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.

 

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Shipping Finance Elements and Concepts

Following Presentations on Shipping Financing have been found on the internet. They are reproduced here as a matter of convenience for readers interested in the subject of how ships have been financed under different structures and different business models, at present and over time.

MV NEPTUNE THALASSA 13 BMK_5610 @There is debt (senior or first preferred ship mortgage, second lien, junior loans) and equity (owners’ equity or sweat equity, friends-and-family money) for the archetypal structure available to independent (individual) shipowner. Shipping banks over time had been the prime financiers of the shipping industry mostly in  the form of asset-backed financing (mortgage). There is leasing whether operating or financial leases, sale and leaseback, or uniquely structured Japanese Operating Leases (JOL), and financing earned via long-term charters (time charters and long-term bareboat demise charters). Independent shipowners have been dealing with shipping banks and often financed vessels via project finance, and when circumstances fertile, dealt with private equity as well. For owners who sought public equity and underwent an IPO process, the capital markets for equities and for bond (shipping bonds) have offered more alternatives. Shipping finance has been experiencing tectonic changes since 2008 and has moved from relatively self-explanatory terms of vessel valuations and Loan-to-Value (LTV) to terminology to accommodate Basel III with its Tier 1 Capital (CET1) to Risk-Weighted Assets (RAW) and the Capital Adequacy Ratio.

Copyright to the presentations and articles listed herebelow belongs to their perspective owners, and hereby duly acknowledged. Presentations have been found posted freely on the world wide web, and reproduced here as a matter of convenience.


Elements of Ship Finance
Zan Yang and Jian Chen
Department of management, Dalian Maritime University                                                  Last accessed on the internet on July 26, 2016.                              http://www.paper.edu.cn/scholar/downpaper/yangzan-2.html


Risk vs Return for Lenders and the Economics for Borrowers
by R. Philip Bailey, June 2015
Last accessed on the internet on July 26, 2016.

By Allan D. Reiss, Morgan Lewis & Bockius LLP, 2014

Last accessed on the internet on July 26, 2016.

Deloitte, 2011
Last accessed on the internet on July 26, 2016.

Irish Maritime Development Office, 2015
Last accessed on the internet on July 26, 2016.

Shipping Finance: A New Model for a New Market                                                  Citi, 2015                                                                                                                       Last accessed on the internet on July 26, 2016.                                    https://www.citibank.com/tts/trade_finance/financing/docs/citi_ss_v2.pdf


The Impact of the Basel III Capital Accord of Asset Finance
by Angelo L Rosa, 2012
Last accessed on the internet on July 26, 2016.

by Basil M Karatzas, 2010
Journal of Equipment Lease Finance
Last accessed on the internet on July 26, 2016.

Dissertation by Alex Orfanidis, 20014
Last accessed on the internet on July 26, 2016.

Ariff Kamarudin, 2012
Lehigh University
Last accessed on the internet on July 26, 2016.

© 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.

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