Is It Time To Get Back Into Shipping?
Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
For a while now I have wanted to invest in a shipping company to play the global economic recovery. I have done some research on individual shipping firms in the past, but never completed a study of the whole industry to find the most undervalued company with the best prospects.
However, as I have only ever done some research on individual shipping companies, I did not know that the rest of the sector was so big! Screening on Finviz for shipping companies returned 47 results – only nine of which are US based companies. The rest are based in Greece or Bermuda for tax reasons.
So, to whittle this group down, I looked for the most active stocks with the highest market caps. The one with highest average daily volume is DryShips Inc. (NASDAQ: DRYS). The next most active stock with the largest market capitalization is Ship Finance International (NYSE: SFL).
Tidewater is next in the list, but this company is more of an oil services company than a pure shipping company, so I am going to leave it out of this analysis for now. Instead, I am going to look at Diana Shipping (NYSE: DSX) as my last choice.
So how do these companies compare? First, here is a quick overview:
DryShips operates container ships, tankers, ore carriers, and through its subsidiary operates nine ultra-deep-water hydrocarbon drilling units. Dryships has the smallest fleet by tonnage in the group. However, the company does have partially own Ocean Rig UDW Inc., an oilfield services company.
The total fleet is comprised of 44 dry bulk carriers, 5 very large ore carriers, 12 tankers, and through its subsidiary, 2 ultra-deep water submersibles and seven ultra-deep water drill ships – that's a total capacity 1.6 million dead weight tons.
Ship Finance International
Ship Finance, through its subsidiaries, is responsible for a fleet of vessels across the world and is also involved in the charter, purchase and sale of related marine assets.
The company's total fleet is comprised of 25 crude oil tankers, 2 chemical tankers, 5 ore vessels, 11 dry bulk, 15 container, 6 offshore supply, 4 jack up and ultra-deep water rigs – that's a total capacity 10.5 million dead weight tons.
Unlike Ship Finance and DryShips, Diana has no direct exposure to the oil industry. However, the company does have a large exposure to the commodities market, which could be both positive and negative for the company.
The fleet is made up of 29 dry bulk carriers, for a total capacity 3.2 million dead weight tons.
So that's the introduction over with--now let's get down to the business of financial analysis.
The shipping industry has undoubtedly had a rough time over the past few years. The Baltic Dry Index, a key barometer for the health of the shipping industry, is nearly at lows that were last seen in 2008. Furthermore, during the last five years the index has not even come close to reaching the highs seen before its drop in 2008.
So, with the Baltic Dry remaining at its lows, how have these companies faired over the past three years?
Rather than relying on EPS or revenues, I am looking at company cash flows, as in my opinion they usually reveal much more about a company.
Diana Shipping's cash flow looks healthy at first glance. The company has sustained its free cash flow at $150 million a year over the past three years, and roughly 60% of this has been translated into free cash flow. Free cash flow totaled $95 million during 2011, which continued throughout the majority of 2012.
However, Diana had to grapple with higher than expected CAPEX costs in 2010, which pulled the free cash flow into the negative for that year. Overall, Diana continues to generate a sustainable and positive free cash flow.
The chart below shows the company's debt profile.
Diana's debt profile is good. The company's free cash flow has allowed it to maintain net debt of below $50 million. In addition, the company actually had a net cash balance of $40 million in 2010 and $40 million during the first nine months of 2012. Furthermore, Diana has kept interest costs relatively low - amounting to about 5% of gross income for all three periods.
Most importantly of all, the company has been able to remain profitable, with gross income remaining above $50 million in the first nine months of 2012 - although this has declined about 66% since 2010.
Ship Finance International
Ship Finance International is the biggest company in this article by dead weight tonnage. Unfortunately, the company is also in the worst financial position. The chart above shows that the company has had a negative free cash flow between -$21 million and -$250 million every year since 2009. In fact, even though it is not shown on the chart, this poor performance has continued into 2012, when the company had a negative free cash flow of $81 million.
The negative free cash flow is attributable to several things. Firstly, the company has been increasing CAPEX spending; secondly, the company is achieving a much lower net income (depreciation is costing the company a large chunk of revenue); and thirdly, Ship Finance International is spending almost 100% of its income from operations on dividends.
The poor cash management that shows up in the company's cash flows continues onto its balance sheet.
Ship Finance has a huge pile of debt, as shown above. The chart highlights the debt pile and staggering interest payments the company has to pay to prevent it from defaulting.
Shrinking revenues and rising CAPEX spending are damaging gross income, and as a result interest expenses currently account for a staggering 63% of the company's gross income before income from affiliates.
However, the chart does make the situation look worse than it is. Ship Finance International has roughly $1.7 billion in net debt, which, when compared to other industries, is not a huge amount. That said, when this level of debt is compared to the company's gross income, the situation looks worse. Ship Finance's gross income was only $164 million for the year 2011, which in gearing terms gives the company a debt to EBITDA ratio of 8.3 times - the highest in this article and possibly the rest of the industry.
The third and final shipping company is DryShips. DryShips is the second largest company by market cap in the group, behind Ship Finance. However, DryShip does have the highest revenue in the group as of 2011. During 2011 Dryships had revenues of $1 billion, Ship Finance had revenues of $300 million, and Diana had revenues of $250 million.
However, DryShips' low market valuation and high revenue shows me that the market does not trust the company or believe in its future.
The market's worries can immediately been seen in the company's cash flows. DryShip's free cash flow was negative $2 billion in 2011 and $500 million in 2010 as a result of increasing depreciation costs and reductions in working capital. In addition, just like Ship Finance, the company has been increasing CAPEX in the last two years.
Finally, cash flows from investing are also poor, even though the company has been issuing huge amounts of shares to try and raise additional funds.
DryShips' balance sheet does not look any better. As of September 2012 DryShips' net debt stood at $4 billion, four times the size of the company's market capitalization.
Indeed, net debt is 7.1 times EBITDA - only slightly less than that of Ship Finance. Furthermore, as of September, DryShips' debt interest accounted for 53% of the company's gross income.
Out of these three companies, Diana Shipping is the only company that I could consider investing in. Both DryShips and Ship Finance have too much debt and very poor cash flows. These two companies are also continuing to spend cash on CAPEX when the shipping industry as a whole is cutting back on capital spending.
As I have shown above, Diana has the best balance sheet by far, and the company is producing a decent cash flow and subsequent return for shareholders.
Furthermore, I believe the rest of the market is also behind Diana, as currently the shares trade on the highest P/E multiple of this group.
Diana is trading on a P/B ratio of 0.5, signifying that the company's share price is only valuing Diana at half of its net asset value. In addition, Diana has a current ratio of 8, highlighting the company's relatively strong financial position.
So, if now is the time to get back into shipping, Diana is the stock to buy.
Data Source: Saxo Capital Markets, Marketwatch
RupertHargreav has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!