Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
If the dry bulk shipping business -- and the BDI -- continue to improve, Genco Shipping could be only the first of new buy recommendations to surface on Wall Street.
Those were my closing words last week, writing up Deutsche Bank's prescient prediction on the future of the Baltic Dry Index and its upgrade of Genco Shipping & Trading Limited stock.
Now those new buy recommendations are rolling in. This morning, Stifel Nicolaus -- one of the best-rated analysts we have on Motley Fool CAPS -- announced a pair of such upgrades, urging investors to buy stock in Scorpio Bulkers (NYSE: SALT) and Star Bulk Carriers (NASDAQ: SBLK) . Here's what you need to know.
Dry bulk shipping stocks Scorpio and Star Bulk are getting a helpful tug from Wall Street this morning. Image source: Getty Images.
Get to know the Baltic Dry Index
It all starts with the Baltic Dry Index, a creation of the London-based Baltic Exchange that tracks rates being charged for ferrying dry bulk cargo (grains, iron ore, coal, etc.) along nearly two dozen major shipping routes. Giving insight into how profitable the dry bulk shipping index is at any given point in time, the BDI has become a touchstone for investors in this industry.
Although nowhere near its high-water mark of 11,793 hit in May 2008, the BDI is way off its score of 948 it saw just over two weeks ago. At the time Deutsche voiced its buy rating for Genco, the BDI had already risen 7% to 1,014. Today, the index is up a further 26% to 1,281.
That seems to have grabbed Stifel's attention.
Upgrading Scorpio Bulkers
Mind you, Stifel isn't 100% convinced this rally in the Baltic Dry Index is for real. To the contrary, Stifel still cautions that "the recovery in dry bulk shipping is likely to be shallow" in a note covered this morning on StreetInsider.com (subscription required). We're still a long way away from 11,793.
Still, with the BDI up 35% since April 6, Stifel believes that "the market is positioned for profitability" at today's prices, and may even book "modest further improvements." This suggests that Scorpio Bulkers stock is underpriced at its current share price of $7.38, which the analyst calls "a 25% discount to our $9.68 [ net asset value ] estimate." (And even then, Stifel is only targeting a $9 price for Scorpio Bulkers stock, leaving further room for upside.)
Where might that upside come from? Of particular note, Scorpio's average dry bulk cargo ship is just 2 years old right now, just one-quarter as old as the global fleet average age of 8 years. Stifel calls Scorpio Bulkers' fleet "extremely modern and efficient." It should therefore be more profitable to operate, and with maritime standards for carbon emissions expected to tighten in 2020, could benefit especially if a "two-tiered market" develops, with younger ships enjoying higher rates than older vessels.
Upgrading Star Bulk Carriers
Speaking of ships, Star Bulk Carriers just made a purchase of "16 modern dry bulk carriers" of its own, says Stifel in a separate note. Although the deal's purchase price of $433 million may sound expensive, the analyst argues that sellers Augustea Atlantica & York Capital let Star Bulk have them for "below [net asset value]," which should make the deal "meaningfully accretive to earnings and cash flows."
What's more, this is assuming Stifel is right in its "dry bulk rate assumptions," which as mentioned above are conservative and assume no more than "modest further improvements." On the other hand, if the Baltic Dry Index continues its recent steep upwards trajectory, Star Bulk's deal could become even more profitable.
Either way, Stifel seems certain that Star Bulk stock is "attractively valued and well positioned to generate strong cash flow." The analyst values the shares at $15 and advises investors to buy the stock.
What else investors need to know
Is Stifel Nicolaus right about all of the above? That's hard to say.
Currently, both Scorpio Bulkers stock and Star Bulk stock alike are unprofitable, cash-burning, debt-laden enterprises. Valued on traditional metrics, there's very little to recommend either one of them. (In contrast, Genco Shipping & Trading, which Deutsche Bank recommended last week, is at least free-cash-flow positive.)
Whether or not Stifel will be proven right in its endorsement of Scorpio and Star Bulk, therefore, depends very much on whether the Baltic Dry Index can hold onto its gains of the past two weeks, and/or achieve even greater gains. If it can, there's a chance these stocks will turn profitable again (on their income statements and in investors' portfolios alike).
On the other hand, if the Baltic Dry Index should resume the downward trend we witnessed earlier this year, all bets are off for this industry's recovery. Long story short: Find yourself a link to the BDI -- and watch that index like a hawk.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .