If a person suffers from nasal congestion, there's a host of relatively quick fixes, ranging from over-the-counter medications to septoplasty. When a port suffers from congestion, there's no quick fix. In an article on Peabody Energy (NYSE: BTU) back in April, I noted Australia's port congestion, caused in part by insatiable East Asian demand for coal. These ship queues have served as a cue for Japan to seek coal from ports that are less askew. But the ports of alternate supplier South Africa are not only further away -- they're facing congestion issues of their own.
These three factors -- huge product demand, ship delays, and longer routes -- are all keeping dry freight rates afloat, and the shippers of coal, iron ore, and grain breathing easy.
As with the crude oil shippers, skepticism about the sustainability of today's elevated dry freight rates abounds. Foolish seafarer Philip "The Admiral" Durell sounded one such alarm in late 2005. Some recent comments by the chairman of India's state-backed shipper could be taken as a red flag, if you're looking for one:
"As we have always maintained, the world economy and world trade have definitely reached a higher plateau. So, we don't expect that there will be any crash or that we will see the nadirs that we had experienced earlier."
Then again, if you agree that global trade is unlikely to severely contract any time soon, it might be worth sizing up the fleet of dry bulk shipping companies. Personally, I'm sitting astride the boom/doom fence, so I'm willing to consider the group, as long as I can buy into a company cheap enough to be compensated for the risk. I've had a look at some of the most widely followed names in the space, but I'm most interested in a company with no operating business at present. Sounds promising, right? Much more on that idea in a moment.
I have to rule DryShips (Nasdaq: DRYS) a dud on account of its corporate governance gaps. Diana Shipping (NYSE: DSX) has a young fleet and pays out a big dividend, but she's not generating free cash flow. Call me old-fashioned, but I'm not comfortable with that arrangement. I like that Excel Maritime (NYSE: EXM) waited to generate free cash flow before recently instituting a dividend policy, but it's still trading above the range at which I feel like I'm getting a big enough margin of safety.
Speaking of margin of safety, I've stolen my dry bulk shipper idea from the guy who wrote the book on the subject. In case you don't have the $1,450 to shell out on a used copy of Seth Klarman's Margin of Safety on Amazon.com (Nasdaq: AMZN), there are extensive notes presented here. Klarman runs a hedge fund called the Baupost Group, and I enjoy checking out his top holdings from time to time. The guy has turned in some world-beating results, even while reportedly maintaining massive cash balances, so his positions are always worth a peek.
I was initially surprised to discover Star Maritime Acquisition (AMEX: SEA) among the firm's largest reported holdings -- first, because I'd never heard of it, and second, because once I looked it up, I discovered that it's a blank-check company. Fellow Fool Emil Lee explained both the how's and why's of investing in these vehicles, also known as SPACs (special purpose acquisition company). I think the key phrase from those articles is "heads I win, tails I get my money back with interest." A SPAC either finds an acquisition target by a set date, or it liquidates and returns the capital to shareholders.
Without getting too deep into speculation, it appears that Klarman's Baupost Group added to its already substantial stake in Star when Amaranth blew up in September, forcing the latter firm to reduce or liquidate many holdings.
That purchase may have been made at an attractive price (i.e., at a meaningful discount to Star's liquidation value), locking in "better than cash" returns, deal or no deal. But I'm more interested in the deal that actually did emerge this past January.
Star Maritime has entered into an agreement to purchase eight dry bulk vessels from a private Taiwanese operator, and to create a new company called Star Bulk Carriers. At less than five times estimated 2007 EBITDA, the purchase looks dirt cheap. The proposed capital structure is very lean, yet provides for robust free cash flow and a double-digit yield right out of the gate. Of course, the shares have appreciated a fair amount since the deal was proposed, so we need consider whether there is still value here relative to other operators.
EBITDA is not a great metric to use for these shippers, because a lot of them are highly leveraged, but I'll start there and refine the valuation a bit. Assuming shareholders support the deal, and warrantholders exercise their right to purchase shares, I come up with a fully diluted enterprise value for Star Bulk of roughly $640 million. That's nine times management's estimated 2007 EBITDA. This is only modestly lower than the low-double-digit multiples afforded competitors like Eagle Bulk Shipping (Nasdaq: EGLE).
However, the EV/EBITDA valuation ignores the superior balance sheet quality of Star Bulk, not to mention its fleet expansion flexibility and its ability to better cover its dividends. I frankly don't quite know how to value that information, but it's critical.
In the end, I find the Star Bulk story pretty intriguing, but it's not cheap enough for me to jump on shares today. There's a small discount to the peer group, sure, but the carrier deal is not yet consummated, and that hypothetical first dividend payout is an even further ways off. I'm happy to hold out for a better entry point, and given the volatility of this sector, I fully expect to be handed one.
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Fool contributor Toby Shute doesn't own shares in any company mentioned. There's nothing stuffy about the Motley Fool's disclosure policy.
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