PANL - Pangaea Logistics Has Upside Potential

2023-08-18 10:13:34 ET

Summary

• The dry bulk shipping sector has been beaten down due to the Russia-Ukraine conflict, high oil prices, high inflation and a distressed demand situation.
• TCE rates have exceeded average published market rates by an average of 49%in Q2-2023.
• In terms of fleet utilization, Pangaea's 25 owned vessels were fully utilized in Q2-2023 driven by its nimble fleet approach.
• The company has also demonstrated better financial health, as evidenced from its low debt-to-equity ratio.

Investment Thesis

Pangaea Logistics Solutions ( PANL ) is a small-cap maritime transportation company. I believe in the current environment, where the shipping industry is going through softer dry bulk rates, Pangaea provides an exciting risk/reward opportunity for investors willing to overcome geopolitical risk towards Russia-Ukraine conflict. The company's flexible chartered-in strategy, strong full fleet utilization and long-term contracts would help to protect revenue growth and margins in the next few quarters. Therefore, it will be able to sustain the economic downturn comfortably, driven by a premium TCE rate well above the benchmark indices.

In the near-term, the recovery of China's economy is expected to be a positive for demand of shipping sector. Furthermore, US infrastructure spending is beginning to increase , creating a favorable situation for infrastructure related raw materials, which is beneficial for Pangaea dry bulk vessels.

Industry Overview

Pangaea is a provider of maritime logistics and seaborne dry bulk transportation solutions through operating a fleet of company-owned vessels and chartering. The Dry bulk transportation is a crucial part of the global shipping industry. It is the most effective way of transporting huge volumes of commodities and finished products. The Russia-Ukraine conflict adds painful uncertainty, with trade-restrictive retaliatory measures imposed. It is expected that demand for shipping industry will remain low for 2023 due to high inflation, the expected continued increase in central bank rates and recessionary pressure on the global economy. In the medium-term , the dry bulk shipping industry will grow at a CAGR of 4% between 2023-2030, driven by transportation of coal and steel.

Stock Catalyst

TCE (Time Charter Equivalent) rates are an important indicator for evaluating the performance of shipping companies, and they calculate the average daily revenue performance of a vessel. In Q2-2023, Pangaea's average TCE rate of $15,558 per day , exceeded the average market rates (Baltic Panamax and Supramax indices) by approximately 49%. I believe this trend will continue into 2023 given the Pangaea long-term contracts (providing multi-year demand visibility), specialized fleet and full utilization, and cargo-focused strategy. Due to a specialized fleet , Pangaea is positioned to benefit from tightening global availability of dry bulk vessels amid improving demand for vessels.

Q2-2023: Post-Earnings Analysis

Below are three things that investors should consider while reviewing the earnings report:

1. Key performance indicators: TCE Rates, Shipping Days & Fleet Utilization

TCE rates, shipping days & fleet utilization are key metrics for evaluating shipping industry performance. Therefore, investors should watch for improvement in these metrics.

TCE Rates in Q2-2023 decreased by 43% YoY to $15,558 from $27,139, while TCE rates improved from Q1-2023 due to overall dry bulk market rates. Pangaea's TCE rates have exceeded average published market rates by an average of 49% over this period due to its long-term contracts, specialized fleet of vessels and flexible cargo-focused strategy. According to management, the current Q2-2023 estimated TCE rate of $16,700 indicates a 96% premium to the market average. Investors should watch for the consistency in TCE rates and comparison with market rates. I believe that TCE rates will increase going forward due to strong demand from China and the peak demand season in the Arctic (Pangaea has a leading position within Ice-Class trade).

Shipping days in Q2-2023 decreased by 14% YoY to 4,056, from 4,703 for the same period in 2022 due to continued demand softness in the market. In terms of fleet utilization, Pangaea's 25 owned vessels were fully utilized in Q2-2023 driven by its nimble fleet approach, also supported by an average of 20 chartered-in vessels.

In a nutshell, for maritime transportation companies, their shipping days, TCE rates and fleet utilization are key determinants that may cause sales to increase or decrease. Therefore, investors should track the growth rates of these metrics in earnings reports.

2. Operating Expenses:

The total revenue for Q2-2023 decreased by 40% YoY to $118.0 million from $195.5 million in Q2-2022 due to the decrease in TCE rates and shipping days. Pangaea integrated shipping and logistics model generates revenue from the voyage segment (93% of total revenue), the charter segment (6% of total revenue) and the remaining from terminal and stevedore revenue through providing inbound and outbound cargo handling services at ports.

In the above table, the total cost of transportation and service revenue is $97.1 million for Q2-2023, which is 82% of total revenue. The total cost of Pangaea consists of voyage expenses (45% of total revenue), charter expenses (24% of total revenue), and vessel operating expenses (11% of total revenue). For investors, these are important metrics to understand the overall operating efficiency of the company.

Voyage expenses : In Q2-2023, voyage expenses decreased by 20% YoY to $54.4 million compared to $67.9 million, due to a reduction in bunker consumption which was partially offset by improved port costs. Voyage expenses include bunker costs, cargo handling operations, brokerage commissions and port charges. The bunker cost per day decreased by 33% YoY in Q2-2023 due to a decrease in voyage days and market prices. Fuel (50% to 60% of the total ship operating cost) is a key cost driver for the shipping industry. Therefore, changes in oil market will impact operating expenses significantly. Hence, the company is poised to minimize the risk of such volatility through a hedging program.

Voyage expenses as a percentage of total revenue dropped to 45% in Q2-2023, compared to 34% in Q2-2022. I believe that voyage expenses will increase in the near-term, mostly due to the increase in fuel prices on account of ongoing Russia-Ukraine conflict.

Charter expenses: Pangaea charters vessels to support its operations. For investors, its important to evaluate the chartered-in days and average chartered rate for determining charter expenses. In Q2-2023, charter expenses decreased by 56% YoY to $29.1 million compared to $65.7 million, due to a reduction in market rates for charter-in vessels. Chartered-in days decreased from 2,501 days in Q2-2022 to 1,915 days for Q2-2023, a reduction of 23% on a yearly basis. The most important aspect of having a flexible charter-in strategy is to support company-owned vessels with chartered-in vessels at market prices to meet cargo demand.

Note for investors: Changes in voyage expenses, charter expenses, and vessel operating expenses are important for evaluating any investment.

3. Operating Margin

In Q2-2023, operating income decreased by 77% YoY to $7.8 million (6% margin) compared to $36.2 million, due to deteriorating market fundamentals reflected by the negative 40% YoY growth in revenue and high inflation impacting the expenses of the shipping industry. Going forward, management is expecting margin expansion due to strategic investments in complementary assets. However, the company may face challenges in achieving net income margin expansion if interest rates change drastically. In general, the shipping sector is very capital-intensive , requiring significant investment of capital expenditure financed from long-term debt. In Q2-2023, Pangaea had a total debt of $106.9 million and equity of $361.5 million. This shows that the company has a debt-to-equity ratio of less than 1. I believe the debt-to-equity ratio has not reached a point where it is becoming a difficult situation on raising additional debt.

Investment Risks

Russia-Ukraine Conflict : This will be a significant catalyst for the shipping industry due to its impact on oil prices and high inflation. Both these factors may deteriorate the margin expansion. On the demand side, the WTO recently projected a slow global trade growth at 1.7% for 2023 due to ongoing war in Ukraine, high inflation and financial uncertainty.

Interest Rate Risk : The shipping sector is very capital-intensive and needs significant investment of capital expenditure financed by long-term debt. Therefore, a significant change in interest rates will impact the bottom line.

Fuel Swap Contracts: As discussed, fuel is an important cost driver for the shipping sector. Therefore, changes in oil prices can negatively impact operating expenses. Hence, the company seeks to minimize the risk of such volatility from a hedging program.

Takeaway

The key takeaway for investors is that the dry bulk shipping sector has been beaten down due to the Russia-Ukraine conflict, high oil prices, high inflation and a distressed demand situation. However, Pangaea is poised to sustain this situation due to better TCE rates, expected improvement in net revenue from Arctic, an expansion in its operating margins, and a better financial health driven by an acceptable low debt-to-equity ratio. Nevertheless, I must add that we are going through a geopolitical situation which can have a direct impact on the shipping industry and investors should be risk-averse.

For further details see: