By
Milwaukee Private
Wealth Management, Inc
:
Our
most recent article
on Stealth Gas Inc. (
GASS
) illustrated how the company was undervalued on a net asset value
basis. Throughout the economic crisis, the fundamentals of not only
Stealth Gas but also the Liquefied Petroleum Gas ((LPG)) Handysize
shipping sector (3,000-8,000 cubic meters (cbm) vessels) remained
favorable and should continue to strengthen. With a 13.5 percent
market share and an average vessel age of 10.9 years for its LPG
carriers (the youngest age in the Handysize segment for a fleet
this size), we believe Stealth Gas will profit considerably from
anticipated rising charter rates.
Stealth Gas is a Marshall Islands-incorporated, vessel-owning
company primarily serving the LPG sector of the international
shipping industry. The company has35 Handysize LPG carriers with a
total capacity of 168,097 cbm, three Medium Range product tankers,
and one Aframax oil tanker. The average size of its LPG vessel is
4,619 cbm. The company is focused on transporting small quantities
of LPG into niche markets.
Handysize LPG carriers typically avoid trade routes dominated by
very large gas carriers, as from the Middle East to Japan or North
America. Instead, these smaller vessels concentrate on moving
products on shorter routes, as from Singapore to Malaysia,
Indonesia, the Philippines, Vietnam, or China. Stealth Gas vessels
also transport LPG along coastal areas, such as Brazil or
Australia, and where it is uneconomical or simply impossible to
accommodate larger gas carriers, as in shallow ports or river
ways.
LPG vessels and ports require special crews and equipment to
transport LPG in either its gas or liquid form. Additionally, the
quality of these vessels varies from one manufacturer to another,
with many of the leading LPG shipbuilders located in Japan. These
characteristics limit the ability of large shipping companies with
access to capital markets, or financial investors investing
directly in LPG vessels, to acquire quality vessels and find
skilled crews. Over the past 10 years, the industry did not witness
a speculative boom in its orderbook of new builds, as was the case
in the dry bulk, tanker and carrier markets (see graph 1). The
fairly flat number of vessels operating in the LPG market, and in
the Handysize LPG market in particular, has caused charter rates to
remain relatively stable throughout the economic downturn and is
leading to even stronger rates today (see graph 2). The newbuild
orderbook for the Handysize LPG segment is flat in 2011. The lower
right corner of graph three demonstrates that the change in the
supply of Handysize LPG carriers becomes negative over the next two
years. (Graphs were provided courtesy of Stealth Gas, Inc.)
[Click all to enlarge]
LPG is a byproduct recovered from refining natural gas and crude
oil. It consists primarily of propane and butane. Both products are
gaseous at room temperatures and liquid when cooled. LPG is used
throughout the world in many different applications, providing
clean, affordable energy for domestic, commercial, agricultural,
and automotive consumers. According to Ken Otto of Purvin &
Gertz, an independent energy consultancy firm, worldwide LPG
consumption has increased by an average of 2.4 percent annually
since 2000 to over 250 million tonnes in 2010 and is expected to
reach 270 million tonnes in 2012. Additionally, the World LP Gas
Association estimates that LPG emits about 15 percent fewer
greenhouse gasses than heating oil and 50 percent less than
traditional electricity sources. We would expect to see further
growth in LPG supply as natural gas production expands
worldwide.
Stealth Gas creates value by chartering-out vessels to either
large integrated oil companies such as Shell (RDS.A), or major
energy trading companies such as Petredrec and Vitol. Stealth Gas
charters out its vessels either in the spot market or on time or
bareboat charters. Bareboat charters offer the least risk, as
Stealth Gas is not responsible for any expenses or liabilities,
such as maintenance, associated with operating the vessel; with a
time charter, Stealth Gas pays for vessel operating expenses, which
include crewing, maintenance, insurance, stores, etc. Finally, in
the spot market, Stealth Gas is responsible for all voyage costs,
including bunker fuel and port expenses.
The company has strategically staggered, both by time and
charter type, the employment of its LPG vessels. It has all of its
product and crude tankers on longer-term bareboat charters. This
staggered approach to fleet management means that vessels will be
coming off charters at different times and ensures relatively
predictable cash flows for roughly two-thirds of the vessels over
the next 12-24 months. Fortunately for Stealth Gas, vessels in the
spot market as well as those coming off of time charters in the
near term will be able to take advantage of today's rising time
charter equivalent ((TCE)) rates.
At present, a 3,200 cbm semi-refrigerated LPG vessel can be time
chartered-out for nearly $10,700/day. Stealth Gas announced in May
that it chartered a 1996-built 5,014 cbm vessel, a 2003-built 5,000
cbm vessel, and a 1996-built 3,517 cbm vessel for an average TCE
rate of approximately $10,000/day.
The value of each vessel in Stealth Gas' fleet is a function of
TCE rates (which translates into bareboat rates), operating and
management costs, depreciation, utilization rate, capitalization
rate, interest rate, and leverage. As previously noted, a bareboat
charter is the amount a vessel owner earns when chartering out
vessels without responsibility for operating charges. The only
expenses that affect an owner who puts the vessel on a bareboat
charter are depreciation, interest, and management fees (usually
paid to a third party manager to find charterers). Once a buyer
establishes his required return on investment, borrowing rate, and
leverage ratio, he can work backwards to determine the value of his
vessel.
After valuing each ship, Stealth Gas becomes a sum-of-the-parts
equation. Stealth Gas currently has approximately 11 LPG vessels
around 5,000 cbm; six LPG vessels greater than 6,000 cbm; 10 LPG
vessels around 3,500 cbm; four 4,000 cbm LPG vessels; one tiny
1,320 cbm LPG vessel; three Medium Range product tankers; and one
Aframax crude tanker. Additionally, it has one 5,000 cbm newbuild
LPG vessel scheduled for delivery this month and two 7,500 cbm LPG
vessels scheduled to be delivered in 2012. Throughout the economic
crisis, Handysize LPG vessels maintained their value because TCE
rates remained stable. Under current market conditions, the value
of these vessels should increase as charter rates strengthen.
Further, upon receiving the product and crude tankers, Stealth Gas
immediately put these vessels on long-term bareboat charters,
extending to 2015 for two of its product tankers and its Aframax
crude tanker.
Since the value of Stealth Gas' LPG vessels has not fluctuated
erratically over the last three years and management prudently put
its product and crude tankers on longer-term bareboat charters,
today's large discount to its estimated NAV provides investors with
a substantial margin of safety. Even in a difficult rate
environment, a private owner of this company could sell all of the
vessels, pay off debt, and walk away with considerably more than
the current $90 million market capitalization.
During a recent conversation with the CEO, Harry Vafias, he
estimated the liquidation value of the company was in excess of
$11/share.
Over the past two years in an environment where many shipping
companies saw operating income from vessels turn negative, Stealth
Gas remained profitable at the operating level. The company's
sporadic quarterly losses stemmed from onetime events. For example,
in 2009 the company cancelled the delivery of a Medium Range
product carrier and consequently forfeited a $5.75 million deposit
and incurred a $10.75 million cancelation fee. Additionally, over
the past two years, the company recognized losses of $11.5 million
on derivative contracts. In 2010, Stealth Gas paid an extra2 to 3
percent in interest to convert half of its floating debt to fixed
rate contracts. W e believe, however, the company wisely hedged a
substantial portion of its interest rate risk. In a rising interest
rate environment, these losses should reverse themselves. Finally,
as of December 31, 2010, the company hedged JP¥2.7 billion, or
approximately $33 million, related to newbuilding construction
costs in Japan shipyards against an increase in the yen versus the
dollar. We believe Stealth Gas has been conservative, not
speculative, and the losses it recognized are not indicative of its
true operating capabilities.
Last year, Stealth Gas generated revenue of $111.4 million with
gross earnings of $50.4 million on a total of 13,835 voyage days
(total days vessels are available for charters). The company had an
average of 38.6 vessels, operated at 98.3 percent fleet
utilization, and realized an average TCE daily rate of $7,064/day.
Cash flow from vessels was $59.4 million. Over the next two to
three years, assuming firmer TCE rates -- which are based on the
Handysize LPG sector's newbuild orderbook and scrappage rate (see
graph 3) as well as expected growth in demand for the
transportation of LPG -- and a stable fleet, we think Stealth Gas
can generate over $115 million in revenue and $70 million in gross
margins annually. This is a gross profit margin of just over 60
percent.
Stealth Gas achieved similar results in 2008 with average TCE
rates of $7,588/day. We expect gross margins to improve more than
revenues because the main cost drivers - bunker fuels and labor
expenses - should not rise as fast as charter rates. Further, we
expect additional vessels to move from spot market employment to
either time or bareboat charters in the future. This action will
reduce the amount of voyage and operating costs associated with
each vessel in the fleet.
Stealth Gas is headed by an ambitious and aggressive CEO who has
a hands-on approach and knows the minutiae of buying, selling, and
operating vessels. Vafias has personally bought or sold more than
220 vessels, a record in his home country of Greece. To appreciate
Vafias' trading acumen, consider one of his first trades. At the
age of 20, he bought a 19-year-old Panamax oil-bulk-ore ((OBO))
carrier on the open market. Senior industry professionals told him
not to do so because it was risky and no charterers at the time
wanted OBOs. Vafias put in a low bid of $2.5 million. He was the
sole bidder and thus bought the vessel. It was vetted and then
chartered out for six months for $18,000/day as a double-hull
Panamax crude tanker. Vafias sold the vessel for $5.5 million nine
month later, netting a 250 percent return. Vafias also has the
discipline not to buy into an overvalued market. He has bought
vessels when rates were lower and then sold them once rates
recovered. In the mid-2000s he abandoned the very large crude
carrier segment in order to focus on the Handysize LPG sector and
take advantage of the low volatility of charter rates. Vafias is
willing to take risks when buying vessels; nevertheless, he favors
having longer-term time charters for vessels before they hit the
water-something, we
suspect
, more shipping companies wish they had done three years ago .
With strong fundamentals in the Handysize LPG carrier sector and
skilled management, we believe Stealth Gas' true value will be
recognized by the market. The open question is when. We suspect the
market will not be able to ignore Stealth Gas' growing asset base
and large free cash flows for much longer, particularly as more
vessels are re-leased at today's higher rates. Vafias stated that
at the current share price he would not issue shares and dilute
current shareholders. Vafias personally owns 20 percent of the
company's outstanding shares; thus his interests are aligned with
other shareholders. He also stated with the share price below $5.00
he may buy back stock. Stealth Gas is willing to sell older vessels
should the opportunity arise. We think Stealth Gas will use the
free cash flow from operations and vessel sales to purchase newer
Handysize LPG vessels and/or opportunistically invest in a related
segment of the shipping industry. We think as investors begin to
appreciate the improving economics and operating leverage of the
Handysize LPG shipping sector during a rising rate environment the
share price will more closely reflect the company's intrinsic
value.
Disclosure:
I am long
GASS
.
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