Description

“Forecasting in shipping is like chewing glass. It is extremely painful and one most likely gets it wrong.”

Extremely painful may be an understatement as I am sure most investors are aware that drybulk shipping rates have fallen by over 90% over the last 6months. For instance, Capesize rates have fallen from $230k in June 2008 to current levels of $9 700 per day.

Despite the strong warning label I am recommending Navios Maritime Partners (NMM) as a buy because the limited downside allows investors to make a safe bet that shipping rates will recover over the next 3 to 4 years.

The Trade

Price                              $7.00

Mrkt Cap                      $149mil

Net Debt                       $210mil

Current EV                   $359mil

In June 2009 NMM will take delivery of a $130mil newbuild Capesize. Because I have included the cash flows from this vessel when calculating the earnings power of the assets the EV I have used in this report has been increased by $130mil to $489mil.  

The essence of the trade is that NMM have fixed their shipping rates for 100% of the shipping days until December 2010. 80% of the revenue is fixed for 2011, 76% for 2012 and 56% for 2013.

Added together the use of the long term charters guarantees NMM R400mil in EBITDA over the next few years which means that investors are only paying $89mil for the remaining earnings power of the fleet.

Fleet

The average age of the 6 owned Panamax vessels is 7 years. Assuming a 25 year lifespan, there are an estimated 1 218 remaining revenue months available in the Panamax fleet. NMM have fixed 346 months leaving 872 months which must still be sold.

The average age of the 2 owned Capesize vessels is 1 year. Assuming a 25 year lifespan, there are an estimated 544 remaining revenue months available in the Capesize fleet. NMM have fixed 127 months leaving 417months which must still be sold.

DCF-Model Cash Flows

I have modelled the contracted revenues for each ship using the rates and length of each charter which are disclosed in the results announcements. (I advise interested investors to refer to these for more detail.)

For those who want to skip the detail the following provides a broad overview of NMM’s contracted revenue stream. The owned Panamax fleet is contracted at an average of $25 600 per day. This is significantly above the current spot rate of $4 600. The average charter rate for the owned Capesize fleet is $33 000 per day. Also well above the current Capesize spot rate of $9 700 per day.

The costs for the owned fleet are very easy to model as NMM have outsourced the operation of the fleet at $5 000 per day for the CapeSizes and $4 000 per day for the Panamax’s. Admin expenses run at about $700 per day per vessel.    

The two chartered in Panamax’s have been chartered-in at $13 500 each per day for 70 months. NMM has in turn chartered out these vessels at $24 000 and $28 400 per day over a similar period.

Finally, I have used a discount rate of 5% even though I am aware that it is generally assumed that the required rate of return for a ship owner is 12%. The main reason I have chosen 5% is NMM have insured their contracted revenues with a AA+ rated European Union governmental agency. High visibility and less risk should translate into a lower discount rate. Also, bond rates are very low.

As was mentioned above the contracted EBITDA is approximately $400mil. The present value of this cash stream is $350mil which means that investors are paying $139mil (EV $489mil - $350mil) for the remainder of the fleet.

Five year old Capesizes are currently being sold for $45mil and Panamaxes for $27mil. (These prices are close to the 2000/2001 values.) Adjusting these prices for the remaining useful life of the ship at the end of the charter period generates a present value of $140mil.

Adding the $350mil for the contracted profits to the $140mil implies that in a worst case scenario the current EV is earned by NMM within 5 years. The downside is therefore limited.

However, if Panamax rates rise above $16 000 per day then investors start to participate in the upside. $20 000 per day implies a 50% upside, $25 000 implies a 90% upside. (Note: For these calculations I have assumed that Capesize rates are double Panamax rates. A regression of Panamax and Capesize rates indicates that the Capesize rates are twice Panamax rates. RSQ=95%.)

Dividend Policy

NMM’s dividend policy is to distribute all the EBITDA as a dividend. This policy is premised on the belief that expansion capex should be funded from external financing sources and not from retained income.

Some shipping companies (eg DSX) have recently cancelled their dividends citing that in the new credit environment they will have to switch from external financing to retained income to fund expansions. While this reason may be valid, a cash flow model also indicates that if Baltic Rates stay at these levels the dividend will be lost in any event as the companies struggle to generate operational cash flows.

In contrast, NMM have contracted 100% of the revenues until December 2010. As a result operating cash flows will easily cover the current dividend of $0.35 per quarter.

Also, ordinary shareholders enjoy an additional layer of protection because 7.6mil of the 21mil shares are sub-ordinated to the ordinary shareholders. What this means is that ordinary shareholders must receive the first $0.35 dividend first before the sub-ordinated shareholders can participates in the dividend.

The only thing that can disrupt the current dividend policy is a switch to fund expansion using retained income. For the moment this does not appear likely.

Catalyst

Living of stock piles is not sustainable and the demand to rebuild stock piles is expected early 2009.

A second reason for the decline is the deluge of new ships which are expected to arrive late-2009 and 2010. The concern is especially acute in the Capesize market where the current size of the fleet is 145mil DWT. Newbuilds on order to be delivered by the end of 2011 equal 130mil DWT, of which 23mil DWT will come from Green Field shipyards. Green Field shipyards are yards that have never produced a ship before.. With only 35mil DWT earmarked for scrapping this means that the Capesize fleet could almost double in 3 years.

This surge in growth is not as ominous if one combines the statistics for the Capesize and Panamax fleets. (It makes sense to group these vessels as both types were designed to load at major iron ore and coal ports.) Existing fleet = 255mil DWT. Estimated scrap = 60mil DWT. Newbuilds over the next 3 years = 125mil DWT from established shipyards and 30mil DWT from Green Field shipyards. Taken together this is a 95mil DWT increase over 3 years given conservative scrapping estimates.

These above factors will definitely slow down the expected growth rate of the Drybulk Fleet.   

As I am writing this NMM is up 16% and I am kicking myself that I did not submit the idea yesterday as planned. However, this strong movement is most likely due to the lack of liquidity in the holiday markets and I hope to see some retracement which will add to the upside.

For those who are not as concerned about the timing, the upside is still significant at $7.00 with very little downside risk. The worst that can happen is that you pay R489mil for NMM which is guaranteed to earn R400mil over 4/5years and the vessels are sold for $140mil when the charters expire.

Catalyst