work, but two weeks ago the company announced that it would buy a $700 million fleet of nine vessels -- five new-builds and four relatively young secondhand ships -- from companies associated with the Restis family, a private ship-owning clan based in Athens. Excel is the "sponsor" of Oceanaut and will retain 16% of the shares. The Restis family took 10.3 million Oceanaut shares as part of its compensation for the ships, so they will own 30% of the company when the deal is consummated.
The Restis family is also involved in another, smaller public dry-bulk firm called
, whose shares have tripled this year.
The Oceanaut fleet will consist of two Capesize, four Panamax and three Supramax dry-bulk carriers. The larger two types of ships will carry so-called "major bulks," or coal, iron ore and grains, while the smaller Supramaxes will carry the "minor bulks," or aluminum, fertilizer, sugar and scrap metals.
Two of the Supramax ships are due for delivery next year, while the third Supramax and the two Capesize ships are due to be delivered in 2009. This is a nice variety of ships, which will allow Oceanaut to take a wide variety of commodity assignments.
Georgakis said the thinking behind Oceanaut was to diversify away from EXM's dependence on the spot market by putting the nine new ships out on medium- and long-term charters of two to five years, maximizing visibility on the cash flow and ultimately paying a
dividend. Georgakis said that he would also opportunistically buy more ships, permitting shareholders to enjoy the best of both worlds -- dividend yield and capital appreciation.
Georgakis said that he will announce charters for Oceanaut's ships in the next month, so we'll soon get a better view of the company's profitability. The new Capesize ships due in 2009 will not get rates that are comparable with current levels because you have to make concessions on price in order to book them forward. "We have been wise, I think, to lock in the benefit of what we think are very good rates for the vessels," he said, apologizing for what will be perceived as a discount.
So, how will Excel and Oceanaut differ?
Excel has a 17-vessel fleet with an average age of 14 years and pays a modest dividend. Oceanaut will start with a smaller fleet with an average age of seven years and will pay a larger dividend. Oceanaut's technical management will be handled by a unit of EXM, while its chartering assignments will be handled by a unit related to the Restis family.
Once the company is under way, Georgakis said that he will resign from his role as chief executive of Oceanaut and help the company's board hire a new management team, while retaining a 1% share of the firm.
In conclusion, I think that marine shipping will maintain its cost edge over other forms of transportation and even improve, as iron ore and coal shipments to China and India increase. I also believe that the industry will not be oversupplied with new boats until 2009, so that makes Oceanaut a good if risky buy right here.
I realize that there's not a lot more to go on other than a bet that Christopher Georgakis and the Restis family can build another successful dry-bulk freighter company from scratch, but it's a bet worth taking if you're into this sort of thing. After the new charters are announced I will provide a price target, but figure it will be over $12.50.
At the time of publication, Markman was long GNK, DRYS and PRGN, although positions may change at any time.
Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. He also writes a regular column for
MSN Money. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback;
to send him an email.