Description

Summary: Pangaea Logistics Solutions (symbol: PANL) is a microcap shipping company. The stock trades near its all-time low even though the company is in no financial distress. The dry bulk shipping industry shows signs of improvement after a very difficult period. I believe that PANL is significantly undervalued. My 12-month price target is $5.00, implying greater than ­­­­60% upside from the current price.

Introduction: Pangaea Logistics Solutions (PANL) is an asset-light, cargo-focused shipper. It is based in Newport, RI, but is incorporated in Bermuda. It is the only U.S. publicly traded shipping company that is primarily an operator rather than an owner. It is also the only U.S. publicly-traded shipping company that was consistently profitable during the industry’s recent collapse. It has unusual strengths in logistics, backhaul shipping, and shipping in the Arctic. Although Pangaea focuses more on cargo than owning ships, it has recently expanded its fleet of ships and is likely to expand further as the industry improves. This company is little-known among investors with minimal sell-side sponsorship.

Background

Pangaea has been providing shipping logistics services for more than twenty years. It was originally called Bulk Carriers and was founded in 1996. The three founders, Carl Claus Boggild, Anthony Laura, and Ed Coll, were experienced in shipping logistics. Coll has been the company’s CEO since its creation. For its first few years, Bulk Carriers grew organically as a specialist in operating ships. It chartered vessels to transport commodities for its industrial customers. In 2001, the company acquired its first vessel as Coll and the others recognized that the firm needed to own some ships to satisfy customer needs. Since that time, the company’s strategy has been to own some vessels but to manage more than it owns. The company carries about 25 mil. metric tons of raw materials each year. Pangaea has recently expanded its owned fleet in anticipation of a stronger bulk shipping market. The founders collectively own about 44% of the outstanding shares.

            Pangaea came public via a blank check company called Quartet Merger Corporation. Quartet was a SPAC (special purpose acquisition company) that was created in April, 2013, and completed an IPO later in the year. The CEO of the Quartet was Eric Rosenfeld of Crescendo Partners. Rosenfeld is a well-known activist investor who has often targeted small companies in the U.S. and Canada. VIC’s own Joel Greenblatt served as an advisor. Quartet announced the merger with newly-named Pangaea Logistics in April, 2014. It highlighted Pangaea’s consistent net income growth, high ROE, and significant management ownership. The firm had been considering an IPO of its own prior to the deal. There was a special profit opportunity involving the rights that was discussed in a VIC report by AAOI that was published in August, 2014. The merger was overwhelmingly approved by Quartet shareholders but, unfortunately, the timing proved to be horrible. PANL’s stock price collapsed from around $10 to less than $3 in just a few months as the shipping industry hit a severe downturn. The stock has never really recovered. Rosenfeld remains as a director of Pangaea but does not own a significant number of shares.

The Business

            Pangaea’s total fleet includes twenty owned, leased, and bareboat chartered vessels, as well as charters on a few dozen more. The number of ships operated by Pangaea varies with demand. It operated an average of 58 ships in Q3 ’17, a year-over-year increase of 35%. Pangaea’s fleet consists of bulk carriers of different sizes / subclasses (e.g., Supramax, Panamax). Most of the vessels are owned by other companies and chartered by Pangaea for terms of less than nine months. The company-owned fleet includes ten ships which are 100%-owned by Pangaea. These vessels have a total book value of approximately $125 million. They belong to four subclasses. Six of Pangaea’s ships are part of a joint venture in which the company has a 1/3 economic interest (discussed later). These six vessels are all in the Panamax Ice 1A subclass. The book value of these ships is approximately $177 mil., so Pangea’s share of the BV is approximately $59 million. Pangaea’s fleet also includes two ships which have been sold as part of sale-leaseback transactions and two bareback charters.

            Pangaea signs both short- and long-term contracts with commodity producers. The company carries cargo to and from more than 200 ports all over the world. Cargo carried by Pangaea’s ships includes bauxite, aggregates, agricultural products (grains), iron ore, coal, and steel. Although Pangaea carries major commodities, it tends to focus on minor bulks which weigh less and can have higher margins. Contracts specify when and where cargo is loaded, shipped, and unloaded. Many of the details are left to Pangaea. It uses a few different types of contracts. These contracts often include fuel price increase clauses to protect margins. Much of its revenue is generated through contracts of affreightment (COA). These contracts typically have terms of one to five years. Pangaea’s use of COAs limits its exposure when industry prices are very low. It navigated the industry price crash in 2015-16 better than many competitors. Pangaea’s charter-in contracts are typically shorter and may run for just a few months. Pangaea also does spot market shipping, especially in the Artic. The company has many repeat customers who ship with the company year after year.  

            Pangaea views backhaul opportunities as key to its business. Its ships travel to many different ports to pick up cargo for customers. Ships do not generate revenue unless they are carrying cargo for customers. Pangaea tries to carry cargo on both the outbound and inbound (“backhaul”) parts of a trip. The company will often highlight its expertise in this area in presentations. A focus on backhaul can result in additional margin as these contracts replace otherwise worthless shipping time. Pangaea claims that its ships carry cargo nearly 90% of their operating time. The company will sometimes turn down shipping contracts if it cannot find backhaul customers.

            Pangaea considers itself more of a logistics company than a shipping company. It will often take on risky and specialized “dirty” jobs that other companies cannot handle or do not want. It will also invest to create demand. Other shippers simply want their ships to be in use as much as possible. As an example of Pangaea’s valued added approach, the company recently connected a gold mine in Newfoundland, Canada, with a port construction project in Charleston, SC. The gold mine had millions of tons of blast rock that needed disposal while the Charleston project needed almost four million tons of aggregate rock. Pangaea built terminal facilities at both sites and shipped the rock from Newfoundland to Charleston. This high-margin contract required four chartered-in vessels to make 65 voyages in a year. It helped Pangaea to remain profitable during the industry downturn in 2016.

The Shipping Industry Sinks

            The worldwide shipping industry is slowly recovering from a terrible period in 2015-16. The Baltic Dry Index (BDI) tracks Capesize, Panamax, and Supramax time charter averages. It was created in 1985 to standardize global cargo prices. It has also been used as a proxy for international trade. BDI has been extremely volatile over the past dozen or so years due to enormous imbalances in supply and demand. Shipping rates soared in the 2006-08 period, but then crashed during the 2008-09 financial crisis. They have never approached pre-recession levels due to a massive oversupply of ships. Shipping companies ordered a huge number of vessels when the market was strong. China doubled its shipyard capacity between 2010 and 2013. Capacity in the dry bulk shipping market increased by an estimated 75% from 2008 to 2014. This excess supply led to a complete collapse of shipping rates in 2015-16. The shipping industry tends to experience cycles of five to eight years. BDI, as seen in the charts below, has risen from the depths of 2016. Average BDI, although still much lower than a decade ago, was approximately 70% higher in 2017 than in 2016.

TCE Rates

            Pangaea’s revenues are largely based on its pricing and utilization. The company, like many shippers, reports time charter equivalent (“TCE”) rates. TCE is defined as total revenues less voyage expenses divided by length of the voyage. Pangaea also reports total shipping days. It defines shipping days as total number of days in which its vessels are performing either a time or voyage charter. The chart below shows historical TCE rates and shipping days for Pangaea. The weak industry conditions can be seen in the 2015-16 results. Signs of improvement can be seen in the 2017 numbers.

            Pangaea earns a premium over competing shippers. In the first nine months of 2017, it reported an average TCE that exceeded the industry average by approximately 22%. In 2016, its average TCE exceeded the (extraordinarily low) industry average by approximately 84%. Pangaea generated over $40 mil. in operating cash flow in 2015-16 while most shippers could not cover operating costs. Pangaea’s focus on logistics allows it to charge premium rates. It reduces the market risk that it cannot control and focuses on the value-added services that it can control.

Earth, Profits Heating Up

            Pangaea has a strong business in Arctic shipping. For centuries, explorers tried and failed to find a Northwest Passage from Europe to Asia. Nineteenth-century explorers discovered some routes through the Arctic, but they were not viable for commercial shipping. Now, though, climate change has made Arctic shipping a reality. Pangaea Logistics was a pioneer in the area. In September, 2010, it became the first non-Russian dry bulk operator to use the Northern Sea Route. One of its ships, the Nordic Barents, transported iron ore from Norway to China by sailing around Siberia. This route reduces travel time by approximately one-third as compared with the traditional route through the Suez Canal. In 2013, Pangaea became the first dry bulk carrier to traverse the Northwest Passage. One of its ships, the Nordic Orion, carried coal from Vancouver, BC, to Finland by sailing around Alaska and northern Canada. This voyage proved that even large ships could safely navigate the Arctic and save the huge time and expense of sailing through the Panama Canal. Since those initial voyages, Pangaea has made a huge investment in Arctic shipping. It now controls a total of ten ice class vessels.

Pangaea’s ice class business includes the operations of a partially-owned subsidiary called Nordic Bulk Holding Company (NBHC). Pangaea owns one-third of NBHC and acts as its operator. The other two owners are commodities giant Glencore and the Aristotle Onassis Foundation. NBHC charters ships from Nordic Bulk Carriers, a 100%-owned subsidiary of Pangaea. NBCH owns six 1A Ice Class Panamax vessels, four of which were delivered in the past three years. Pangaea is compensated for achieving premium rates and receives an effective economic interest of roughly 50%. The firm consolidates NBCH as a VIE in its consolidated financials.  

The Arctic routes are very profitable for Pangaea. Customers are willing to pay premium rates for these routes because they save time and fuel costs. Cargo shipped on these routes includes cement, steel, fertilizers, and grains. Pangaea has invested nearly $250 mil. to build its ice class fleet. In the first nine months of 2017, Pangaea reported returns of 90% above market rates on this business. While there are many small vessels that operate in the Arctic, Pangaea controls eight of the ten Ice 1A bulkers over 40,000 dwt (deadweight tonnage) in the world. Large-scale Arctic shipping is a limited business, but it is growing. Global warming may be catastrophic for the world, but it may also increase mining, sea traffic, and energy exploration in previously inaccessible places. As former Secretary of State George Shultz said in an interview, “In the Arctic, we’re having a new ocean being created. Fast.”

http://www.sacbee.com/opinion/opn-columns-blogs/dan-morain/article25444039.html

 Noranda Bankruptcy

            Pangaea overcame the bankruptcy of one of its key customers. For years, it has had a shuttle contract to ship bauxite from a mine in Jamaica to a processing plant in Louisiana. The company also backhauls mining supplies from the U.S. to Jamaica. Bauxite is processed into alumina and then into aluminum. The owner of the Louisiana plant and the Jamaica mine was publicly-traded Noranda Aluminum. Noranda filed for bankruptcy in February, 2016. It had suffered significant losses due to persistently low market prices for aluminum and other problems. This bankruptcy was a concern for Pangaea as the contract represented 13% of its 2015 revenues. Noranda continued to operate the mine and processing facility during bankruptcy. A few months later, a company called DADA Holdings bought the bauxite mine and the Louisiana facility in a bankruptcy auction. It maintained the contract with Pangaea.

The new bauxite contract has good potential. DADA adopted the Noranda name after acquiring the bauxite and alumina businesses. The “new” Noranda continues to use Pangaea for shipping, partly due to its experience with hazardous materials. Pangaea can charge a premium to ship bauxite as it is potentially unstable and dangerous. Tragically, eighteen people died when a (non-PANL) ship carrying bauxite sank of the coast of Vietnam in 2015. Pangaea continuously operates two owned vessels and one time-chartered vessel for the bauxite business. The company reportedly accepted a 20% price reduction on the contract, but there is potential upside as there is a provision for price increases based on the market price of aluminum.

Capital Raises

            Pangaea recently completed a PIPE deal and filed for a shelf offering. In June, 2017, the company closed a PIPE at the price of $2.25 / share. It sold approximately 6.7 mil. shares to institutional investors and received proceeds of approximately $15 million. PANL used approximately $4.5 mil. worth of shares to cover accrued dividends and debt that was owed to the original owners of the company. The remaining proceeds were partly used to fund vessel acquisitions. The company announced the addition of two vessels to its fleet one month after the PIPE was completed. The private placement had a detrimental effect on the stock price as the stock had been trading above $3 prior to the deal. It took about five months for the stock to recover.

            Pangaea filed for a shelf offering in January, 2018. The filing indicates a sale of up to $100 mil. in securities and registered insiders’ shares. Pangaea has not disclosed a specific reason for the potential sale of securities. It may issue shares to raise cash to purchase vessels as the company has been expanding its fleet. The shelf, like the PIPE, had a detrimental effect on the stock price as it caused the stock price to fall below $3. In mid-February, Pangaea issued a press release which stated that it had no immediate plans to issue shares and that there is a restriction on the number of new shares that can be issued in any 12-month period. There is a limited float in Pangaea’s stock. Insiders hold significant stakes and decade-long shareholder Cartesian Capital, managed by Peter Yu, owns approximately one-third of the outstanding shares. The February, 2018, press release states that major shareholders Ed Coll and Cartesian, “…have no present intention to sell Pangaea common shares…” Further, it states that they both have, “…continued confidence in the Company, particularly given the improving shipping market.” The press release rescued the stock price a bit after the initial drop.

Shipping Mania

There were mysterious bubbles in shipping stocks in each of the past two Novembers. In November, 2016, PANL’s stock nearly doubled for no apparent reason. Many other shipping stocks had even bigger moves. DRYS, the worst stock in the history of stocks, was among the big movers. In November, 2017, PANL’s stock price had another weird move as it inexplicably jumped from about $2.25 to $8.40 in a week. In both instances, PANL’s stock price eventually gave back all the gains. It is possible that these rallies in shipping stocks were based on expectations of stronger pricing in the industry. It is also possible that it was just stock manipulation and / or irrational behavior by shipping company insiders, short-term traders, and algos. I would take the opportunity to sell PANL if something like this happens again.

Sell-Side Reports

            There are only two small firms with reports on Pangaea. Noble Financial Group initiated with a “Buy” and a price target of $5.50 in December, 2017. Norway’s Fearnley Securities also rates the stock with a “Buy” and a price target of $3.80. The consensus (of two) EBITDA estimates are $40.4 mil. in 2017, $49.6 mil. in 2018, and $58.2 mil. in 2019. The consensus EPS estimates are $0.30 in 2017, $0.52 in 2018, and $0.70 in 2019. My estimates for 2018 and 2019 EPS and EBITDA are slightly higher than these numbers.

Estimates

            Pangaea’s stock price trades at very low multiples based on historical and expected financial results. It is difficult to forecast earnings for the company as the company’s results are partially dependent on the strength of the worldwide shipping market and pricing. Pangaea does not provide any earnings guidance. There is reason for optimism because the company survived a very bad period for the industry. In a 2016 interview, CEO Ed Coll said that, “The industry right now is the worst I’ve seen it in 35-plus years in the business.” Indeed, Pangaea’s revenues dropped 40% from 2014 to 2016.  Despite the turmoil, Pangaea reported positive EPS of 21 cents in 2016. I forecast that revenues and earnings will increase in 2018 and 2019. My revenue estimates of $456.5 mil. for 2018 and $479.3 mil. in 2019. My EPS estimates are $0.67 for 2018 and $0.77 for 2019. There is no line item for taxes because PANL is incorporated in Bermuda. Taxes are included in expenses. Recall that PANL consolidates 100% of NBCH in its numbers. My estimates:

Balance Sheet

            Pangaea has a manageable level of debt. It has issued numerous tranches of debt when acquiring or accepting delivery of ships. One important note is that Pangaea consolidates NBHC in its financials but only owns 1/3 interest. This means that long-term debt is overstated on Pangaea’s balance sheet. The firm reports long-term debt of approximately $140 mil., but this number includes approximately $91 mil. in joint venture debt. The debt attributable to Pangaea is about $80 million. The company reported $29.3 mil. in unrestricted cash at the end of Q3 ’17. Pangaea also reports capital lease obligations of approximately $27 million. I project that the company will generate enough more than enough cash flow to cover debt maturities and decrease net debt over the next few years. Pangaea is also likely to take on some new debt for vessel acquisitions. The company should close 2018 with net company debt in the range of $50 – $55 million.

Valuation

            Pangaea trades at low multiples on revenues, EBITDA, and EPS. My estimates and those of the sell-side analysts suggest that the company will report nearly $30 mil. in net income in 2018. Yet, the EV of the company is approximately $200 mil. if adjusted for the debt attributable to the other owners of NBHC. I estimate that Pangaea will report EPS of $0.67 and adjusted EBITDA of $66 mil. in 2019. A P/E of 7.5x on 2018 earnings suggests a price target of $5.00 / share. It is notable that the net fleet value of this company is more than $3.00 / share. Investors appear to be giving practically no value to the operating business.

Some Risks

·         Weak shipping rates. Pangaea and the industry have suffered through years of low pricing. The biggest risk to the investment is that pricing does not recover as expected.

·         High charter rates. Pangaea charters a sizeable number of vessels. There is a risk that charter rates increase or that vessels are unavailable. In some cases, Pangaea uses Forward Freight Agreements (FFAs) to hedge price risk.

·         High fuel (bunker) costs. In many cases, Pangaea can pass on fuel cost increases to customers. It also uses derivatives to hedge its exposure to fuel. According to the CFO, the recent increase in bunker costs has had minimal effect on Pangaea.  

·         Unavailable financing. Pangaea is a small company with significant debt. The company is likely to take on more debt for vessel acquisitions. Any disruption in Pangaea’s ability to obtain financing would be detrimental.

·         Disaster occurs. There is always some risk of piracy, terrorism, natural disaster, human error, etc., in international shipping. Damages could exceed Pangaea’s insurance coverage and cause major business disruptions. Pangaea carries some cargo which is known to be unusually volatile and dangerous.

·         Loss of customers. Pangaea has a few large customers which are important to its business. Pangaea is exposed to the financial health of these customers. One of Pangaea’s customers (Noranda) suffered a bankruptcy in 2016.

·         Environmental laws. Shipping companies must comply with various environmental laws. Compliance can entail costs and non-compliance can lead to regulatory actions.

·         Global trade war and / or economic collapse. Pangaea engages in international trade. Tariffs are not likely to be helpful, but they could aid Noranda’s aluminum business.

·         Weak commodity prices. Shipping rates are partially dependent on demand for commodities, especially from China. Pangaea, though, has many long-term contracts.

·         Global warming is a hoax and Pangaea’s ice class shipping comes to an end. Pres. Trump recently claimed that ice caps are “at a record level”. There is very high likelihood that Pangaea’s management knows more about polar ice than he does.

Conclusion

Pangaea Logistics should benefit from better pricing in the shipping industry. The industry overcapacity situation has been reduced as orders have fallen and ships have been taken out of service. Pangaea has remained profitable and built its business through the industry turmoil. It has expanded its fleet in anticipation of better industry conditions. PANL appears to be a lower-risk investment than other shippers due to its focus on logistics and the limited size of its owned fleet. This is an obscure stock that trades at a low valuation. It does not even trade at the value of its fleet. I believe that it can trade up to $5.00 in the next 12 months. It could be worth much more than this price if shipping rates continue to improve.

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

improvement in shipping rates; greater investor interest; 2018 results