GNK - Genco Shipping: Yield Of 13% And Improving Prospects

2023-06-12 07:35:00 ET

Summary

• In this article, we will look at Genco Shipping. This is a unique company in the shipping sector with great prospects.
• GNK is very attractive at current prices, with a TTM yield of over 13%.
• Its "net debt" is at an extraordinarily low level for this industry. It is only 11% of gross asset value and only 2/3 of 2022 annual income.
• This is an excellent income play for dividend investors with big upside potential.

Co-authored with Philip Mause

The shipping sector has disappointed many investors. Shipping companies (companies that own commercial ships) frequently show up on screens programmed to yield value opportunities because shipping stocks can have very low price/earnings ratios and high dividend yields. This seems superficially very attractive to many investors. However, typical shipping securities present several serious risks.

• First of all, many shipping companies are set up as limited partnerships. Typically, The general partner has complete decision-making authority. Worse yet, the partnership is usually managed by an external "manager" who often has a relationship with the general partner. This creates enormous risks of conflicts of interest and distorted incentives – including an incentive to expand in order to maximize management fees at the expense of profits.
• The shipping company is usually formed outside of the United States, most often in Greece or Monaco, and does not have full SEC reporting and compliance obligations. To top it all off, the entity frequently has gargantuan levels of leverage, which does not work well in an industry with very volatile demand and pricing. As a result, the stage is set for a scenario in which the general partner and the external manager reap enormous rewards while the limited partners get skinned alive. It is not surprising that there have been many, many investors who have been extremely disappointed by this sector.

This is an article about Genco Shipping and Trading ( GNK ), a shipping company that does not fit this model. GNK is a U.S. "C" corporation subject to SEC requirements. Management is internal. There are no related party transactions. And – most importantly – debt levels are very, very modest with a strong management commitment to reduce or contain debt ratios. Tax reporting is on a 1099 (no Schedule K-1).

The Industry

The shipping industry is divided into several sectors based on the type of ship. We are all familiar with container shipping, which is a massive part of the industry. There are also fleets of petroleum, refined products, and LNG tankers. Another sub-sector is roll-on/roll-off shipping which is designed primarily to transport vehicles. Dry bulk shipping involves ships with large holds capable of transporting (primarily) iron ore, coal, grain, fertilizer, construction materials, and animal feed. GNK is in the dry bulk sector.

Within each sector, there are different size ships often designated based on whether they can traverse the Suez and/or Panama Canals. Another distinction is whether or not ships are equipped with scrubbers, which reduce air pollution. Scrubber-equipped ships generally command higher rates because of lower fuel costs.

Each sector of the industry has its own supply/demand dynamics in terms of cyclical, secular, and seasonal trends and patterns. Shipping companies try to protect themselves from the earnings rollercoaster that this can produce by offering advance contracts at fixed fees to lock in a revenue stream. There is a lead time in ordering new ships, so that the industry has to estimate future demand and supply in order to avoid excess capacity.

It is not surprising that the cataclysm of 2020 adversely affected this industry. On the other hand, demand has returned strongly, and there are trends which are promising. In the dry bulk area, it is pretty obvious that the economy of China is very important because – when the Chinese economy is roaring ahead – lots of iron ore and coal are imported using dry bulk ships.

GNK is not among the largest dry bulk shippers. The largest in the industry is Oldendorff Carriers – which is a privately held company in Germany. Trends in industry pricing are often followed by using the Baltic Dry Index ('BDI'), which is also an important macroeconomic indicator.

Because different types of ships cannot easily (if at all) be repurposed to operate outside their own subsector, analysts follow capacity data for each subsector separately. In the dry bulk subsector, there is evidence that the pipeline for new capacity (sometimes called the "order book") is very limited and that the fleet is aging with a large number of vessels more than 20 years old. This suggests that pricing power may emerge in the coming years as the total number of ships in service declines or at least fails to keep up with growing demand. It is also the case that new environmental regulations may lead to the scrapping of a number of older vessels.

Genco

GNK's strategy is called a barbell approach with some very large Capesize ships (17 vessels) that tend to have more volatile earnings and tend to be focused on iron ore shipment, as well as a larger number of smaller Ultra/Supra Max ships (27 vessels) that are more versatile and have more stable earnings. The industry is subject to increasing environmental scrutiny, and GNK has installed scrubbers on its Capesize vessels. This means that the vessels are not required to use low-sulfur fuel (which is much more expensive), resulting in enormous fuel savings. GNK is continuing to keep its vessels up to date on environmental compliance.

GNK had a soft quarter in Q1 2023 (the first quarter is often weak in dry bulk) with revenue of $94.6 million and earnings of 6 cents a share. Adjusted EBITDA was $19.9 million. At the end of the first quarter, GNK had cash and restricted cash of $50.6 million and debt of $156.6 million leading to net debt of $106 million. GNK closed recently around $14.00 and paid a first-quarter dividend of 15 cents a share on May 23rd. Net debt was 11% of the fair market value of assets (the estimated value of the ships). Net debt was actually only 40% of the scrap value of GNK's vessels.

A better metric to assess GNK is full-year 2022 data. Revenue was $536.9 million, and net income was $159.4 million. With a share count of 43 million fully diluted shares, the net income per share was $3.70. 2022 dividends total $2.57 cents per share. Net debt was roughly two-thirds of 2022 net income.

It is also important to note that GNK has paid down $287 million in debt since 2021, putting it in a very enviable balance sheet situation. No mandatory debt principal debt payments are due until August 2026. Even using depressed Q1 2023 data, net debt is only 1.3 times annualized EBITDA.

Using 2022 data, GNK is trading at 3.4 times annual earnings. The dividend yield is 20.3 % – again, using 2022 dividend data. Obviously, this stock's pricing is heavily based on Q1 2023 data, and a return to 2022 performance will pay off big time. GNK doesn't really have to go anywhere near 2022 performance levels to pay off handsomely. And investors don't have to worry about General Partners or External Managers sneaking away with the loot.

Another way to view the yield issue is to look at trailing twelve-month dividends. In the case of GNK, TTM dividends come to $1.93. Comparing this to GNK's June 8th price of $13.98 produces a dividend yield of 13.8%.

Conclusion

GNK is very attractive at current prices. Net debt is at an extraordinarily low level for this industry. It is only 11% of gross asset value and only two-thirds of the 2022 annual income. This is really unusual in a highly leveraged industry. It gives GNK some important advantages – the ability to buy assets at deep discounts if trouble emerges and the ability to sustain profitability at much lower price levels than its competitors.

Investors should be aware that dividends vary quarter to quarter. This is not a company with respect to counting on a steady stream of dividends. GNK may not pay 14% going forward... but on the other hand, it may pay considerably more. GNK is very well positioned to take advantage of a surge in demand, but it is also structured to be able to ride out a slump. For the dividend investor tolerant of quarter-to-quarter variation in dividends, GNK is a solid choice at the current price level.

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