Star Bulk Undervalued on Rates, Oaktree Stock Sale

• Star Bulk Carrier is often undervalued when it comes to its stock rates.
• Research Analyst William Meyer believes the company’s stock will be up in the next few months.
• The primary stock owner of this company is Oaktree who owns 43% of the share.
• With the bulk rates rising up and the P/E ratio looking reasonable, the star bulk carrier is scheduled for a rise in the next 6 months.

Research Analyst William Meyers has come up with a detailed report about the Star Bulk Carrier and their business propositions. As we all know, Star Bulk Carriers owns and operates over 70 of the world’s largest vessels used to ship dry bulk goods like ores and grains around the world so knowing about their business greatly affects the shipping industry. So here is the detailed report by Meyers as found in the Seeking Alpha website.

The stock price was strengthening in anticipation of continued improvement in freight rates and hence profits, but it pitched down suddenly last week following a news that the largest shareholder was selling a portion of its shares.

Right time to invest

William Meyers believes that the market situation has some, however it is very likely that buyers can make super-profits while the price is relatively low.

The stock should be up over the next few months, as well as over the next few years, for fundamental reasons.

Bulk Rates Are Headed Up

Dry bulk shipping is a very volatile and seasonal business. Ships last about 20 years before being scrapped and take as long as 2 years to build. When there is a surplus of ships for any reason rates fall; when a surplus of demand for shipping, rates can climb suddenly. The Baltic Dry Index (with its sub-indexes based on ship cargo capacity) is an average. Rates can be plummeting in Australia while they are surging in Brazil, or vice versa, for instance.

Nevertheless there are seasonal patterns that usually hold, as shown by this 5-year chart of the BDI:

Source: Bloomberg

Rates tend to be highest in Q4, often peaking in November, as northern hemisphere nations import coal for winter heating. Conversely rates tend to be lowest in Q1. Bulk shipping company stock prices tend to follow this pattern, despite the predictability of it. However, in 2015 instead of rates rising in Q4, rates fell, frightening investors and presenting the opportunity to buy low that I mentioned above. The main reason rates were so bad in 2015 is that a lot of newly built ships (“newbuilds”) came onto the market, ordered earlier in the decade when demand was high (that peak at the left of the chart).

Demand yet seen

Volatility continues, and everyone fears a trade war, but demand has been creeping up, while few new ships have been put in the water since 2015, and not many are being built right now either.

Typically the rates at the end of June, as indicated by the BDI, are a base that gets built on during the second half. On June 29 the BDI was at 1385, up 54% from 901 one year earlier (image does not include the 29th):

Source: Bloomberg

As you can see in the chart, last year the index bottomed in early July, then climbed, with volatility, into December. That is a typical pattern.

Keeping in mind that the BDI is an average, and each shipment is booked at an individual rate that may vary greatly from the average, I would characterize the 1000 level as where rates become profitable for Star Bulk, and for most of the more efficient shippers. The more time the curve is above 1000, the more profit.

Profitability

An investor selling stock does not change the earnings of a company. Star Bulk earnings have been growing as rates have increased from bottom since 2016. Here are the last five available quarters:

Note the seasonal retreat in Q1 2018, which nevertheless represents a y/y swing to profit from a loss. In addition to earnings, the usual data on Star Bulk is available in its press releases and SEC filings.

Cash and debt are particularly important in the bulk shipping industry because building an individual ship is so expensive. Usually bank loans are needed to finance a new build. Here is the critical data from the end of Q1, 2018.

In particular, note that cash added to the value of the vessels, minus debt, is about $1 billion. Compare that to the market capitalization (Friday, June 2) of $825 million.

The Oaktree Opportunity

Star Bulk’s stock price was sent lower starting on June 26, 2018 by the announcement of a secondary offering. On June 27 the price of the offering was announced, at $13.10, for 5 million shares. Yet on Friday, on the open market, the stock could be bought for less per share.

A secondary offering does not cause dilution of existing shares. It indicates the share owners would rather have cash, and the usual interpretation is that they have lost faith in the future of a company.

On the other hand, clearly other investors had faith that SBLK was a good buy at $13.10.

Oaktree was the majority owner of stock before the sale, and still owned 43% of the stock after the sale. That is a lot of stock for an investor to own in one company. I believe that Oaktree has made a lot of money from its investment in Star Bulk, and simply wanted to diversify.

If you go back to the February 2, 2017 Star Bulk press release, you will find Oaktree and affiliates then bought 6.3 million shares at $8.154 per share. Oaktree then owned 51.4% of Star Bulk. If you consider the recent sale to be essentially the shares that were bought in 2017, Oaktree made 5 million times $4.95 per share, or $24.73 million, in a little over a year. They had added cash to Star Bulk when cash was needed. Now they can take some cash out because Star Bulk is generating positive cash flow each quarter.

I see no reason to assume the Oaktree is doing anything other than limiting its risk in a single investment.

New Vessel Acquisitions

Star Bulk is expanding its fleet to over 100 vessels. I think that is good, given that I think rates are going up. It should increase profits. I am not going to analyze the specific deals, but here are links to the press releases, if you want to check out the details:

Caveats

Of course, it is possible that Oaktree Capital Management does have knowledge about Star Bulk, or about the dry bulk sector in general, that I do not have. They could be dumping more stock later because they foresee a lower stock price in the future.

Some other caveats are: 1. Shipping rates are based on supply and demand and are not guaranteed to rise this fall. 2. There could be an unforeseen, Star Bulk specific negative event or even disaster. 3. Even if rates and earnings continue to rise, there is nothing that forces investors to bid up the stock to what would normally be an appropriate level.

A global recession would almost certainly dampen rates. An escalation of the trade war could cause a recession. Even if the global economy remains intact, problems with a major dry-bulk consumer like China, or an industry like steel or aluminum, could dampen demand for shipping and rates.

Other Dry Bulk Stocks

The general reasoning in this article about increasing shipping rates should apply to other dry bulk shippers as well. I believe Star Bulk is particularly efficient and well managed, but each company has its specifics, and stock prices may reflect that. This is not a complete list:

DryShips (NASDAQ:DRYS)

Safe Bulkers (NYSE:SB)

Scorpio Bulkers (NYSE:SALT)

Genco Shipping (NYSE:GNK)

Golden Ocean Group (NASDAQ:GOGL)

Conclusion

I don’t think any of the negative scenarios are likely in the next six months, and if the global economy continues to expand in 2019, there will be serious shortage of ships, and hence even higher rates and profits.

I believe that Star Bulk will look better to new investors as the year rolls on. After third quarter results there will almost certainly be 4 straight quarters of positive EPS results. That also means the P/E ratio will appear more reasonable, even if the stock price climbs into the upper teens.

I see no reason except investor fear that Star Bulk should not break through $20 a share if rates go up as usual in the fall and it looks like the world economic expansion will continue in 2019.

Of course, if you think Donald Trump is really going to bring international trade to a complete halt, you should not invest on this thesis.

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Source: Seeking Alpha

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