In yet another example of The Shipping Man
being used a reference point through which to analyze the market, investor and Seeking Alpha contributor Steven Reiman writes that the book inspired him to analyze Greek LPG shipping company StealthGas in a follow up to an article he’d written two years earlier.
My first article for Seekingalpha was published almost exactly two years ago and was about the substantial discount that a Greek LPG shipping company was trading at in relation to its ability to generate cash. The company, aptly named StealthGas (GASS), operated in a niche market that had not fallen victim to the mass oversupply problems that other shipping sectors were experiencing and as such, was able to continue to hire out its ships and generate substantial cash flow.
Since writing about the company, StealthGas has appreciated substantially and while I booked some gains, I kept my streak of consistently selling too early alive by selling at a price much lower than the current 10.30 price. The main reason I sold out was a fundamental disagreement regarding the company’s capital allocation policy.
My interest in returning to take another look at StealthGas was piqued by a book I recently finished reading called The Shipping Man, the main plot of which revolves around an American hedge fund manager that is trying to break into the shipping world. While at first simply trying to capitalize on the oversupply crisis in 2009 to purchase some ships on the cheap, Robert Fairchild, our hedge fund hero, eventually gets pulled deeper and deeper into the shipping world and in the process meets Greek and Norwegian shipping tycoons. While the book certainly does not have Hemmingway quality prose, the story is highly entertaining and serves as an excellent beginner’s course into the inner workings of the shipping industry.
In the spirit of Mr. Fairchild, let us also delve head first into StealthGas to see if the company is still selling at a discount to its intrinsic value.
“…there are no economies of scale in the shipping business, not beyond a fleet of 10 ships. That is the perfect sized fleet. You can capture the rest of the efficiencies by being the big client of a third party ship manager”
-Coco Jacobsen, Norwegian Shipping Mogul
When I last checked in with StealthGas, the company had around 30 handysize liquid petroleum gas (LPG) carriers, a few MR product tankers and one crude oil Aframax tanker. The company’s main strategy centers around their LPG fleet in which they hope to build a dominant position in the handysize segment and leverage the growing global supply of LPG, a supply that should only grow with the proliferation of unconventional drilling that has led to the unlocking of previously unreachable LPG resources.
As we can see below, company management has big plans to grow the fleet by a little over 50% by the end of 2015:
So how is this major fleet expansion being financed? The answer, unsurprisingly, is with a combination of equity and debt with the equity financing coming from a large secondary offering that took place last April in which the company sold 12M shares, increasing the total shares outstanding by 60%. This offering was done at ~25% discount to the company’s net asset value per share.
As can be seen in the above slide exhibiting the fleet expansion, the company wasted little time in putting this money to work. Furthermore, management is so excited about growing the fleet that they announced yet another equity offering in early December that was only canceled due to the extremely negative response the announcement created in the market.
“Are you crazy, man? If you order a ship you will have dead money for 18 months…”
-Spyrolaki, Greek Shipping Tycoon
One of the large risks when investing in new ships is the long lead time it takes between the time you order the ship and the time you actually take possession of said vessel. In the interim period, a time that can generally be measured in years, the market can change. This was the trap that many shipping companies fell into in the late 2000′s. They purchased massive amounts of tonnage when spot rates were astronomically high due to then tight supply. However, when everyone had the same idea at the same time what resulted were far too many ships slipping out of shipyards from Southeast Asia and Japan as compared to what was needed. Combining this oversupply with the financial shock of 2008 caused the demise of many previously high flying shippers.
It is possible that StealthGas could fall into the same trap of ordering ships into an oversupplied market. Already the company has reported having trouble chartering out some of its older vessels. While this could merely be a function of the vessels being old, I would think that if the market was sufficiently robust, they would have no trouble chartering out any of their vessels.
Furthermore, company management has indicated that while the order book remains subdued in relation to other shipping segments, there are other players that are beginning to enter the arena, mainly Chinese and Japanese players. I could envision a scenario where people enter this segment enticed by the growth in unconventional drilling and thus too much supply is ordered to come online in the next few years. This would obviously act as a downward pressure on charter rates.
“…charter rates and ship prices are linked and they end up at the same residual value. If the market goes up the charter keeps the upside and if the market goes down, they are likely to default or come back to you and restructure, at which point you have zero leverage because the market is so weak.”
-Spyrolaki, Greek Shipping Tycoon
Yet another danger that shippers face is charterers reneging on their contracts. StealthGas tries to stay out of the spot market as much as possible in order to limit revenue volatility. As such, the majority of the company’s fleet is on bareboat charters or time charters. While this improve revenue visibility, it does create a situation as described by our Greek shipping tycoon in which the charterer keeps the upside and but has leverage to renegotiate should the market turn south. While the segment StealthGas primarily operates in is known for its low volatility, the company has had experiences in the past where it has had to renegotiate with its charters that had run into financial difficulties.
The main point here is that while investors may think that there is some protection from market turbulence due to the long term nature of the company’s contracts, if the market collapses the charterers have all of the leverage and will most likely be able to renegotiate the terms that will most likely be unfavorable to StealthGas.
“The Norwegian sale and purchase brokers who sell you the ship will make money; the British banker who finances the ship will make money; the chartering brokers who find cargo will make money; and the manager who operates the ship on your behalf will make money…that is the point; everyone will make money…everyone except you”
-Spyrolaki, Greek Shipping Tycoon
Ultimately, I feel like the unfortunate American that Spyrolaki is addressing in the above. While I believe the management team at Stealthgas is better than most in terms of acting in the best interests of shareholders, I cannot reconcile the idea that they are acting in my best interests with the fact that they have issued shares at a 25% discount to NAV and were fully prepared to issue even more before the market backlash. Given the fact that there is little operating leverage to be had in this business model, the only reason for pushing forward such dilution is to simply build a bigger shipping empire. While this may ultimately work out for shareholders, if I am going to invest in an inherently risky industry like shipping, I want a management team that has a proven desire to increase value on a per share basis. It is for this reason that I currently hold no position in StealthGas.