Description

I advocate a long position in the common stock of Navios Maritime Partners L.P. (“NMM” or the “Company”), as it is undervalued by the market with an intrinsic value of ~$65, representing upside of ~24% over the next 18 months.

The long thesis for this ~$1.6 billion market cap (~750M EV) shipping company focuses (in detail below) primarily on my view on the dry bulk market, NMM’s unique structural advantage, a good margin of safety, and the strength of the management team Angeliki Frangou (and her father and grand-father before) have maintained a strong reputation which, among other things explained below, is very important in the shipping industry). NMM is part of the Navios Maritime Holding family, a far-reaching and somewhat complex shipping conglomerate headed by well-regarded CEO, Angeliki Frangou (more below).

So, why do I think it is currently mispriced by the market? NMM’s valuation is currently depressed partly due to the small dividend and the shipping sector being out of favor. Additionally, management’s desire to grow the business to position it for the uptick doesn’t seem to sit well with investors who are looking for their dividend payout as holders of an MLP (more below) which has likely resulted in flows away from this name or the sector in general.   

Investment Thesis

• The Dry Bulk market is starting to improve
  • The dry bulk market is buoyed by iron ore, coal, and grain exports.
  • Chinese steel production is expected to pick up pace at the end of winter, in the second quarter of next year, by which time production curbs will have relaxed.  Strong infrastructure and construction activities are expected to further strengthen steel consumption.
  • At the same time, the Chinese government is closing down inefficient and highly polluting mills which will pave the way for efficient millers to produce high quantity steel, strengthening demand for high-grade imported ore, largely coming by ship.
  • The major iron ore companies continue to increase production to meet demand from China. BHP Billiton increased iron ore production by 8% y/y to 70 million tons, with 2024 FY output up 4% to 268 million tons, within its guidance of 268-272 million tons.
  • BHP believes its production guidance will be 275-280 million tons (up 3.7%). Vale further cemented its status as the world’s largest iron ore producer with output up 5.8% y/y to 91.8 million tons.
  • China’s iron ore imports have been up 9.3% y/y at 539 million tons somewhat due to current prices resulting in inventory building and are expected to reach 800 million tons this year
  • Chinese steel production is expected to pick up pace at the end of winter and in the second quarter of next year, by which time production curbs will have relaxed.
  • Strong infrastructure and construction activities will likely strengthen steel consumption along with the fact that the Chinese government is closing down inefficient and highly polluting mills paving the way for efficient millers to produce high quantity steel, strengthening demand for high-grade imported ore.
  • Coal fundamentals remain firm, as Chinese coal inventories have steadily declined and imports have remained robust
  • Short-term coal demand appears to be moderately positive due mostly to China and India. Last year, China experienced heavy rainfall, forcing officials to reduce hydropower electricity by over 66% at its Three Gorges and Gezhouba plants, the world’s largest power station. There has also been a major heat wave throughout the country, which has increased air conditioning use and thus required increased coal demand. China plans to add an additional 200 million tons of new coal capacity in the year, following already adding 90 million tons through mid-year
  • India plans to shut down about 5.5 gigawatts of outdated coal-fired power plants and has already retired about 4.0 gigawatts of coal-fired plants since 2015. However, similar to China, Indian officials will invest $10 billion in new coal-fired power plants through 2024. Although both countries plan to significantly reduce coal usage as part of their overall energy consumption mix, which will likely have negative implications on dry bulk demand, in the short term, both countries remain heavily dependent on coal imports, which are cleaner and much more efficient than domestic coal products in both countries.
  • An added boost here comes from recent heighted tension related to North Korea.
  • The initial UN resolution, first adopted in November 2016, sought to limit North Korea’s exports to 7.5 million metric tons of coal a year. In early August last year, the UN voted to heighten restrictions, banning the export of certain key commodities—most notably, as it pertains to NMM at least—coal and iron ore. The backfill of these North Korea tons, likely from North America, will result in great shipping miles.
  • As it relates to grain, this should be a good year for grain trade as the Americas are projected to have solid harvests, with North America up 9% and South American up 23%, according to the USDA.
  • Demand also remains strong as China agreed to resume U.S. beef imports and agreed to several deals worth about $5 billion to buy 12.5 million tons of soybeans and 371 tons of beef and pork.
  • Additionally, China has agreed to allow imports of rice from the U.S., of which China imports 5 million tons of a year.
  • As China's population increases (two child policy etc.), it will require more crops and higher grain imports, specifically from longer distances such as U.S. which should help maintain a minimum level of steady dry bulk demand over the next several years.
  • Growing grain consumption in African and Asian countries will also likely support grain trade.
  • Other aspects to consider are the China driven Belt and Road initiative (BRI) will also drive dry bulk shipping in the long run with the Chinese government planning to invest heavily in infrastructure development to revive the 16^th century silk-route from China through Central Asia and the Middle East to Europe, extending to the maritime route linking China to Southeast Asia and East Africa by sea.
  • The BRI would involve building new ports, roads, railways, power plants and pipelines. This highly ambitious project will create strong tailwinds for dry bulk shipping, taking into account the massive planned infrastructure development undertaken by the Chinese government, which can entail an expenditure of up to $8 trillion by 2025.
  • On the supply side, the dry bulk fleet is expected to moderately improve. Improving charter rates are reviving the interest of shipowners in the newbuild market; however fleet growth will remain in check because of the thin orderbook and IMO regulations (low deliveries in the short-term and high demolition activity in the long-term related to the Ballast Water rules etc.- see industry section below). Hence, a big chunk of the orderbook will be replacement tonnage.
  • The BDI has shown some signs of life in 2023, with current rates up 17% from the same time last year. 
  • Given its emphasis on the dry bulk market, NMM’s stock price has traditionally tracked that of the BDI except since late 2015 when the company suspended its dividend following a crash in dry bulk rates.
  • As the BDI recovers and NMM starts paying a bigger dividend, the stock could see a meaningful bump.
• Unique Structural Advantage
  • Beyond the slowly improving macro backdrop, NMM has a number of operational advantages:
  • Attractive Opex: Navios oversees a broad shipping conglomerate, which generates scale advantage for both the parent and its related entities. Specifically, NMM has a management contract with Navios Holdings to provide all operational services to its ships (Opex and G&A) at a fixed price, below industry average:
  • Pipeline to build fleet: Again leveraging off of the expertise of the parent, NMM has access to an impressive pipeline of deal flow, helping it grow its fleet.
  • Access to capital: NMM has financed these acquisitions through a range of bank financings. 
  • Navios also has access to the broadly syndicated loan market, further diversifying its sources of funding.
  • In short, NMM benefits from the parent platform and size giving them access to both deal flow and capital to continue growing its fleet size.  
• Margin of Safety
  • NMM has a good margin of safety when looking at it from an asset perspective, the cash on its balance sheets, its FCF generation and the lack of near term-maturities
  • From an asset value perspective, consensus does not vary that significantly but a fair estimate from JPM below has the net asset value of the Company at $60/share under current market rates.  I view this as conservative with upside as the market tightens.
  • From a cash flow perspective, NMM’s use of Time Charter contracts is attractive when analyzing downside.
  • Should the rate environment firm up in 2024, I anticipate NMM will layer-on multi-year time charters (three years or greater) to lock-in cash flows, allowing a more robust distribution.
  • From a liquidity perspective, unlike many of its peer in the shipping industry (its parent NM included), NMM enjoys a solid balance sheet.  
  • A strong balance sheet and the lack of near-term maturities should enable NMM to grow as the market recovers while limiting downside should the recovery fail to take hold.
  • In short, this balance sheet should allow NMM to wait for the shipping market to eventually recover.
  • Broadly, the container market has struggled in recent quarters due to overcapacity, muted demand and, most importantly, a structural shift in the market with the completion of the Panama Canal expansion. With the new locks, the Canal can accommodate Container ships up to 13,000 TEU’s versus the former limit of 4,500-to-5,000 TEU vessels. This change (not unexpectedly) has impacted the market structure, by cutting demand for the former Panamax Max; since 2015, 88% of the 4,000-to-5,100 TEU vessels scrapped have been Panamax Max.
  • Navios Container, however, focuses on relatively smaller vessels—a segment of the market which enjoys more attractive fundamentals
  • These smaller vessels have entered into new market segments, including Africa and Intra-Asia where port infrastructure eliminate larger and deeper vessels. Ships from 2,000 to 5,100 TEU have seen an increase of 82% since 2013 of deployment on Intra-Asia trade lanes while the size of the fleet in this segment of the market has continued to shrink as well.
• Valuation
  • With the dry bulk recovery just starting, NMM will likely trade on NAV in the near-term.
  • They have had great success in building NAV by opportunistically adding ships and more substantive transactions like Navios Containers (as mentioned above).
  • Should the recovery take longer to play out than expected, investors should continue to benefit from NMM’s unique capabilities to build Enterprise Value.
  • When the recovery does take hold, I expect NMM to be valued on an EV/EBITDA basis. NMM currently trades around 3.1x LTM EBTDA, but has historically traded around 8.5x EV/EBITDA.
  • My base case assumes NMM trading at 5x EBITDA which implies a potential gain of atleast 24%.
• Management
  • For anyone that has seen Moby Dick or any movie involving ships, it is obvious that people in the shipping industry have to account for numerous uncertainties and be able to adapt to them especially while out at sea. 
  • Owning and operating a shipping company is significantly more complex where a keen understanding of the industry, its operations, and strong reputation are important in navigating oftentimes complex markets globally.
  • Angeliki Frangou is the founder, CEO, and chairwoman of the Navios empire who owns 27% of parent NM and exerts effective control of the company.  She got started in the business in 1990 after doing a stint for a few years as a trader on Wall Street after graduating as a mechanical engineer from Farleigh Dickinson University in NJ.
  • While the shipping industry is populated with managers of questionable regard, Angeliki has a strong reputation as an operator and as an allocator of capital.
  • As testament to her market acclaim, the creditors under the Navios Holdings Term Loans wrote into the credit agreement the ability to execute a default notice if Angeliki’s ownership drops below 20%.
  • One need not understand the intricacies of the Navios complex to appreciate the NMM story.  The key takeaway is that the Navios conglomerate has deep expertise in shipping, which yields operational advantages to NMM as well as access to deal flow that can help NMM continue building Enterprise Value.
  • Additionally, as the satellite of related entities shows, the alchemy of Navios entails its expertise in financial engineering; Navios has built an impressive track-record of tilting between equity and debt markets to capitalize on funding opportunities to build Enterprise Value. 
  • NMM’s very existence underscores this dynamic, as parent NM created the entity to capitalize on formerly robust MLP multiples. While MLP’s subsequently collapsed (for reason well beyond Navios’ control, obviously), it nonetheless highlights the company’s financial acumen; they tapped a hot market at the right time.
• Risk/reward is very attractive given no near-term maturities and the locked-in charters for the existing fleet.  Meaningful upside potential from improving day rates in the dry bulk market, multiple expansion, and optionality on the container side of the business.

Industry – Dry bulk

• Dry bulk shipping has been caught in a perfect storm for the past three years with a massive oversupply of vessels paved the way for this historic bear market.
• Dry bulk shippers specialize in transporting cargos, typically commodities, such as iron ore, coal, grain and other materials around the world.
• Companies with exposure to dry bulk include Diana Shipping, Inc. (NYSE:DSX), Eagle Bulk (NASDAQ:EGLE), Genco Shipping (NYSE:GNK), Golden Ocean Group Ltd. (NASDAQ:GOGL), Navios Maritime Holdings, Inc. (NYSE:NM), Navios Maritime Partners L.P. (NYSE:NMM), Scorpio Bulkers (NYSE:SALT), Safe Bulkers, Inc. (NYSE:SB), Star Bulk Carriers Corp. (NASDAQ:SBLK) and Ship Finance International Limited (NYSE:SFL)
• It is widely accepted that currently the dry bulk market is experiencing supply and demand disequilibrium. This was the result of too many ships being ordered prior to the 2008 crash to supply a commodity demand boom that was unsustainable in the long run. The end result was a massive amount of supply that was ordered before 2008 and being delivered as late as 2018 due to the lengthy nature of the shipbuilding process and the backlog in many shipyards that spanned several years. Thus, the available supply soon outstripped post-boom demand.
• This oversupply problem has been compounded by lackluster demand growth for the dry bulk trade which eventually led to historic lows in the leading economic indicator for the segment known as the Baltic Dry Index.
• The Baltic Dry Index, or BDI, is a composite of the Baltic Capesize, Supramax, Panamax, and Handysize indices. It is useful in determining the cost to move materials by sea.
• Introduced on January 4th, 1985, at 1000 points, this economic indicator had reached a record high 11,793 on May 20th, 2008 and a record low of 290 on February 10th, 2016.
• In 2008, Chinese demand for raw materials carried by dry bulk ships was nothing short of insatiable. This demand, which proved to be unsustainable in the end, created a boom for dry bulk vessels which saw rates peak in June of 2008 at $233,988. In an effort to capitalize on this environment, owners responded to this boom by ordering a lot more ships.
• By 2009, when the boom had clearly turned to bust and the orderbook for newbuilds stood at a whopping 78%.
• Traditionally, 15% is seen as what is required to replace aging vessels coupled with historic demand growth.
• As Chinese demand for raw materials returned to a more sustainable level many of these newbuilds that were contracted prior to the bust began to hit the water. This led to a massive oversupply of vessels for a market which was no longer experiencing that insatiable Chinese appetite for raw materials.
• As more of those vessels hit the water competition became more fierce leading to lower rates which resulted in a record low for the BDI in February of 2016.
• This situation resulted in two important market driven trends.
• First, low rates meant that almost all vessels were losing money. This led to the scrapping of older vessels. Overall, it comes out to basic loss projections. Which way would lose the least amount of money. Owners must now take into account time frames and projections. If the bearish time frame looks short, older vessels may keep sailing if a projected recovery means they can still make money over the long-run vs what they will lose in the short-run. However, if the bear market looks to be fairly long in duration, owners may not feel as confident that these older vessels will return to profitability in their remaining life. Even if they think they might get a couple years of recovery toward the end, would it be enough to ride out a 5 year bear market amid record low rates? Probably not.
• Second, these reactionary owners did what was expected and cut orders for vessels due to this low rate environment leading to a shrinking orderbook. This thinning orderbook would eventually lead to a rebalancing of the supply side years down the road (as noted above in the first point of this long thesis above).
• Currently, the vintage fleet (older than 15 years) surpasses the amount of newbuilds on order.
• Many astute shipping aficionados probably will note that drybulk vessels typically have a 25-year life span so the vintage fleet could have some significant time left on the water. Normally, you would be correct.
• But a recent mandate out of the IMO (International Maritime Organization) will have a significant impact on the scrapping of vessels. That mandate is the Ballast Water Management Convention and it entered into force on September 8^th this year
• So what is the BWMC and why does it matter?  Ballast water may be taken on board by ships for stability and can contain thousands of aquatic or marine microbes, plants and animals, which are then carried across the globe. Untreated ballast water released at the ship's destination could potentially introduce a new invasive marine species. Hundreds of such invasions have already taken place, sometimes with devastating consequences for the local ecosystem.
• The International Convention for the Control and Management of Ships' Ballast Water and Sediments was adopted in 2004 to introduce global regulations to control the transfer of potentially invasive species. Once the treaty enters into force, ballast water will need to be treated before it is released into a new location, so that any micro-organisms or small marine species are killed off.
• The prices for these systems vary depending on their type and level of sophistication, but prices range from $1.0 million to $2.25 million (including installation) for a top-of-the-line system. These systems must be installed during the first dry docking following the implementation date.
• Gibson Shipbrokers offered this insight: "The announcement yesterday that the Ballast Water Management Convention will finally enter into force from September 2017 will have an impact on the older ships where many may not be considered viable to retrofit in terms of costs versus age and earnings potential. In all probability, next month we will learn from the IMO the timing of the implementation of the new global sulphur cap for marine fuels. Many stakeholders believe the global maximum permissible sulphur limit on marine fuel will be 0.5% (lower limits for the ECAs) and implementation will be brought forward to 2020. Both these pieces of legislation will impact on owners in terms of the expenditure required to comply with these regulations. We believe that the impact of both directorates will enhance the prospects for increased scrapping. Once again legislation will have a huge impact of fleet numbers going forward, similar to the impact of the introduction of double hulls in the 1990's."
• Costs become increasingly prohibitive, especially in a high-rate environment which we are experiencing now. But adding to the decision to scrap in the short run is a bump in prices for demo candidates.
• Intermodal noted in its week 36 report that "vessel demo candidates keep flooding Indian subcontinent region and prices offered across the board keep climbing at a rather impressive pace for yet another week, the demolition market is currently witnessing a rather unexpected performance compared to the one most of us expected up until very recently. Although we still think that this is not a rally that can last for too long as fundamentals have not materially changed in such a short period of time, it seems that a few things have been supporting the market lately. From one side local scrap steel prices in the Indian subcontinent seem to have brought back the appetite of breakers in the region, while at the same time it seems that part of the demand might have been in place all this time but was kept on the sidelines up until a more clear direction was taken by the market. Either or the surge in prices is more than welcome by those owners determined to scrap and it seems that many of them are taking advantage this window of opportunity before the rally stalls."
• It stands to reason that those owners facing special surveys amid low rate environments may want to take advantage of this unexpected increase in demo prices especially as they face further costs in the form of retrofitting ships for the soon to be implemented Ballast Water Convention agreement which has now been adopted by several prominent nations.
• It is noteworthy that demo rates are slightly more attractive now.
• While much of the very old tonnage has already been removed from the global dry bulk fleet, given the high costs of surveys, the expense of Ballast Water Management installation, and the continuing low rates we should see for a couple more years, it is likely we will see a wave of demolitions as we head toward this implementation date and beyond.
• Additionally, the IMO has implemented new sulfur emissions guidelines which call for a move to 0.5% sulfur content bunker fuel from 3.5%. This goes into effect in 2020. So this is an ongoing issue that must be addressed immediately as it will still factor into an owners decision to scrap/spend money on an aging vessel for the BWMC.
• In short, the reduction from 3.5% sulfur to 0.5% could mean significant cost increases for bunker fuel. Estimates place the potential impact anywhere from 44% to a 100% price increase.
• But those estimates are based on traditional pricing. With demand side dynamics being severely altered there is the potential that refiners may face extreme difficulty in meeting the demand.
• Furthermore, while major bunker centers like Singapore and Fujairah will be able to supply 0.5% sulfur fuel oil, smaller ports may not have the infrastructure and blending components which could create a shortage.
• Of course, a demand shortage, whether from port availability or refining capacity, will inevitably impact prices.
• Depending on the type of vessel, bunker costs compose anywhere from 40% to 70% of total 'on the water' operating expenses.
• The orderbook is thinning, contracting for newbuilds remains practically non-existent, and mandates are set to take hold which should accelerate scrapping. This should lead to a rebalancing of the fleet.
• What we need is for owners to refrain from newbuild orders and scrap vintage tonnage in advance of these mandates, something that is already starting to happen. The degree of both will have a direct impact on the speed and magnitude of a potential recovery.

Risks

• Conflicts and Intercompany risk
  • As mentioned above, Angeliki runs Navios and its related entities.
  • There are separate boards and different management teams, but, functionally she controls them all.
  • Investors in NMM bear a degree of risk related to inter-company activity that could adversely impact NMM as there are a number of inter-company loans. From a high-level, given NM’s over-levered capital structure, there is a risk of Holdings tapping NMM’s low levered balance sheet as a source of capital.
  • The NMM Term Loan B has a covenant to limit this dynamic, but it is a risk for investors nevertheless.   
• Dilution
  • Should the NMM stock recover meaningfully, I would expect the Company would issue additional shares, perhaps to raise capital to dividend to the parent.
  • Again, the Restricted Payment basket under the NMM credit agreements will limit the magnitude of dividends to the parent, but I’d expect Angeliki will capitalize on any opportunity to raise additional equity capital.
• Cyclicality
  • Maritime transport is very cyclical. Should global growth slow, particularly in China, NMM and the rest of the shipping universe could be dragged meaningfully lower.
  • I believe downside is mitigated by the stock’s current valuation and the Company’s low-cost Opex, attractive capital structure and use of chartering.
• Order book risk
  • Part of the bullish thesis with NMM right now depends on the market is improving, but not too much.
  • Should the rate environment recover too much or too quickly, there is a risk of new orders and/or slowing of scrapping that could prevent a rebalance of supply and demand (see industry section above).

Catalyst

• Improvement in dry bulk rates
• Increasing of the dividend
• Improvement of the order book, through scrap rates remaining at present levels
• Continued capital market transactions enabling NMM to purchase fleet at attractive levels, building NAV