Are you really a contrarian investor? If so, you may be interested in an industry that has been loathed by many investors, but which Evermore Global Advisors thinks will rebound.
David Marcus, CEO of Evermore Global Advisors, and Thomas O, a portfolio manager at Evermore, say marine shipping offers a golden long-term opportunity, with low stock prices and a “confluence” of factors that will lead to a vast improvement of industry fundamentals and a tremendous increase in shareholder value.
The firm has made large investments in several shippers and has been researching the industry for three years, which includes learning as much as possible about the “characters” who dominate it, Marcus said.
For years, the story for the marine shipping industry was one of mistimed orders for new ships, which arrived and had to be paid for as economic growth in China slowed, according to Marcus.
“Just as the ships were being delivered, the stock prices of the shipping owners collapsed. The day-rates were so low, they were below the prices of operating the ships. This is all before we began focusing on the space,” he said in an interview Aug. 6.
Marcus went on to say that desperate shipowners were unable to continue borrowing from banks, so they began raising money by selling equity, which diluted the ownership positions of then-current shareholders, placing further pressure on stock prices.
And here’s a 15-year chart:
So we have a brutal setup for what Marcus described as a “commodity cyclical business.”
Marcus said some of the shipping stocks had declined between 60% and 90% over the past five years, and that many were undervalued by the stock market, in part because their vastly lower market capitalizations excluded them from broad indexes and the index funds that track them.
But “the market is looking backwards in this industry and not forwards,” he said, which is providing an opportunity for reasons described below. And when discussing the trade conflict that has led to a suspension of Chinese imports of U.S. agricultural goods, Marcus said the shipping industry wouldn’t be greatly affected.
“It is moving goods around that drives these companies,” he said. “So if they are picking up soybeans from Brazil instead of the U.S., they don’t care — it is the number of miles they move that determines how they make their money.”
To be sure, investing in the maritime shipping space isn’t for the faint of heart or for people who cannot remain committed, especially if the global economy slides into a recession. You can see on the charts how volatile the stocks can be. You can also see how many moving parts the typical shipper is juggling in this market and regulatory environment in Genco Shipping & Trading’s second-quarter results, which were announced after the close on Aug. 7.
Marcus expects the International Maritime Organization’s new global sulfur caps on fuel emissions, known as IMO 2020, to “lead to a continuation of older ships being scrapped,” which will mean a lower total ship count and rising day-rates. The new rules go into effect in January, when marine shippers will have to reduce the sulfur content of their ships’ fuel oil to 0.50% from 3.50%. Marcus said that for ships that are more than 15 years old, retrofitting for IMO 2020 won’t be cost-effective.
“This is very similar to when tanker vessels went to double hulls,” Marcus said. “This will be heavily regulated and there will be punitive consequences if people do not comply.”
”You have that coinciding with 15- to 20-year lows for new ships being ordered” globally, O said. Cleaves, a shipping broker and provider of financial services to the industry, has a third-quarter market summary with a link to a detailed report about various industry segments.
“You have scrapping growing, and an economy that is not booming globally, but is doing fine. You need an increase in the number of ships for basic growth. So we would expect to see the rates ships charge to go up dramatically,” Marcus said.
So he believes there is a “lining up of the stars” for long-term investors, with the regulatory change, high ship scrapping levels and a “collapsing” of ship orders, leading to a sustained increase in day-rates, and therefore profits for the surviving shippers.
Evermore’s Large Shipping Bets
Marcus said Evermore had recently sold its entire position in Hapag-Lloyd AG, having “made good money there.” He and O named five companies that Evermore continues to have large stakes in:
The five-year figures tell a particularly ugly story, but sell-side analysts can only be described as overwhelmingly enthusiastic for this group right now:
Sell-side analysts’ price targets and ratings are usually based on 12-month periods, which are short time frames for serious long-term investors.
Here are comments from Marcus and O about the five maritime shipping companies they discussed:
Frontline is one of the world’s largest oil tankers, with 61 ships at the end of 2018. The company is controlled by its chairman, John Frederiksen, who owns 46% of the shares, according to FactSet. Marcus favors Frederiksen’s approach of returning capital to investors through special dividends, rather than share buybacks. Evermore, through the fund and separate accounts managed for clients, owns about 3% of Frontline. You can see the firm’s ownership percentage of the five companies on the first table above.
O pointed out that Frontline owns about 30% of Feen Marine, a privately held manufacturer of fuel scrubbers that Frontline and its competitors are buying to retrofit ships for compliance with IMO 2020. Marcus believes Feen will eventually go public, which might be a further boost for Frontline.
Shares of Scorpio Bulkers have had the second-worst performance this year and the second-worst five-year performance among the five companies Marcus and O discussed. Marcus said the company was hurt by the collapse of two Vale SA iron-mining dams in Brazil. But after the most recent dam collapse in January, when daily shipping rates for ore shipping dropped to $3,500, they rose to $13,000 “in a matter of weeks,” he said, as Brazil continued to export iron.
Scorpio Bulkers owns a 10% stake in Scorpio Tankers, and that stake is worth about 40% of Scorpio Bulkers’ net asset value, Marcus said.
Emanuele A. Lauro is CEO of both Scorpio Bulkers and Scorpio Tankers. Marcus described the Lauro family as “one of the best operators out there,” and called Scorpio Bulkers “one of the best capitalized companies among its dry-bulk peers.”
“They have moved fairly quickly in retrofitting its existing fleet. So both Scorpio entities are at the forefront of taking advantage of IMO 2020,” he said.
Genco is a dry-bulk shipper. Marcus said Evermore began building a position in the company about a year ago, and that he believes the company’s new management team, led by CEO John Wobensmith, is now managing the company “with more of a shareholder focus.”
O said: “They have a pretty big pile of cash — about $200 million,” and that the new CEO “has done a tremendous job realigning and thinking about the most efficient paths” to move cargo, which is “showing up in their numbers.”
O believes Genco can put the cash hoard to good use by making an acquisition, but that the cash also makes the company a takeout target.
Marcus said Star Bulk has been aggressive in acquiring other dry bulk shippers and that “like Genco, they are aggressively managing the business, focusing on modernizing the fleet.”