Through the first nine months of 2018, Star Bulk Carriers Corp. (SBLK +2.83%) saw revenue roughly double over the same period in the previous year. Adjusted EBITDA rose from around $72.4 million to $178.5 million in the span. And during the third-quarter conference call, management explained that it has a pretty strong outlook for the bulk carrier industry right now. So far, Star Bulk Carriers Corp. sound like a solid buy, but read this before you jump aboard.
Taking a lay of the land (or sea in this case)
Star Bulk owns 112 dry-bulk ships (a couple are still being built, with expected delivery dates in early 2019) spread across the various industry standard sizes. These are the vessels that carry "bulk" commodities like coal and iron ore from where they are mined/grown to where they get used. Bulk carriers are vital assets in the fabric of world trade, and Star Bulk is one of the largest U.S. listed names in the space.
Image source: Getty Images.
At the end of the third quarter, long-term debt made up around 45% of the company's capital structure. That's a figure to keep in mind, though it's not an outlandish number for a company that has to invest in expensive, long-lived assets like massive boats. And at this point, Star Bulk doesn't expect material new-build costs in the future, because it has already paid for the small number of bulk carriers it has on order.
The only major expense it has over the next year or so is installing scrubbers on its fleet, which will allow its ships to use lower-cost fuels (helping keep operating costs down) while still complying with increasingly stringent environmental regulations. At an average cost of around $2 million per boat, though, that cost could, erring on the side of caution, add about $200 million in debt to the company's balance sheet. That would leave long-term debt at a still reasonable 50% or so of the capital structure.
Meanwhile, Star Bulk management has a pretty positive outlook for the next couple of years. According to CEO Petros Pappas, a combination of slower boat speeds, industrywide scrapping of older vessels, and a relatively modest pace of new construction should reduce bulk capacity by an annual rate of about 2% over the near term. Demand, meanwhile, is expected to increase by as much as 2.9% a year. No wonder the prices Star Bulk has been able to charge customers have been strong lately, increasing 50% year over year in the third quarter. This positive outlook also helps explain why the company's fleet utilization could remain high, with utilization through the first nine months of 2018 at roughly 99%.
The fly in the ointment
Star Bulk may still sound like a great investment opportunity, especially since the stock is up more than 400% over the past three years. And it might be, but it's also a fairly risky one that's only appropriate for aggressive investors...and investors with strong feelings about the prices Star Bulk can charge its customers.
Demand for bulk carriers is highly dependent on global economic activity, making it a highly cyclical industry. If there were to be a global economic recession, or even just a material slowdown in a large demand source like China, global demand for iron ore, coal, and other bulk materials would likely drop off fairly quickly. That, in turn, would lead to lower demand for the ships Star Bulk owns.
Lower demand would be a double-whammy. Not only would fewer ships get used, lowering utilization, but the rates Star Bulk could charge for the use of its ships would likely fall as well. Now add in the company's leverage. Although not outlandish for the industry, it still comes with notable interest expenses and can help to make Star Bulk's earnings a little volatile. In fact, 2018 is likely to be the first year in five years that the company has positive earnings.
Yes, the outlook today looks very good. But the year-over-year rate increase of 50% in the third quarter, and the positive impact that had on earnings, are both an exciting development and a warning. If rates fell by that much, which isn't out of the realm of possibility, there would be a great deal of pain to endure. On that front, it's worth pulling back the performance graph above just a few more years, revealing that the stock is down 85% over the trailing-five-year period.
Only for aggressive types
Star Bulk isn't a good option for most investors. Yes, it may appear that the "stars" have aligned for solid results over the next year or two, but that's only true if global economic growth remains strong. And if the positive outlook the company is currently projecting doesn't materialize, there is notable downside risk to financial results and, likely, stock performance. This is a stock that only an aggressive investor with deep knowledge of the bulk carrier space should be looking at today.
Check out the latest Star Bulk Carriers earnings call transcript.
