There is no Alpha (α) in Shipping

Companies, seen as going concerns, are usually valued as a multiple of their earnings or cash flows (selectively), reflecting that a buyer of a company will be generating profits in the years to come based on the business’ assets, contracts, reputation, management, corporate competitive advantage, etc Based on the nature of the business and market conditions, the preferred multiple can differ or modified to accommodate unique circumstances. Of course, there are exemptions to the rule. For instance, who could forget the dotcom years when internet startups where valued on “eyeballs” rather than actual cash flows, reflecting hope and ambition that the distant future will be rosiest?

And, then, there are ship-owning companies – on the other spectrum of company valuations. Shipping companies are asset-heavy entities since they own the vessels, expensive capital assets with long economic lives. The prospect is that these capital assets will be utilized to generate cash flows and earnings – and, logically, shipping companies ought to be valued of some multiple of cash flows or earnings rather than just the assets. Valuing a refinery company, for instance, at the cost of their plant value most likely would imply a liquidation or a fire-sale scenario and not a going concern.

For those paying attention to publicly listed shipping companies, the valuation metric is the so-called “NAV”, that is the Net Asset Value – that is, the current value of the fleet less outstanding debt (mortgages) plus cash in the bank or other tangible assets. That’s how publicly listed companies are valued, as the value of the “steel” (ships) with little immediate consideration for earnings. In general, shipping companies are valued at or below NAV – effectively, if one were to liquidate the business would end up with the same or more hard cash in their bank account. Philosophically speaking, being dead (liquidated) has a higher price than being alive (going concern); this does not exactly sound very inspiring…

Perusing a current research report from a major investment bank one sees that the mean stock price of shipping equities stands at 0.97x of NAV and the median at 0.87x; with the exception of two companies that have long term contracts for their fleets (MPLs in the LNG space) that trade above NAV, more or less, any other shipping company trades at a discount to NAV; even the mighty Maersk with its hundred-plus year old name, gloried history, global reach and household name “doesn’t get no respect” – below NAV valuation, too; one tanker company actually at the time of this writing trades at 0.60x of NAV, meaning that if the stock price per share represents $10 worth of shipping assets, the price of the share stands at only $6. Ouch!

Shipping freight rates fluctuate over time and shipping asset values move accordingly with some time lapse and a varying degree of correlation. And, it’s well known that, unlike other assets that only depreciate, shipping assets do also appreciate in price. In a hot freight market, ships get more valuable despite their age. Low NAVs follow weak freight markets and usually indicate the prospects of freight rates are anemic in the near future, which is the current state of the market.

Theoretically, from an investment point of view, there is an arbitrage opportunity and money to be made between undervalued shipping equities (buy the stock or sell the ships when NAV is low) or sell shares when stock trading above NAV; and there has been just a case of the management team of two affiliated publicly listed shipping companies that have presented to the investment community an arbitrageur model of making money in shipping, buying back their own stock when below NAV or selling their ships when overvalued. Unfortunately such an investment strategy has not played well in real life in this case; many reasons, in our opinion, that the arbitrageur model has not panned out well, but let’s say that real life in the shipping industry is more challenging than an investment proposal often assumes.

The paradox, and a disheartening fact, in our opinion, remains that shipping companies are valued according to the value of their hard assets. There is zip premium for brand name (or “franchise”) value, for intellectual property, for charters and other contracts in place, for intangibles, and, regrettably for management expertise. And, if one adheres literally to the valuation definition, a below NAV valuation implies that the company’s management team not only does not add value to the firm, but, in a sense, is a liability to the firm. One gets the firm cheaper than one can buy the assets. Ouch!

From an investment point of view, one could argue that shipping management teams offer little alpha (α) – the premium return over the market return. Their expertise, knowledge, efforts and hard work mean precious little when it comes to adding value; the shipping equity stocks move along the beta (β) of the market, without adding any value. Ouch, again! Unless, there are concerns with the agency theory

Shipping company management teams most obviously generate value by timing vessel acquisitions and disposals, mainly by buying ships when they are cheap or undervalued. Effectively, it’s a focus on market beta (β) and market timing versus capturing alpha (α) by building and running a superior business. And, by focusing on beta – instead of alpha – there is a re-emphasis of a trading model at the expense of an operating business model, one to focus on generating profits from running the ships and not trading the ships themselves.

Some have argued that the public markets with their short-termism, regulatory constraints and poor valuation metrics are not the ideal source of capital for the shipping companies. Irrespective of whether such criticism is valid, the shipping industry is ripe for a shipping company management team that will be able to provide a superior business model and convince the investors to value shipping companies on metrics that go beyond the value of the “steel”.

And, just for the record, Basil M Karatzas, Founder and CEO of Karatzas Marine Advisors & Co., is an Accredited Senior Appraiser (ASA) for Machinery & Equipment by the American Society of Appraisers.

Love the “steel”, hate the shipping stock! Image credit: Karatzas Images

© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

The great disconnect for tanker asset prices

This article was first published on October19th, 2015, at the Seatrade Maritime News, The Daily Insight into the Shipping World at this link: “The great disconnect with tanker asset prices”

The tanker market has been enjoying a robust freight environment reminiscent of the days of the great bull market in 2008, with rates for the flagship sector of VLCCs topping $100,000 per diem. The strength of the market is well-deserved, and one is content to see smiling tanker owners after the brutal 2011-2014 bear market when rates barely topped $20,000 pd for the VLCCs, as per Exhibit A.

2015 10OCT15 The great disconnect with tanker asset prices_EXHIBIT A_VLCC Freight Rates

EXHIBIT A: Average VLCC Earnings Worldwide; Karatzas Marine Advisors & Co.

There has been no real catalyst for the change of direction for tanker rates, but many factors have contributed to a better market. First, the shale oil story in the US has been a game changer in the energy industry, and this has cascaded to the tanker market: the US is not the biggest importer of crude oil anymore, and most of the oil now flows eastwards to China, slightly increasing ton-mile, but mainly, by disrupting established trading patterns and bringing more uncertainty to the market – and, we all know that uncertainty is always good to shipping. Second, the brutality of the bear market had caused immense pain to many a shipowner, pain that actually scared some people off and away from newbuilding contracts and investing money in special surveys which led to increased tanker demolitions, bringing some order of balance in the tonnage equation. And, Saudi Arabia’s decision in November 2014 at the OPEC meeting in Vienna to go after share rather than price margins, an action meant against high cost oil producers, effectively guaranteed a strong tanker market for the foreseeable future.

It seems that at least for now, the trade-winds are fairly favorable for the tanker market: rates are respectable throughout the tanker market, both for crude and products tankers, and the trends of oil trading seem to have some time to run, and crucially the tanker tonnage supply is well defined for the next eighteen months – more or less the time that would be required for newbuilding tanker orders to hit the water. Well, under such circumstances, both tanker stock prices and also tanker vessel prices should have been enjoying a rally commensurate to the freight market rally and the present expectations. However, that has not been the case, to the dismay of shipping analysts, ship brokers, investors, shipbuilders, and ultimately the shipowners.

It’s well known that skyrocketing freight rates always pull up with them asset prices, with some small time lapse of one-two months. Volatility in freight rates leads to ‘asset play’, the favorable way of shipowners hitting the jackpot. It’s well known that shipping asset prices can double, treble or quadruple in a matter of a few short years, allowing for enormous paychecks. Actually, this is the reason that many shipowners and investors and private equity funds have been attracted to this industry in the first place.

2015 10OCT15 The great disconnect with tanker asset prices_EXHIBIT B_VLCC Asset Prices

VLCC Tanker Prices. Karatzas Marine Advisors

The present pricing environment for tanker vessels has been a major head-scratcher. While freight rates have more than doubled in the last eighteen months in the VLCC market (Exhibit B), tanker prices have barely moved higher by 10%, or 20% depending on asset class and vessel age profile. The difference in the order of magnitude is just too big to be attributed to ‘statistical error’ or just to a market anomaly or temporary dislocation. Trying to find out the reason behind the disconnect is not a pure academic inquiry; it has commercial value in the short term, to say the least, and it may imply that the market has changed and new expectations / leads / drivers are prevailing now; and the sooner an investor deciphers the meaning of vessel values in the new environment, the sooner one can dodge the troubles of a changing market or the sooner one can position themselves better for the paradigm shift.

Why this big disconnect?

The overall shipping industry, dry bulk, containerships, and now offshore assets, have not been doing well; actually, the dry bulk market has been making headline news for setting all time lows at the beginning of the year, with little improvement to show since then. The dry bulk market has a much wider ship ownership distribution, with many more owners worldwide, all of them bleeding cash for almost two years now; dry bulk owners are based everywhere, they are conspicuous – despite their efforts to keep a low profile, and they are particularly visible in bankruptcy courts. When shipowners in basically all major segments of the shipping industry are doing badly, it’s hard to see how tanker owners and tanker investors can get exorbitantly optimistic and start bidding up prices to the tune of the freight market. By association, tanker owners and investors are pulled down by the malaise of the overall shipping market.

The years between 2011 and 2014 have been awfully bad for tanker owners as well, and many of these shipowners have burned more cash than they cared to; thus, now after three years of major losses, the focus has been on building up some cash, bring their loans current with the banks, and otherwise setting their financial house in order. Since the years 2011-2014 scared some of the tanker owners to bankruptcy, getting aggressive at this phase of the cycle is a bit too premature for many of them. And, accordingly, chasing tankers to buy and bidding up prices has not been the case; it’s understandable.

When the overall shipping market crashed after 2008, many institutional investors rushed to invest in shipping via joint-ventures with shipowners and vessel managers. Lots of money has been invested in shipping, and not a negligible amount of that investments in newbuilding contracts. The truth of the matter is that many of these investments have been under water, so to speak, and many of these institutional investors have been burned with their shipping investments. Thus, now that the tanker market has been performing well, many institutional investors still do not think that it’s time to bet the farm on the tanker market. They are about to book losses in the dry bulk, containership and offshore markets, or know funds with losses from shipping, and now that the tanker has been strong, the rally has been seeing with a great degree of skepticism.

And, the present rally in the tanker market, as delightful as it has been, it could be best described as a big yawn. It has been extremely timid and well-behaved, even exhibiting the classic signs of seasonality with a weak summer and a strengthening in the fall; there is no violent movement, exogenic shocks to the market like disruptions due to natural or political or events of that nature. A pretty boring rally, once again, extremely welcome and desirable, but with no urgency of the type ‘buy tankers now because tomorrow will be too late to buy’.

Most shipping banks have been departing the shipping industry at present, for their own reasons. It’s fair to say, that debt finance in the form of ship mortgages for tankers is tough to obtain, especially for tankers older than eight to ten years of age. Thus, another reason for tanker asset prices failing to follow up the freight market has to do with the state of the banking industry, and the financial markets overall. For institutional investors like hedge funds and private equity investors, the prospects of shipping have faded of recent, thus, taking away any hope for the asset market to sparkle.

Thus, there are collateral reasons that tanker asset prices have not drawn the strength and the inspiration that the freight market would imply; an overall shipping industry in malaise, with tanker owners looking to build their cash positions rather than expand, and the lack of outside investors and bankers to chase up prices.

One however has to wonder whether there are more fundamental reasons that the tanker freight rally has failed to be more inspiring. For starters, despite the fact that tanker newbuilding orders collapsed during the crisis, the world tanker fleet keeps growing at 3-5% annually, not a negligible pace – especially when given that this is the lowest it can get. And, of course, when tanker freight rates moved up, tanker demolitions almost became negligible, thus the tonnage supply and demand balance has started shifting unfavorably, Further, a commanding majority of the world tanker fleet is newer than ten years of age, a fairly young age, given that vessels have 25 years of design life; and, by now, all single-hulls and other poor quality tonnage have already been scrapped, thus the remaining fleet is young and virile. Additionally, the outstanding tanker orderbook stands at approximately 15% of the world fleet overall, while for certain asset classes like VLCCs, Suezmax and Aframax tankers, the outstanding order is higher than 20%, not a negligible number; almost all these vessels will be delivered with two years from now, thus that impact on tonnage supply cannot be ignored without consequences. Today’s rally is great, but there are headwinds expected before asset prices have a chance to pull up the market.

Looking a bit deeper into the market, one can discern the lack of the strong buying interest from ‘smart money’, shipowners and market players who have the reputation for sensing and timing the market over time, and placing the right ‘bets’. Most reference name Greek shipowners have been conspicuously absent from the sale & purchase market, and similarly for names like Fredriksen, Zodiac, etc It seems that the present rally has failed to impress this demanding audience to open up their wallets (some of these owners have bought tankers, true, but on a much smaller scale than their financial appetite would afford to saturate). Most prominent recent transactions in the tanker market have been with OPM (other people’s money) by publicly listed companies like Euronav and Gener8, companies that their stock price trades below their NAV (their net value of their fleet) in the hopes that they will be able to pull the asset market higher and possibly benefit their own shares.

The changing seascape in shipping has affected many fortunes and still will affect many more. There have been many variables and parameters that have been changing since the market crashed in 2008, and the present disconnect between the tanker freight market and the price of tankers has been an interesting conundrum. If tanker asset prices fail to follow the freight market, is this a paradigm shift for future valuations and benchmarking, or just an indication that the tanker rally does not have real steam for a long, full-sail run?

© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.