EGLE - Star Bulk: The Market Outlook Is Not Strong

Summary

• Due to the continuing global recession, the dry bulk market outlook is not strong.
• Based on the CCA method, compared to other dry bulk stocks, SBLK stock price has a 10% downside potential.
• However, recent measures by the Chinese authorities may support the demand for dry bulk commodities.
• Also, the company’s leverage ratios improved significantly in the past two years, meaning that Star Bulk is financially healthy.
• The stock is a hold.

Star Bulk Carriers (SBLK) stock price decreased by 18% in the past six months as TCE rates dropped significantly. Due to the continuing global recession, the dry bulk market outlook is not attractive. According to the Comparative Company Analysis ((CCA)) method, compared to its competitors, SBLK's current stock price is a little high and even has the potential to decrease by 10%. However, it is important to know that as China is the biggest importer of dry bulk commodities, recent measures adopted by the Chinese fiscal and monetary authorities to support infrastructure investment can support the demand for dry bulk vessels. Also, even with the current market outlook, SBLK can continue optimizing its capital structure and remain healthy. The stock is a hold.

In its 3Q 2022 financial results, SBLK reported voyage revenues of $364 million, compared with 3Q 2021 voyage revenues of $416 million, down 13% YoY. The company's net income decreased from $220 million in 3Q 2021 to $110 million in 3Q 2022 down 50% YoY. SBLK reported an adjusted net income of $136 million in the third quarter of 2022, compared with $225 million in the same period last year. The company's net cash provided by operating activities decreased from $251 million in 3Q 2021 to $184 million in 3Q 2022. In the third quarter of 2022, Star Bulk reported EBITDA and adjusted EBITDA of $164 million (down 40% YoY) and $190 million (down 32% YoY), respectively. SBLK reported a 3Q 2022 TCE per day of $24365, compared with a 3Q 2021 TCE per day of $30626. Also, the company's daily OPEX per vessel increased from $4596 in 3Q 2021 to $5107 in 3Q 2022. "Looking to Q4, we have covered ~66% of our available days at a TCE of $22,772 / day per vessel," the CEO commented. "With the dry bulk orderbook at an all-time low and with new environmental regulations coming into force and expectations of a gradual reopening of the Chinese economy, we remain optimistic about the long term prospects of the dry bulk market despite global macro uncertainties," he continued.

The market outlook

Interest rates in the United States are now at their highest levels within the last 15 years, and as the inflation rate is still high, I expect the monetary authority of the United States continue its tight monetary policy in the following months. Major economies are still suffering from the negative results of COVID-19 and the war between Russia and Ukraine. The war in Ukraine is not expected to end soon and the trade disruptions caused by the war will continue hurting the demand for dry bulk commodities. According to Figure 1 , IMF expects the world economic growth in 2023 to be lower than in 2022. The United States and Euro area will continue staying in the recession. However, IMF expects China's growth rate in 2023 to be higher than in 2021.

Figure 1 - World economic outlook

Despite the weak outlook for the global economy, which means low demand for dry bulk vessels, we have to consider the effect of China's move to ease COVID-19 restrictions that can unblock supply chains. One of the main reasons behind the low steel demand in China in the past months was the weakened construction in the country. However, due to the recent real-estate-friendly policies in China, Shanghai Metals Market ((SMM)) expects significant real estate growth in 2023. Also, SMM expects that infrastructure investment to progress in 2023 as the Chinese government may increase its investments in infrastructures to hedge the economy against the global economic downtrend. Figure 2 shows that iron ore prices increased significantly in the past two months as a result of the recent pro-growth measures of the Chinese government and the central bank of China. It is worth mentioning that China's biggest commercial banks pledged $162 billion in new credit lines for private developers. Figure 3 shows that in Chinese iron ore port index and iron ore seaborne index increased in the past two months, which are consistent with the rising global iron ore prices. Notwithstanding the positive effect of the Chinese government and central bank's recent measures that support the dry bulk market, as the global economic outlook is weak, I don't expect TCE rates for dry bulk vessels to increase significantly in the following months.

Figure 2 - Iron ore price

Figure 3 - Iron ore port index and iron ore seaborne index

Performance outlook

The debt-to-assets ratio measures SBLK's debt capacity. This ratio indicates the proportion of assets that are being financed with debt. The higher the ratio, the greater the degree of leverage and financial risks. The company's debt-to-asset ratio decreased from 0.49 in 2020 to 0.21 in 2021 and decreased further to 0.40 on 30 September 2022. Thus, the decreasing debt-to-asset ratio of SBLK (as a result of significantly lowered total debt in the first nine months of 2022), shows that Star Bulk decreased its debt financing in 2022. It implies that the company expects its future free cash flow to be weaker than before. Also, SBLK's debt-to-EBITDA ratio (which determines the probability of defaulting on debt) dropped from 7.38 at the end of 2020 to 1.78 at the end of 2021 and 1.42 on 30 September 2022. Finally, SBLK's asset-to-equity ratio decreased from 2.06 at the end of 2020 to 1.81 at the end of 2021 and 1.74 on 30 September 2022 (see Figure 4).

We can see that as a result of significantly high TCE rates in 2021 and the first half of 2022, Star Bulk's leverage ratios improved in the past 2 years. In 2022, Star Bulk has agreed refinancings of more than $400 million, reducing its annual interest cost by about $5 million. "From a risk management perspective, we have $754.7 million of swaps fixed at an average of 46 bps, protecting the Company from increased interest costs for an average remaining maturity of 1.4 years," the CEO stated. Thus, even with the current dry bulk market conditions, SBLK has the potential to remain financially healthy.

Figure 4 - SBLK's leverage ratios

SBLK stock valuations

The CCA method indicates that SBLK stock is not attractive. Comparing Star Bulk with other dry bulk competitors like Genco Shipping ( GNK ), Golden Ocean Group ( GOGL ), Eagle Bulk Shipping ( EGLE ), Navios Maritime ( NM ), and Grindrod Shipping ( GRIN ) I estimate that the stock's fair value is about $17. This method reflects the real-market data and is an appropriate way to analyze GRIN for the sake of the company's stability. I considered dry bulk companies with similar sizes and financial conditions. Data was gathered from the most recent quarterly and TTM data (see Table 1).

Table 1 - SBLK financial data vs. peers

When looking at SBLK's valuation ratios and comparing them with the peers, we can realize that Star Bulk's ratios are not as strong as its peers. The company's EV/EBIT ratio is 3.61x, which is 6% higher than the peer's average of 3.42x. It represents that the stock price is higher than its potential value. Also, SBLK's EV/EBITDA ratio is 8% higher than the average of 2.82x. Meanwhile, the company's P/E ratio is 2.58x, which is 7% higher than the average of 2.42x. Ultimately, I evaluate that SBLK's fair value is around $17 per share (see Table 2).

Table 2 - SBLK's valuation

Summary

In terms of the market outlook, I don't expect the demand for dry bulk commodities to increase enough (as a result of the recent Chinese authorities' measures) to cause a jump in the TCE rates. Also, compared to other dry bulk stocks, SBLK's stock price doesn't have the potential to rise. However, the company can cover its current and future obligations as it has improved its leverage ratios in the past two years. The stock is a hold.

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