GRIN - Star Bulk: The Market Outlook The Peers And The Risks

2023-04-23 06:00:35 ET

Summary

• TCE rates for Capesize vessels improved in the past few weeks, and Capesize vessels account for 55% of SBLK’s fleet.
• China's 1Q 2023 economic growth was better than expected and may improve further in the second half of the year.
• Compared with its peers, Star Bulk is in a good position and can benefit from the market condition.
• The company’s gross profit margin was over 57%, which was far higher than GOGL’s and GRIN’s 37% and 36%, respectively.
• SBLK’s return on assets sat at 16.5% in 2022 versus 18% at the end of 2021. However, still better than GOGL’s 13.7% and GRIN’s amount of 16.2%.

In my previous article on Star Bulk Carriers ( SBLK ), I explained why SBLK is a hold. Now, I am upgrading the stock's rating to a buy as due to the better-than-expected economic growth in China, I expect the dry bulk market outlook to improve to the levels that justify a buy rating. Also, I compared SBLK's financials with two of its peers, indicating why SBLK can be one of the dry bulk companies that can benefit more from a better market condition than other dry bulk companies. Albeit lower profitability ratios in 2022 versus 2021, SBLK had higher margin and return ratios compared with its peers. Also, SBLK's return on assets is better than its peers.

The market outlook

A month ago I mentioned that as TCE rates dropped continuously in 2022, SBLK's TCE revenues decreased from $428 million in 4Q 2021 to $267 million in 3Q 2022 and decreased further to $216 million in 4Q 2022. Also, I said that as dry bulk rates decreased further in January and February, Star Bulk's TCE revenues in the first quarter of 2023 can be lower than in 4Q 2022. Finally, I said that despite the higher Baltic Dry Index in March, to be considered as recovered, the Index still needs to increase much further.

In the past few weeks, the Baltic Dry Index didn't change significantly. As Figure 1 shows, the Baltic Dry Index is still lower than the 1-year and 5-year mean. However, Figure 2 shows that dry time charter estimates (4 to 6 months) for Capesize vessels increased further in April. Newcastlemax/Capesize vessels account for 54.6% of Star Bulk's fleet. In the week ending 15 March 2023, the dry time charter estimate (4 to 6 months) for Capesize vessels was $16000 per day pro rata (pdpr) and increased to $18500/pdpr in the week ending 19 April 2023. The reason behind the recent increase in dry bulk shipping rates is connected to the reopening of China. Due to China's reopening policies, the demand in manufacturing, infrastructure, property, and the green economy sectors is increasing.

For the first quarter of 2023, China claims that it achieved GDP growth of 4.5%, which is higher than expected. It is worth mentioning that Bank of America has increased its forecast for China's GDP growth in 2023 from 5.5% to 6.3%. IMF estimates that China will be the top contributor to global growth in the next five years. It is important to know that in the past week, China increased iron ore imports from Australia. China is Australia's largest trading partner. Actually, China's iron ore imports from Australia account for 80% of Australia's iron ore exports. China's iron ore imports in 1Q 2023 were the highest recorded in the past 13 quarters. All of this means that TCE rates for Capesize vessels may increase in the near future, and SBLK can benefit significantly from higher Capesize rates.

Figure 1 - Baltic Dry Index

Figure 2 - Dry time charter estimates

SBLK, GOGL, and GRIN's performance

I looked at Star Bulk Carrier's profitability ratios as compared to its peers to analyze how well the company can turn a profit and use its assets to make money for its investors. I have examined the profitability ratios for margin and return ratios to provide useful insights into the financial health of the company. I calculated the ratios in comparison to recent years to be more helpful.

In general, margin ratios evaluate the ability of the company to turn revenues into profits in a number of ways. Overall, due to the shortcomings of the dry bulk market in 2022, this shipping company had weaker gross profit, EBITDA, and net profit margins compared with the end of 2021. Albeit the total revenue of the company stayed approximately unchanged, lower levels of profits and EBITDA amounts led to lower margin ratios in 2022 versus 2021.

SBLK's gross profit margin was 57.7% in 2022, which is lower than its amount of 65.7% at the end of 2021. Also, the company's EBITDA margin was about 54% in 2022, which is circa 879 bps lower compared with its amount of 62.7% at the end of 2021. Moreover, Star Bulk's net profit margin, which is a final picture of how profitable the company is after all expenses, dropped to 40% in 2022 versus its previous amount of 47.6% at the end of 2021. As a result, the weakening market conditions in the preceding year affected Star Bulk Carrier's revenue and declined its margin ratios (see Figure 3).

Figure 3 - SBLK's margin ratios

To investigate more accurately, I compared SBLK's margins with its peers, Golden Ocean Group ( GOGL ) and Grindrod Shipping ( GRIN ). Overall, as compared to competitors, SBLK has performed better and obtained higher margins. Golden Ocean's gross profit margin was 37% at the end of 2022, while Grindrod Shipping was at 36%. Thus, SBLK's higher gross margin indicates its higher efficiency of core operations. Also, regarding the profit margin, GOGL's ratio was 41.8%, which was very close to SBLK's 40%. Meanwhile, GRIN's was only 22.4%. This ratio takes everything into account and shows SBLK and GOGL would keep about 40% of their revenue after covering all their costs including interests and taxes. Ultimately, GOGL's EBITDA margin hit the highest level of 57.7% at the end of 2022, which is slightly higher than SBLK's 54%. Again, Grindrod Shipping had the lowest level of 40%. When all was said and done, Star Bulk Corporation indicated that notwithstanding dry bulk markets drawbacks, the company could relatively perform better than its peers to cover operating expenses, fixed costs and etc., while providing earnings to the business (see Figure 4).

Figure 4 - GOGL and GRIN's margin ratios

Furthermore, I looked into SBLK's return on equity and return on assets ratios to show how well the company can tailor returns to its shareholders. The ROA ratio illustrates the amount of profit a company may produce for each dollar of its assets. The ROA ratio of 18% for Star Bulk Carrier in 2021 decreased by 164 bps to 16.4% in 2022. Additionally, its return on equity of 28% at the end of 2022 is lower than 32.7% at the end of 2021. ROE ratio shows the company's net income concerning shareholders' equity and is important since it calculates the rate of return on the capital invested in the business. The company's net income of $680 million in 2021 dropped by 16% to $566 million at the end of 2022 and thus affected its return ratios. However, SBLK's return ratios are still higher than its peers (see Figure 5).

Figure 5 - SBLK's return ratios

As it is observable, notwithstanding lower return ratios in 2022 as compared to 2021, Star Bulk Carrier's ratios are still higher than its competitors. In minutiae, Golden Ocean's return on assets sat at over 13% at the end of 2022, which is 272 bps lower than SBLK's. However, the ROA amount of Grindrod Shipping is 16.2%, which is almost the same as SBLK's. Additionally, the return on equity ratio of GOGL indicates that shareholders could see a 24% return on their investment. As this ratio is about 28% for SBLK and 30% for GRIN, this expresses that these companies are more capable to generate cash internally and thus are less dependent on debt financing. Ultimately, Star Bulk Carrier's margin and return ratios well indicate that the company could cater to higher profitability for its investors in comparison to its peers (see Figure 6).

Figure 6 - GOGL and GRIN's return ratios

Risks

Despite the growth potential, some risks should be considered if you decide to buy SBLK. Based on the iron ore demand outlook, the dry bulk shipping market may get stronger in the second half of the year. However, if the opposite happens, SBLK may have insufficient liquidity to fund its continuing operations or cover its obligations under its credit facilities. Moreover, according to these debt agreements, a sudden decrease in the TCE rates can remain for a long time and, may cause SBLK to lose a large part of its assets. Also, due to its outstanding debt agreements, Star Bulk may need to seek permission from its lenders to take actions that are in its best interests. In another word, due to these debt agreements, SBLK's ability to execute its business strategies and capital policies is limited.

Besides, Star Bulk's fleet is aging and one of the company's strategies is to purchase and use secondhand vessels. The average age of SBLK's 128 vessels is 10.9 years. It is worth noting that the average ages of GOGL and GRIN's fleet are about 6 years. Higher ages mean less fuel-efficient vessels and a higher cost of maintenance. Also, buying a secondhand vessel means that the buyer will not receive the benefits of the warranties from the builders. Thus, SBKL's operating costs can increase unexpectedly and the company may be forced to off-hire some of its vessels.

Summary

In the past few weeks, Capesize TCE rates improved, and based on China's economic outlook, which supports a more robust demand for iron ore, I expect the dry bulk shipping market to improve. Compared with its peers, SBLK is in a good position and can benefit from higher demand for dry bulk commodities. The stock is a buy.

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