Description

Summary

The latest downturn in shipping rates and investors’ well-earned hatred of shipping stocks has pushed Genco Shipping & Trading (GNK) down to a cheap price. The company performed well in 2017-18 but isn’t getting much credit from investors concerned about the current macro environment. Genco is in no financial distress and has a relatively solid balance sheet. The stock trades at less than 6x TEV / adj. EBITDA and 50% of its NAV. My 12-month price target of $15 implies 75% upside from the current price of about $8.50. This stock traded at $20 as recently as last June.

Profile

Genco Shipping & Trading (GNK) transports drybulk commodities (including coal, iron ore, steel, and soybeans) worldwide on its fleet of 58 vessels of all sizes. Genco operates 26 ships on contracted time charters, 30 ships on spot market basis, two on spot market related time charters, and time charters six third-party vessels. Genco has been actively selling older vessels and buying new ones to reduce the age of its fleet and improve efficiency. Genco has also changed its business model from a pooling and time charter business to more active management of its fleet.

History

Genco, like so many other shipping companies, has gone through its share of distress. The company was founded in 2004 by well-known New York shipping executive Peter Georgiopoulos. Genco performed well at first as shipping rates skyrocketed on high demand for commodities from China. Then, the company and the entire industry experienced a crash in rates due to the 2008-9 recession, lower commodity prices, a slowdown in demand from China, and the massive overproduction of ships. Genco, drowning in about $1.5 billion in debt, filed for a pre-packaged bankruptcy in 2014. The filing did not include a separate, healthier subsidiary called Baltic Trading. Equity holders fought the deal in court, but a judge ruled in favor of the company. Genco emerged from bankruptcy (after less than three months) under the control of three private equity owners who recapitalized the company: Centerbridge Partners, Strategic Value Partners, and Apollo Global Management. In 2015, Genco merged with Baltic Trading and John Wobensmith of Baltic became CEO of the combined company. In 2016, as shipping rates plummeted to extremely low levels, Genco restructured again. Georgiopoulos (likely under pressure from the private equity owners) resigned as chairman and left the company. Facing delisting, Genco completed a 1-for-10 reverse stock split in July 2016. The company maintained its listing and the risk of another collapse was reduced.

Shipping Rates

Genco, like other worldwide shippers, is highly exposed to changes in shipping rates. The Baltic Dry Index, which tracks shipping rates, has been extremely volatile for years. The BDI was in major bubble territory prior to the 2008-9 financial crisis due to heavy demand for shipping to China. The good times for shippers didn’t last, however, and the BDI subsequently crashed on weaker demand and oversupply of ships. Due to long lead times, significant shipbuilding continued even as demand remained low. The BDI hit extreme lows in 2015-16 (when Genco filed for bankruptcy), but eventually started to rise. It moved up from under 300 in 2016 to greater than 1,700 by mid-2018 as the supply/demand relationship became more favorable. Some ships were taken out of service new ship builds declined. The 2018 BDI average was the highest for any since 2011. Over the past few months, however, the BDI has fallen off a cliff (again) from 1,400 in December to under 700 today. Shipping rates have dropped for a few reasons, including Trump’s trade dispute China, coal restrictions in China, and the Vale dam disaster in Brazil. The latter event has led to turmoil in the worldwide iron ore shipping business as significant supply has been taken out of the market and iron ore prices have spiked to multi-year highs. Although some of the production may be made up for at other mines (in Australia, for example), there are great uncertainty on Vale’s production going forward. Genco operates in this market and the uncertainty in iron ore partly explains the stock price decline.

The supply/demand relationship may still be beneficial for Genco and other shippers. In its most recent presentation, Genco release several statistics that suggest that shipping rates will rebound despite the current issues. Genco claims newbuilding deliveries were down 27% year-over-year in 2018 and that the order book for future deliveries suggest further declines. Further, global trade in some commodities, such as grains and coal, appears relatively stable. Genco is bullish on the outlook for steel. There is no guarantee, of course, that rates will rebound in the short-term.

The Business & Change in Strategy

Genco has been moving to a commercial strategy from a pooling strategy. For most of its history, Genco was part of pooling arrangements (joint ventures between shipowners with common vessel types). These arrangements may carry less risk, but they also allow for limited control by individual owners. In the last couple of years, though, Genco has terminated these arrangements and pursued an owner-operator, commercial strategy. It has opened two new offices and now manages its own fleet. Instead of long-term contracts, Genco is pursuing short-term deals. It has also made efforts to reduce costs. Any fuel savings, for example, flows directly to the bottom line. The company believes it can improve margins in this way. Also, Genco can diversify its customers and cargo. Genco argues that it is outperforming the industry on rates and expense savings.

Genco is pursuing a fleet renewal strategy. The company has been selling its older ships and buying new ones in order to operate a more fuel-efficient, cleaner fleet. In mid-2018, Genco acquired six ships for approximately $240 million. Each of these ships was built in 2014 or later. Genco financed this deal with a secondary offering and a new credit facility. In the second half of 2018, Genco sold eight vessels for $52.5 million. The company plans further sales, likely selling seven or so ships in 2019. These (potential) sales could reduce debt by $50 million or more and reduce the age of the fleet. Genco has also reduced the average age of its fleet by nearly two years (to 9.0 years). Further, if shipping rates remain low, Genco may be able to purchase ships at good prices and may be more aggressive with acquisitions. Genco’s fleet renewal strategy is part of its compliance with IMO 2020 (discussed later).

The average TCE in Q4 ’18 was more than $13,000 per day. Due to the lower shipping rates, Genco has fixed about 85% of its available days in the first quarter of 2019 at TCE (time charter equivalent) rates of about $10,000 per day. There is significant operating leverage in this business. An increase or decrease in TCE rates of $1,000/day will increase or decrease Genco’s annual cash flow by more than $20 million. Cash flow breakeven is roughly $7,000 per day and net income breakeven is about $11,000 per day. It is likely, therefore, that net income will be depressed in the first half of 2019. My view is that shipping rates will be higher in the second half of 2019.

IMO 2020

A new regulation is causing big changes in global shipping. In 2016, the International Maritime Organization (IMO) adopted a new rule known as “IMO 2020”. The rule requires ships to reduce sulfur oxide emissions by lowering the limit on sulfur in bunker fuel from 3.5% m/m to 0.5% m/m. So, ships will need to use fuel oil with less sulfur. Alternatively, ships can reduce pollutants by installing exhaust gas cleaning systems known as “scrubbers”. The scrubbers remove sulfur oxide from the ship’s engine and exhaust, thereby allowing ships to reduce emissions even if using fuel with higher sulfur content.

Genco will install scrubbers on all 17 of its Capesize vessels at a cost of about $38 million. It makes financial sense for Genco to install scrubbers on these ships as they have the longest routes and most sailing days and consume the most fuel. Genco already has financing in place for this effort. Genco released a detailed presentation (available on its website) in October 2018 on its IMO 2020 Plan. Genco’s ships which do not have scrubbers will consumer the low sulfur fuel. The company may install scrubbers on more vessels depending on market conditions. It has options to install scrubbers on 15 additional vessels.

IMO 2020 could reduce the number of ships in operating and push shipping rates up. Ship owners must decide how to comply with the new rule this year. It is expected that compliance costs will lead some ship owners to scrap inefficient older ships. So far, however, there has been no major increase in scrapping. It is possible that fewer ships will be decommissioned than expected. Genco’s management, though, expects to see an increase in scrapping in the second half of 2019. If that happens, shipping rates could rise. Also, many ships will be drydocked for scrubber installations this year, reducing the overall supply of ships.

Liquidity & Balance Sheet

Genco has a good balance sheet and does not appear to be in any distress. As of 12/31/18, Genco has $567 million in total debt and $203 million in cash, so net debt is approximately $364 million. The debt consists primarily of two bank credit lines of $460 million and $108 million. The average interest rate is approximately LIBOR + 250 bp. The $460 million line was recently amended to allow for $35 million in new borrowing to pay for new scrubbers. Both facilities have final maturity dates in 2023, so Genco has no large payments due for four years. It will have to refinance at some point, but has a lot of time to do it.

Genco restructured again after its 2014 bankruptcy. Persistently low shipping rates put Genco (and competitors) into trouble in 2016. The company completed a $400 million preferred stock offering to remain afloat. This preferred stock was converted to common in early-2017, accounting for the sharp increase in the share count in that year. Genco completed a $100 million public secondary offering in June 2018. The timing of the secondary turned out to be quite good as it was completed at $16.50 / share versus the current stock price of about $8.50. Proceeds of the offering were used for vessel acquisitions. The three largest shareholders now own about 63% of Genco’s outstanding shares. One positive of the financing deals is that the public float is much greater than it used to be.

Genco’s TEV is lower than the value of its vessels. As the company reported 41.8 million shares outstanding at the end of 2018, the market cap is approximately $355 million at $8.50 / share. Genco’s net debt is approximately $364 million, so the TEV is about $720 million. For comparison, Genco reported total assets of $1.63 billion and shareholders’ equity of $1.05 billion as 12/31/18. Most of these assets consist of its 58 vessels. The company reported the book value of its vessels (net of depreciation) at $1.34 billion as 12/31/18. The average age of Genco’s vessels is 9.0 years. Their current value is based on cash flow projections. Sell-side analysts estimate Genco’s net asset value in range of $17-$19 per share. So, even at the low end, Genco may be trading at 50% of its NAV. While it’s common for shipping stocks to trade at a discount to their NAVs, they also trade above their NAVs at times. Genco itself likely traded above its NAV as recently as last summer.

Genco reported positive operating cash flow in both 2017 and 2018. The company reported operating cash flows of $65.9 million and $24.1 million in 2018 and 2017, respectively. Cash flows improved on higher shipping rates and cost reductions. Based on my forecast, Genco should reports operating cash flow above $2 / share in 2019, implying the stock is trading at only about 4.3x 2019 operating cash flow.

Possibility of Cash Return

Genco does not currently pay a dividend or repurchase stock. It is likely that some retail and institutional investors avoid the stock for this reason. Genco refinanced its legacy facilities in Q2 ’18. The new loan facility has a 5-year tenor and reduced Genco’s interest expense by about 100 basis points. Moreover, the refinance released $28 million in restricted cash and allows for the payment of a dividend. Investors have asked about dividends on the company’s conference calls. I think Genco might announce a dividend or stock buyback by the end of 2019, possibly attracting new investors to the stock. The recent decline in the stock price makes a buyback more likely. However, the public float and daily trading volumes are already fairly thin.

Financial Statements & Estimates

Genco had a good year in 2018 as adjusted EBITDA more than doubled. Operating expenses came in under budget and TCE was the company’s highest since 2011. Investors, though, are concerned about the short-term outlook.

I forecast Genco reports EPS losses in the first two quarters of 2019 but returns to profitability in Q3 and reports EPS of $0.49 for the year. I estimate 2018 adjusted EBITDA of $125.4 million, up from $122.6 million in 2018 and $56.4 million in 2017. I forecast a slight increase in total revenues to $380.0 million in 2019 from $367.5 million in 2018. These forecasts are based on improved shipping rates in the second half of 2019. My 2020 adjusted EBITDA estimate is $138.5 million and my 2020 EPS estimate is $1.06.

Valuation

I forecast Genco’s 2019 adjusted EBITDA at $125 million and its TEV is about $720 million, so Genco is only trading at about 5.8x TEV / adj. 2019 EBITDA. My 12-month target price of $15 is based on 8x TEV / 2019 adj. EBITDA. I don’t view this target as aggressive it implies a TEV / NAV of only 85%, lower than historical highs for the stock.

Some Risks

It’s a shipping company. There are all the usual risks: accidents, regulations, lawsuits, commodity prices, Somali pirates, environmental issues, wars, terrorism, increased wages and other costs, irrational pricing and market behavior, recessions, etc.

·         Genco went through bankruptcy once and needed to be restructured again two years later. I believe the distress was caused by macro issues which have largely subsided. Also, Genco has far less debt than the predecessor company.

·         Genco’s shipping is based on supply and demand of commodities. The Vale disaster shows how commodity markets can change without warning. Markets will react to changes, such as, for example, shifting iron ore production to Australia from Brazil.

·         Trump’s trade war isn’t helping anyone, least of all shipping companies involved in international trade.

·         Three investment firms own a majority of Genco’s stock and could, therefore, act against outside shareholders. Shareholders have been significantly diluted in the past.

·         Fuel (bunker) prices are relatively low. Genco has some exposure if prices rise.

·         IMO 2020 has created uncertainty in the industry. Genco, though, may benefit from it.

Summary

The shipping industry is in some turmoil (again) and investors hate shipping stocks (again) but the risk-reward on Genco looks favorable at the current price. This is, in part, a call that the BDI will not stay this low for long. While nobody knows how long shipping rates will stay relatively low, most industry participants believe the period of extreme oversupply of ships has ended. Genco has a diversified and increasingly modern and young fleet. I wouldn’t own Genco forever (given the cyclical nature of the industry) but I think this stock has good upside to $15.

Legal Disclaimer: This research report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author has a position in this stock and may trade this stock.

Catalyst

higher shipping rates, IMO 2020, vessel acquisitions / disposals, dividends / stock buybacks, refinancing