2023-05-09 14:27:04 ET
Summary
- Eagle Bulk Shipping owns and operates a fleet of 53 dry bulk vessels that transport various bulk cargoes worldwide, serving miners, producers, traders, and end-users.
- After all the purchases and sales, now 96% of EGLE's fleet has scrubbers installed - the company is the largest owner of ships with scrubbers in the midsize dry bulk.
- EGLE trades at 4.6 times EV/EBITDA [FWD] and has one of the lowest leverage ratios among its peers, which makes the stock relatively undervalued.
- I expect positive revisions to continue or earnings to beat consensus figures in Q2 FY2023, both of which are positive for EGLE shareholders.
- So I reiterate my earlier buy recommendation after ~1.5 years of silence and recommend buying EGLE stock despite a number of risks associated with this company.
My Thesis
The last time I wrote about Eagle Bulk Shipping Inc. ( EGLE ) was in early October 2021 - since then, the stock's price return has fallen nearly three times as much as the S&P 500 Index ( SPX ), but thanks to dividends, the total return is now over 4%, which is way better than the broader market:
Seeking Alpha, my past article on EGLE stock [October 2021]
However, since the beginning of the year, EGLE shares have been in a more depressed position, falling below the rest of the peers - in my opinion, this underperformance is positively correlated with the change in the dividend yield of the analyzed sample. The more the yield has fallen since the beginning of the year, the worse the total performance of a stock, and EGLE looks like an obvious underdog by this criterion:
In today's article, I reiterate my earlier buy recommendation after ~1.5 years of silence and recommend buying EGLE stock despite a number of risks associated with this company.
My Reasoning
If you read my last article on Star Bulk Carriers ( SBLK ), you'll probably remember a number of reasons why I'm now even more bullish on dry bulk carriers in particular. Let me review my main macro-related arguments.
The dry bulk industry is currently experiencing a significant shift from its recent state, according to S&P Global and BIMCO. The growth rate of the dry bulk fleet is expected to slow down to 2.5% in FY2023 and 2.1% in FY2024 due to a limited order book, compared to 3.4% in FY2021. Recent months have seen volatile dry bulk shipping rates because of sluggish economic growth and a weak real estate sector in China. Nevertheless, contracts for the second half of 2023 are witnessing strong support as China's policies shift to foster economic growth. While there is optimism that a change in China's "zero-COVID" policy will improve market fundamentals, caution still prevails in the near term, especially in Q2 2023.
In my view, the present valuation multiples of dry bulk carriers, especially EV/EBITDA, have entirely accounted for the risks of a potential cycle downturn. The multiples are close to the 2010 lows. However, a key difference between the current scenario and 2010/11 is that the supply of ships is no longer expanding, whereas back then, bulk carrier deliveries had surged dramatically. This resulted in a decline in TCE rates and, consequently, multiple expansions that could be attributed to the cycle. On the other hand, I believe the demand for the services of companies like EGLE and its peers will remain stable as China has depleted its reserves of crucial metals/minerals and requires replenishing.
A few words on the recent developments that caused many income-seeking investors to flee EGLE after the Q4 FY2022 results released in March [before the recently released Q1 FY2023 numbers - I'll come back to them later].
Eagle Bulk Shipping's Q4 FY2022 earnings were lower than the consensus estimates due to a combination of weaker charter rates and record-high operating expenses. EGLE declared a quarterly cash dividend of $0.60 per share in accordance with its variable dividend policy adopted at the end of 2021. However, this represented a significant dividend cut that surprised investors. As another SA fellow analyst, Henrik Alex, noted , the company's TCE rates would significantly outperform the market quite meaningfully after the Q4 facts, as the vast majority of its fleet is equipped with scrubbers.
In early May 2023, it was time to report for the first quarter of fiscal 2023, and EGLE showed that Henrik was right:
EGLE reported better-than-expected Q1 non-GAAP EPS of $0.26, beating estimates by $0.07 [by ~37%], and revenue of $105.2M, surpassing expectations by $35.98M. The adjusted EBITDA amounted to $18.7 million. The company also executed agreements to acquire two high-specification scrubber-fitted Ultramax bulk carriers, which are expected to be delivered during Q2 FY2023. Eagle Bulk Shipping declared a quarterly dividend of $0.10 per share for Q1 [40% of net income].
Eagle Bulk Shipping has achieved a net time charter equivalent [TCE] of $12,917 in the first quarter, outperforming the benchmark BSI index by about 31%. The management believes that Q1 represents a low in FY2023 for both the BSI and its TCE due to seasonal lows, but Q2 has shown a significant improvement, with approximately 65% of owned available days fixed at a net TCE of $16,030.
During Q1, the company sold and delivered its oldest vessel, Jaeger, and realized a gain on sale of $3.3 million. However, the crew management changeover initiative impacted the crew-related costs, leading to elevated crew costs related to wages, travel, and the company's seafarer and nationality makeup, primarily Eastern European. The CFO, Costa Tsoutsoplides, estimates that the crew management transition will negatively impact crew-related costs for the next few quarters until the management changeover is completed.
After all the purchases and sales, now 96% of EGLE's fleet has scrubbers installed - the company is the largest owner of ships with scrubbers in the midsize dry bulk vessel segment in the world. The management gave some color on how the existence of these scrubbers may impact the bottom line - they should make ~$32 million more in profit each year, based on current fuel prices and projections. And that's like ~13% of last year's net income in case you wonder - it looks quite solid to me.
During the Q1 earnings call, EGLE's CEO - Gary Vogel - discussed the company's dividend policy and potential share buybacks. He stated that share buybacks are definitely an option, and the company has a $50 million share buyback authorization already. However, he noted that there is currently a negative carry against cash for the convertible bonds, and the company is evaluating all possible uses of capital for the benefit of shareholders.
When asked about the coal being a driver of demand and whether it was due to overall consumption or longer ton-miles, Vogel responded by saying that it was mainly due to more volume and China's significant increase in imports, particularly of Indonesian coal. So, against the backdrop of the reduction in net supply side expected to come into the market in 2H FY2023 and into 1H FY2024, EGLE's fleet is quite well positioned indeed, in my view, if China's coal import stays relatively stable. And that seems to be true so far, based on Reuters' data.
The combination of new incentives for large manufacturers alongside anticipated support for the construction and property markets will result in greater total power consumption in China over the coming months, and in turn even higher emissions.
Source: Reuters [ 2 May 2023 ]
China's utilities have imported a record amount of thermal coal to fuel economic recovery, with total imports between January and April rising 85% YoY to 97 million tonnes. This is expected to increase further in the summer during the peak demand period for air conditioning. Additionally, the wider price spread between thermal coal and natural gas is also supportive of coal imports, even though cleaner-burning natural gas can also be used for power generation. Nevertheless, power generation companies are finding natural gas unattractive for energy production due to its domestic market price being more than 4x higher than that of coal. These companies are facing pressure to minimize energy costs, which makes coal a more favorable option for them.
So, I think EGLE is positioned quite favorably in terms of the demand side. I don't think the 10 cents per share for Q1 FY2023 can be extrapolated to the next 3 quarters because a) it's obvious that dry bulkers are seasonally least profitable in Q1s, and b) the company will have more flexibility to generate more cash going forward thanks to scrubbers and picking up demand from China and Latin America. Costs will likely be higher, but in any case, a return to an annualized dividend yield of 8-12% seems quite feasible to me.
Back to earnings - I want to pay particular attention to the Street's forecasts . Consensus estimates rose sharply after the earnings announcement, reflecting all the positives I mentioned above.
Seeking Alpha, EGLE's Earnings Revisions, author's notes
However, these revisions don't seem convincing enough to me - if we look at the annual estimates, the market prices FY2024 EPS lower than at the beginning of the year, when the outlook for the industry looked much bleaker.
Seeking Alpha, EGLE's Earnings Revisions, author's notes
The company trades at 4.6 times EV/EBITDA [FWD] and has one of the lowest leverage ratios among its peers, which makes EGLE stock relatively undervalued in my opinion.
I expect positive revisions to continue or earnings to beat consensus figures in the second quarter of fiscal 2023, both of which are positive for EGLE shareholders. The technical picture supports my conclusion - EGLE stock is currently trying to stay at the recovery trendline on the weekly chart, while the stochastic indicator is heavily oversold. This combination has caused the stock price to bounce off nearby resistance levels [currently 18-20% higher] in the recent past:
TrendSpider Software, author's notes
Risks To Consider
Investors should be aware that Oaktree Capital Management holds 3,782,000 shares, representing a 27.64% stake in the company. This institutional investor poses a significant risk to minority investors if they seek to exit their positions - these fears are already in the air after this investor recently sought to exit the capital of another company, TORM plc ( TRMD ).
It's important to keep in mind that investors in EGLE may be negatively impacted by a downturn in the shipping cycle in multiple ways. Lower freight rates can result in reduced revenues and negatively impact the company's profitability and cash flow. Additionally, a decrease in the value of the vessels can negatively impact the balance sheets of shipping companies that own a large fleet of vessels.
If EGLE is unable to generate sufficient cash flow to service its debt, it may need to issue additional equity or debt to meet its obligations, which can dilute the value of existing shares and increase the company's financial leverage, making it more vulnerable to changes in market conditions. In this case, no dividends will be paid.
Your Takeaway
Despite the risks, I think Q1 FY2023 was most likely really kind of a bottom for EGLE in terms of earnings and dividend payouts. As the world's largest owner of scrubber vessels in the mid-sized bulk carrier segment, the company will have a comparative advantage over others in its niche, and its relatively low valuation makes EGLE very attractive at the current, technically oversold price level.
For further details see:
Eagle Bulk Shipping: Time To Buy The Stock Again