Declaring bankruptcy has one clear benefit. It allows management
torestructure a business without worrying about near-term debts
coming due. Airline carrier AMR, for example, is fixing the holes
in its business and aims to exit bankruptcy in a financially and
operationally stronger position.
That's the same path
Overseas Shipholding Group (Nasdaq:
is taking. The company filed for bankruptcy on Nov. 14. "We will
use theChapter 11 process to definitively resolve our financial
issues. An orderly restructuring in Chapter 11 will provide
stability both to Overseas Shipholding and to the entire shipping
industry,"CEO Morten Arntzen said in a company press release.
This move comes after four lean years in the dry-bulk shipping
business. The whole industry is still paying the price for ordering
up too many new ships back in 2007 when global trade was robust.
The subsequent glut of new ships has made it hard for almost every
operator to command high lease rates for their ships and, in some
instances, the debt burdens are adding another punch to the
How bad has it gotten for this industry? A year ago, a typical
ship leased for $26,000 a day, but now goes for less than half of
that. When costs such as debt service andoverhead are accounted
for, these ships are operating at a loss every day. This situation
can't go on indefinitely.
Adding insult, the glut of ships means that more than half of
them aren't even being used, bringing in zero revenue on a daily
basis.Game Theory would suggest that the industry's operators would
pull enough ships out of service to cut supply and boost pricing.
Yet these companies debt covenants are so restrictive that they are
unable to make such a move.
How will you know when this industry has finally brought supply
down to the appropriate level? When the Baltic DryIndex , a key
measure of lease rates, movesback up above 2,500. We have to go
back a couple years to find the last instance of when that
All eyes on China
Industry analysts have been keeping a close eye on China, as that
country's insatiable appetite for thermal coal, iron ore and other
dry-bulk items can play a huge role in boosting demand. But the
global economic slowdown has led to a reduction in demand for raw
materials in China as that country now produces fewer finished
goods for exports and earmarks fewer infrastructure projects at
home. Simply put, it's unwise to expect China to rescue this
industry in 2013.
You can see the ongoing distress among the stock charts for
various industry players. Checkout the chart for
DryShips Inc. (Nasdaq:
This kind of drop suggests investors may be anticipating a
bankruptcy filing here as well. At first glance, DryShips would
appear to be quite vulnerable, with roughly $1.75 billion in debt
coming due in the next 24 months, $250 million in plannedCapEx in
2013 and only $130 million in cash in the bank. The company has
been able to raise cash by selling its stake in
Ocean Rig (Nasdaq:
Dry Ships now owns a little more than half of Ocean Rig, which
is currently valued at $2 billion. Despite its financial troubles,
DryShips is taking delivery of three more ships in 2013, which
sounds quite senseless. The company will need to keep sellingshares
in Ocean Rig just to pay for the ships, let alone cover operating
losses. DryShips hopes to finalize its funding agreements for the
new ships in the first quarter of 2013 -- an event investors need
to watch closely.
On a recentcall with analysts, management suggested it would
terminate the deals to buy the newly-built ships -- at significant
financial penalties, before it is pressed to conduct a fire sale of
its Ocean Rig stake. Don't be surprised if DryShips indeed looks to
unload a big chunk of stock through asecondary offering . Though
management says the stake in Ocean Rigs is inviolable, lenders have
started to take pledges of stock ascollateral in recent
But at least DryShips has assets in place against its debts.
Eagle Bulk Shipping (Nasdaq:
has a similarly distressing stock price chart and abalance sheet
that may not be able to hold up. The company has generated just
$2.6 million in operatingcash flow in the first nine months of
2012, compared with $37.1 million a year ago. This cash flow is far
short of the roughly $60 million in annual interest expense. At
this rate, Eagle Bulk's current $18.5 million cash balance may have
evaporated by this coming January. Analysts at Citigroup don't
expect cash flow to exceed interest expense until 2014, which means
this company is running out of time as cash dwindles.
Risks to Consider:
As an upside risk, these distressed firms could buy themselves
more time by restructuring loan agreements, though time is starting
to work against them.
Action to Take --> Genco Shipping (NYSE:
Navios Maritime (NYSE:
don't look financially healthy either and need to see a quick
industryturnaround . But there is a sliver lining: Stronger
industry players such as
Diana Shipping (NYSE:
Safe Bulkers (NYSE:
would surely benefit from an industry shakeout that would reduce
capacity. So even as you focus on possible further bankruptcy
filings in coming months and look to play the short side, also
monitor the opportunity for long-oriented value opportunities in
this distressed industry.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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