Lessons Learned From a Tumultuous Year in Dry Cargo Industry

Summary

Despite the worst market in memory, big-name shipping companies survived the storm by bravely recapitalizing their balance sheets.

Dry cargo companies restructured outside of bankruptcy court protection.

By helping to recapitalize, private equity firms engaged in counter cyclical investing, acquiring shares at bargain basement prices instead of cheap assets.

A Year ago we forecast that as we entered 2016, dry cargo shipping companies would have to make do with a spot market barely covering vessel operating costs; they would have to tap their cash reserves to service their loan obligations; falling asset prices would lower their borrowing capacity for new building deliveries; and, at some point, even the better-capitalized companies would breach their loan covenants or simply run out of cash.

Even then it was clear to us that shipping companies would need to raise cash.  Preferably in the form of equity.  We wondered, would capital markets be there for them? Would controlling shareholders shore up their investments? Or would a trip to a bankruptcy court become the new norm?

So, did any of that actually happen?

For starters, the freight market has been pretty bad overall in 2016 – even worse than the worst-case scenario we had envisaged.  The four companies in our stress test generated record negative operating cash flows.

Yet none of them ran out of cash, nor did they seek bankruptcy protection.  All four companies had ample cash reserves as of September 30, 2016, as we were entering a seasonally strong quarter.

Operating cash flow and reserves

(1) Includes private placements for EGLE and GNK after September 30, 2016

Source: Company filings, Lloyd’s List

How is that possible? The answer lies in the ingenuity of each company’s executives to actively manage their capital budgets, and to look for solutions to adversity before it became an insurmountable problem.

Although each company faced a different set of circumstances, they all adopted one or all of the following strategies: reign over operating costs to extend cash burn; trim capital expenditures by selling assets or extending newbuilding deliveries; negotiate debt repayment holidays with lenders (which also included temporary waivers on loan covenants); and, last but not least, recapitalize their balance sheets by issuing fresh equity.

Yes, companies recapitalized, and in some cases radically, as we had predicted.  But because of a painful lesson the industry had learned in the recent past about bankruptcy costs (once bitten, twice shy as the saying goes), executives chose this time to restructure their balance sheets outside of court protection.

This is not to say that recapitalizations were harmless.  Because of distressed stock prices, the more a company raised in equity, the higher the dilution was to old shareholders.  Case in point, Eagle Bulk Shipping – the supramax specialist raised a total of $188m in two private placements, but the new shares issued (including approximately 17m shares issued in connection with a new loan facility) represent 97% of total shares outstanding.

Share count and equity proceeds

(1) Includes private placements for EGLE and GNK after September 30, 2016

Source: Company filings, Lloyd’s List

Genco Shipping and Trading is about to complete a similarly radical restructuring.  Having issued $125m in preferred securities in November 2016, it will convert them to common shares pending shareholders’ approval in early January 2017.  Assuming the approval goes ahead, the new shares issued will represent 79% of total shares outstanding.

Scorpio Bulkers and Star Bulk Carriers also raised $133m and $52m in 2016, respectively. The dilution in these cases was lower but it must be noted that the two companies had also raised substantial sums of equity in the prior year.

In all cases above, the majority of existing shareholders, many of whom are marquee private equity firms, contributed the bulk of new funds.  These firms are already nursing heavy losses from their original investments that are deep under water.  Which begs the question – have they lost it or is this time going to be different?

Although many dry cargo experts like to blame private equity for all industry’s woes, perhaps this time these firms are doing the right thing.  And not just for their benefit, but for industry’s sake too.

A fundamental principle in shipping is to make counter-cyclical investments, or to buy assets when they are cheap and unwanted, and sell them when they are expensive and in high demand.

By recapitalizing publicly traded companies at distressed share prices, private equity firms engage in such counter-cyclical play.  The only difference is that instead of buying cheap vessels they are buying shipping shares at bargain basement levels.

The industry also benefits by not having cash-strapped companies operating sub-standard vessels without proper care and maintenance.

John Angelicoussis, one of the industry’s most successful figures, told an audience at the recent Marine Money Forum in New York that his secret to success has been patience, long-term focus, and the ability to correct prior mistakes.

Is it possible, then, that the much vilified private equity firms have borrowed a page from one of the industry’s best by staying the course and correcting their past mistakes?

Only time will tell.

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Source: Seeking Alpha

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