GASS - Toro Corp.: Strong Operating Performance But Poor Corporate Governance Persists - Sell

2023-08-17 05:05:11 ET

Summary

• Last week, junior tanker operator Toro Corp. reported respectable Q2 results with decent cash generation. That said, earnings were boosted by a large gain from the sale of two vessels.
• Q3 results will show a similar gain as the company has disposed of additional vessels in the current quarter.
• However, future earnings and cash flows will be impacted by the recent replacement of four Aframax tankers in exchange for an equal number of much smaller LPG carriers.
• Corporate governance issues persist as the company surprisingly purchased $50 million in convertible preferred stock from former parent Castor Maritime.
• Investors should consider taking some money off the table following the recent 100% rally in the shares. Given the substantially decreased discount to NAV, I am downgrading shares from "Hold" to "Sell".

Note:

I have covered Toro Corp. ( TORO ) previously, so investors should view this as an update to my earlier articles on the company.

Last week, junior tanker operator Toro Corp. or "Toro" published its second quarterly report following the spin-off from Castor Maritime Inc. ( CTRM ) in early March.

While the company's Q2/2023 operating performance deteriorated somewhat from very strong first quarter levels, overall results were boosted by an aggregate $40.6 million gain from the recent sale of the Aframax tankers Wonder Bellatrix and Wonder Polaris .

Toro used some of the proceeds to acquire a quartet of second hand LPG carriers from StealthGas ( GASS ) with the vessels Dream Terrax and Dream Arrax having been delivered to the company in the second quarter.

Subsequent to quarter-end, Toro completed the previously announced sale of the Aframax tankers Wonder Avior and Wonder Musica at a net gain of $35.7 million which will be recognized in the current quarter.

In addition, the company has been taking delivery of the two remaining LPG carriers Dream Syrax and Dream Vermax .

Cash generated from operating activities amounted to $19.7 million, down from $28.6 million in Q1 but still decent considering the replacement of two Aframax tankers with two much smaller LPG carriers during the quarter.

In addition, the company received gross proceeds of $19.5 million from the sale of 8.5 million new shares to an entity controlled by its Chairman and Chief Executive Officer, Petros Panagiotidis, at a purchase price of $2.29 per share in April.

Not surprisingly, cash and cash equivalents of $128.2 million almost doubled on a quarter-over-quarter basis while debt declined to just $5.9 million at the end of Q2.

Following recent vessel dispositions and purchases, Toro's current fleet looks as follows:

With the earnings power of the small LPG carriers currently being a fraction of the recently disposed Aframax/LR2 tankers, Toro's top- and bottom line will be impacted quite meaningfully going forward.

That said, third quarter results will include the above-discussed $35.7 million gain from the sale of the Wonder Avior and Wonder Musica.

Following the recent rally in the shares, discount to estimated net asset value ("NAV") has narrowed to approximately 40%:

While the share sale to the CEO at a massive discount to NAV illustrated poor corporate governance, the transaction actually resulted in Mr. Panagiotidis becoming aligned with common equity holders to a meaningful extent, a rare exception among small Greece- or Cyprus-based shipping and in very much in contrast to his main company, Castor Maritime.

On the flip side, he just transferred a whopping $50 million from Toro to Castor Maritime by the means of a convertible preferred share investment as noticed in the earnings press release:

On August 7, 2023, the Company agreed to purchase 50,000 Series D Preferred shares of Castor of $1,000 each for a total consideration of $50 million in cash. The distribution rate of the Pref D shares is 5%, paid quarterly, and they are convertible to common shares of Castor from the first anniversary of the issue date at the lower of (i) $0.70 and (ii) the 5 day value weighted average price immediately preceding the conversion, subject to a minimum conversion price. The distribution rate is set to increase by a factor of 1.3 times per annum from year 7 with a maximum rate of 20%. This transaction and its terms were approved by the independent members of the board of directors of each of Castor and Toro at the recommendation of their respective independent committees who negotiated the transaction.

Please note that conversion of the preferred shares remains subject to a $0.30 minimum conversion price.

Quite frankly, I have to admire this latest dodge as the terms of the convertible preferred shares provide Toro with the option to grab a substantial stake in Castor Maritime at a tiny fraction of NAV next year.

Please note that shares of Castor Maritime currently trade at an approximately 90% discount to net asset value. Assuming the discount to remain in place until the conversion option becomes exercisable next year and Castor Maritime not issuing a substantial amount of new common shares, Toro would become Castor Maritime's majority shareholder by effectively paying pennies on the dollar for the company's assets.

However, I do not expert Toro to exercise the conversion option as long as Castor Maritime intends to further dilute common shareholders under its recently established $30 million at-the-market offering with Maxim Group LLC.

Bottom Line

While Toro Corp.'s second quarter results were boosted by a large gain from the disposal of two Aframax tankers, cash flow generation remained strong.

That said, future earnings will be impacted by recent changes in the company's fleet composition as contributions from the newly-acquired LPG carrier fleet won't be anywhere close to the cash flows earned by the replaced Aframax tankers.

Following the recent rally in Toro Corp.'s shares, the company's discount to NAV has narrowed significantly, likely due to the favorable combination of strong earnings, tiny free float, and very low probability of near-term dilution.

However, investors should remain wary of the company's ongoing corporate governance issues and consider taking some money off the table following the recent 100% rally in the shares.

Given the substantially decreased discount to NAV, I am downgrading shares from " Hold " to " Sell ".

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