GNK - Genco Shipping Is Still A Great Value Play

2023-10-11 02:03:03 ET

Summary

• Genco Shipping & Trading Limited stock has fallen 1.4% since my last bullish call but remains attractive at current price levels.
• Genco reported strong financials for Q2, including a net income of $11.6 million and a liquidity position of $54 million in cash.
• The company's management provided a positive outlook for the dry bulk industry, citing demand catalysts and a tight supply-demand balance. BIMCO's research supports these findings.
• The stock seems to be cheap in absolute figures. The dividend yield is going to be in high-single digits in FY2024.
• GNK is still a Buy, in my opinion.

Instead of an investment thesis

The last time I wrote about Genco Shipping & Trading Limited ( GNK ) was in early April. Since then, the stock price has fallen 1.4%, while the total return has been a measly 0.73%, while the S&P 500 ( SPX ) ( SP500 ) has risen 6.14%:

Nevertheless, I do not give up my previous "Buy" thesis and believe that GNK stock looks even more attractive at the current price level.

My reasoning

Genco Shipping & Trading Limited is a global company specializing in transporting dry bulk cargoes across the ocean. They own and operate dry bulk carrier vessels for commodities like iron ore, grains, coal, steel products, and other dry-bulk goods. Their vessels are mainly chartered to trading companies, producers, and government-owned entities.

In Q2 FY2023 , Genco reported a net income of ~$11.6 million [EPS = $0.27], revenue of $90.6 million, and a strong liquidity position with $54 million in cash and $207 million in undrawn revolver availability. The management expects a cash flow breakeven rate of $9,715 per vessel per day for Q3 2023, according to the earnings call commentary . The executives also provided insights into Capesize and Supramax rates and discussed factors impacting cargo volumes, especially iron ore and coal into China.

1. Capesize Rates: They mentioned that the Baltic Capesize Index crossed $20,000 per day in early May but later pulled back. As of the time of the call, spot Capesize rates were standing at ~$15,000 per day. This suggests that Capesize rates experienced some volatility during the quarter, with rates initially reaching a higher level before declining.

2. Supramax Rates: Genco noted that the Baltic Supramax index started the second quarter at ~$13,000 per day but had since declined to ~$8,000 per day. This indicates a decrease in Supramax rates over the course of the quarter.

Despite the year-over-year decline in freight rates, the company had a fairly strong cash flow, much of which was used to pay dividends and reduce debt.

The company's unwavering commitment to shareholders was reflected in its $0.15 per share dividend , continuing its impressive record of reliable dividend payouts. As you can see from the cash flow statement above, operating cash flow still covers dividend distributions, so I don't mind the high payout [ 81.03% , according to Seeking Alpha Premium]. As freight rates recover and grow again, I expect this ratio to drop and the dividend to become more reliable.

The firm's financial prudence in Q2 allowed Genco to utilize a portion of its quarterly reserves to pay a higher dividend, demonstrating its confidence in its low cash flow breakeven rate and overall financial resilience. At the same time, the company maintained its debt reduction strategy, with the goal of reducing net debt to zero in the medium term.

Genco's management also presented a positive outlook for the dry bulk industry, citing significant demand catalysts such as robust cargo volumes, particularly for iron ore and coal bound for China, and emphasizing the resilience of this demand even in the face of depleted inventory levels. The last statement is confirmed by the actual dynamics according to MacroMicro data :

GNK's executives underlined the industry's historically strong supply-side fundamentals, highlighting a relatively low annualized net fleet growth of 3.3% year-to-date. This low growth was attributed to a front-loaded delivery schedule and minimal scrapping activity, and they further noted the enduring impact of a historically low order book as a percentage of the fleet, coupled with impending near-term and long-term environmental regulations, which were expected to maintain a tight supply-demand balance in the years ahead.

The potential positive catalyst for freight rate sustainability is also confirmed by BIMCO's research - I refer to their high-quality work very often and consider it one of the best in the industry. From what I see, the supply/demand imbalance that BIMCO analysts predict speaks to the stability of rates and a potential upward trend.

Therefore, I believe GNK has great potential from the perspective of industry trends. However, it cannot be said that investors are overpaying for this potential at current prices: GNK stock trades at 7.6 times next year's EV/EBITDA, with an FCF yield of ~19%, which is about average for peers either way, but looks pretty good in absolute terms.

When comparing other important metrics for valuation analysis - the price-to-earnings ratios - many will ask a question: Why is GNK so expensive compared to other companies? To answer this, one must know that dry bulk carriers operate in a cyclical industry where it is important not to look at TTM multiples, but several years ahead. Actually, GNK looks very cheap compared to its peers with its 8.27x price-to-earnings ratio for FY2024, especially if we also consider the projected EPS growth of >300% for that particular year [based Seeking Alpha data]:

Closing Thoughts

Investing in GNK stock entails several risks that warrant caution. The dry bulk shipping industry's cyclicality makes GNK susceptible to economic downturns, and volatile freight rates can dramatically affect its revenue. Dependency on commodity prices further exposes GNK to market fluctuations, while its debt levels and exposure to regulatory and environmental compliance pose financial risks [even though the debt levels are shrinking]. As we saw above in the analysis of valuation multiples, GNK is not undervalued by all measures. Intense competition in the shipping market, currency exchange fluctuations, geopolitical tensions, piracy, and security threats in certain regions all add to the operational and financial challenges GNK faces. Moreover, fuel price volatility, the impact of natural disasters, trade policy shifts, liquidity constraints, and increasing ESG concerns could potentially harm GNK's performance and reputation, necessitating careful consideration for prospective investors.

On the other hand, I think GNK is well positioned to benefit from the recent performance of the Baltic Dry Exchange Index , which seems to follow the existing imbalances in the industry and has seen strong growth recently.

GNK looks cheap but has a high-quality fleet structure to absorb the existing imbalance and further reduce debt, without forgetting dividends. Of course, dividends in FY2023 will be lower than before. However, if the current industry recovery momentum continues, GNK should start paying a high single-digit dividend yield next year, and by that time the company will already have significantly less debt on its balance sheet.

That is why I consider my previous "Buy" thesis still valid.

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