GNK - Genco Shipping: Dividend Play With Upside Potential

Summary

• Genco Shipping's strong dividend yield of 11% builds a solid base for the investment case here.
• The upside potential in market capitalization is a good option for investors.
• Low debt levels decrease risk in a high interest rate environment compared to Genco's industry peers.
• A good strategy and a management team with a long history in the company and industry make Genco a stable player in the dry bulk market.

Editor's note: Seeking Alpha is proud to welcome Henri Suutari as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

A strategy focusing on dividends and low leverage makes Genco Shipping & Trading Limited (GNK) interesting for value investors. The company has a track record of paying a stable dividend and the ability to deleverage the balance sheet. Its valuation is reasonable, with a strong dividend yield of 11%. In addition to the strong dividend, the stock has upside potential if the company can hold free cash flow at current levels. The main risks are GDP development and cost inflation.

Genco Shipping Background

Genco Shipping & Trading Limited is the largest U.S.-based dry bulk shipper. Genco's fleet is used on dry bulk routes globally, and the company has offices in Singapore, Copenhagen, and New York (its headquarters). Genco is fully focused on dry bulk shipping and does not own other freight-type vessels. The company owns 44 dry bulk vessels transporting iron ore, coal, grains, cement, fertilizers, and other dry bulk products. Seventeen are Capesize vessels delivering major bulk (iron ore and coal) products, and 27 are Ultra-/Supra-size vessels delivering minor bulk (grains, cement, etc.) products.

Genco's vessel portfolio enables operation in all major dry bulk product categories. Genco's fleet is relatively young, with an average vessel age of 12 years. The vessel portfolio is fully compliant with IMO 2020 environmental regulations , and the company has fully made the investments (exhaust scrubber systems) needed to become compliant with regulation.

Dividends in Focus: Management Strategy

Genco's strategy has three main pillars. The first pillar is significant dividends through cash flow generation and reduced cash flow breakeven rates. The second pillar is balance sheet deleveraging through debt prepayments utilizing cash reserves. The third pillar is growth through acquisitions (the third pillar will be discussed in more detail in the risks section below).

From a dividend investor's perspective, the first and second pillars are the most important. Genco's management has presented strong performance in both. The company has a dividend yield of approximately 11% as of Feb. 10, 2023, with upside potential in market capitalization. Cash flow generation has been relatively strong through the last five quarters, with only one quarter with negative free cash flow. And even in that quarter the company paid dividends. However, volatility in cash flows also indicates the risk for this dividend strategy. Free cash flow volatility can be seen in the quarterly cash flow chart and if cash flows are inspected annually.

Low-Debt Levels Help GNK Operate in a High Interest Rate Environment

The company began balance sheet deleveraging efforts in 2020 and has successfully decreased its total outstanding debt from $449 million to $171 million in Q4 2022 (the company disclosed its unaudited debt level at the end of Q4 2022 before publishing its official quarterly report). A decrease in outstanding debt gives Genco good positioning in a high-interest-rate environment. According to the Q3 2022 quarterly SEC filing , Genco's average interest rate on its current outstanding debt is 5.34%. With debt levels at Q4 2020, the interest rate of 5.34% would mean an annual interest cost of $24 million. At the current debt level, annual interest rate payments will be around $9.1 million. Interest payments on a lower debt burden mean approximately $14.9 million in savings on interest costs.

Overall, Genco's position with low relative debt decreases risks related to refinancing and interest rate costs. Compared to Genco's peer group, the company outperforms on leverage ratios. According to data compiled by Seaborne Capital Advisors , Genco's total debt/asset value is 17.6% when the peer group median is 44.9%. Also, Genco's average total debt/EBITDA in 2022 is 0.7x, while the peer group median is 2.0x. Genco's next mandatory debt repayment is as late as 2026, but the company has regularly conducted voluntary debt repayments. In Q1-Q3 2022, the company paid the debt back at a rate of approximately $20 million per quarter. Genco's corporate presentation shows that their net LTV (loan to value) stands at 11%. The LTV calculation contains estimates of fleet values from a third-party vessel valuing agency.

Financials

Genco's revenue has been in a decline on a rolling quarterly basis. The main driver in the top-line development is freight rate development. The company identifies Baltic Capesize and Baltic Supramax as the main index for its pricing. We can see a clear correlation between Genco's top line and the Baltic Dry Index's development over time. The Baltic Dry Index peaked in late 2021 and has significantly decreased to its current level.

The profitability of Genco's business remains strong. The expense side of the income statement is more stable than the volatile top line. We can see that total COGS (cost of goods sold) have remained relatively stable quarterly, even when we see revenue volatility.

From a dividend investor's perspective, the ability to generate cash flow is important. Net operating cash flows have remained strong on quarterly inspection. Operating cash flow is fully dependent on revenue development. The main takeaway regarding operating cash flow is that the company's underlying business is strongly cash profitable.

Valuation

We will approach Genco's valuation through simple DCF calculation with two scenarios. The first scenario estimates Genco's current valuation, and the second takes a positive outlook on the cash flow growth rate. During early February 2022, Genco shares traded at approximately $18.50. From the DCF table above, we see that in a five-year period with a free cash flow annual growth rate of -95%, we get to the current share price of $18.48. The current price means that the stock market estimates Genco's cash flows to decrease almost to zero in a five-year time frame.

The second scenario, which can be viewed in the DCF calculation below, estimates that Genco can keep free cash flow generation at current levels. If Genco can keep its cash flow generation at current levels, the price per share could be $32.92. The second scenario means the stock could have a 78% upside potential. However, multiple risks might affect Genco's cash flows. The company noted interest rate risks as one of the major risk for its business in the Q3 2022 filing linked above.

Individual investors are encouraged to do their own due diligence when it comes to valuation. The current market environment seems to have little belief in Genco's ability to sustain its cash flows at current levels.

Risks

Genco operates in the commodity market and is exposed to multiple risks, with limited ability to affect outcomes in the market environment. The development of macro factors has a major impact on dry bulk trade.

Genco's third strategy pillar, growth through acquisitions, can be seen as a potential risk from a dividend investor's perspective. The company discloses its intention for mergers and acquisitions indirectly in its strategy slide by noting that it's able to "use shares as a currency to grow." If the company decides to utilize this tool in its strategy toolbox, management might shift its focus too much away from running smooth operations. Failed corporate acquisitions can put a lot of financial stress on the company and might weaken Genco's ability to pay dividends.

Global GDP development is heavily correlated with dry bulk trade. Global GDP and dry bulk trade have a correlation of 0.72. If global GDP development is negative, Genco's business might suffer.

Interest rates also have an impact on Genco's costs. The company is hedging its interest rates to improve interest cost forecasts. However, even when hedging interest rates, the company is still exposed to interest rate volatility through unrealized losses and gains on forward contract positions.

Genco has decreased its leverage significantly, but the company still has long-term debt on its balance sheet. This could affect the company's ability to negotiate financing terms with suppliers.

Conclusion

In conclusion, Genco Shipping has a good position in the dry bulk shipping market. The company has a credible strategy focusing on dividends and low leverage. Management is experienced in the industry and has served at Genco for a long period. The balance sheet is strong compared to its competitors, which helps Genco navigate inflationary and high interest rate environments. When adding in a relatively low valuation with a P/B of 0.64 and P/E of 3.50, the stock seems to be an interesting candidate for a dividend-focused value investor's portfolio.

For further details see: