Star Bulk Carriers Corp. (SBLK): 10 Bagger Or Bust
I believe that over the next 3 years it’s possible that Star Bulk Carriers Corp. (SBLK) could rise 1000%, a 10 bagger if various scenarios unfold in the proper sequence.
Every investor is familiar with the ongoing China crash and the fact that dry bilk rates are hovering at 3k currently, the gloom is thick. In fact a recent article in Hellenic shipping news referred to the industry as operating in an Armageddon position. This is the first time in my long career as a distressed investor that I have heard an industry operating in an argamagedon scenario. If an investor is to buy when blood is in the streets this is an apt time.
As many analysts have referenced in seeking alpha SBLK does not suffer from balance sheet insolvency, it is suffering from a cash flow crises. In the table below I have crafted a back of the envelope table for future ebitda based on 80 ships at various TCE rates.
| Star Bulk Carriers EBITDA and Free Cash Flow Generation | |||||||
| TCE Rate | 5,000 | 7,000 | 8,000 | 10,200 | 11,750 | 15,000 | |
| Revenue | 138,700,000 | 194,180,000 | 221,920,000 | 282,948,000 | 325,945,000 | 416,100,000 | |
| Expenses | 122,640,000 | 122,640,000 | 122,640,000 | 122,640,000 | 122,640,000 | 122,640,000 | |
| Gross Margin | 16,060,000 | 71,540,000 | 99,280,000 | 160,308,000 | 203,305,000 | 293,460,000 | |
| Dry Docking | 15,000,000 | 15,000,000 | 15,000,000 | 15,000,000 | 15,000,000 | 15,000,000 | |
| SGA | 24,000,000 | 24,000,000 | 24,000,000 | 24,000,000 | 24,000,000 | 24,000,000 | |
| EBITDA | -22,940,000 | 32,540,000 | 60,280,000 | 121,308,000 | 164,305,000 | 254,460,000 | |
| Interest | 50,000,000 | 50,000,000 | 50,000,000 | 50,000,000 | 50,000,000 | 50,000,000 | |
| Principal Payments | 110,000,000 | 110,000,000 | 110,000,000 | 110,000,000 | 110,000,000 | 110,000,000 | |
| Free cash Flow | -182,940,000 | -127,460,000 | -99,720,000 | -38,692,000 | 4,305,000 | 94,460,000 | |
| EBITDA | -22,940,000 | 32,540,000 | 60,280,000 | 121,308,000 | 164,305,000 | 254,460,000 | |
| Restructured Interest | 80,000,000 | 80,000,000 | 80,000,000 | 80,000,000 | 80,000,000 | 80,000,000 | |
| Restructured Principal | 40,000,000 | 40,000,000 | 40,000,000 | 40,000,000 | 40,000,000 | 40,000,000 | |
| Restructured Free cash Flow | -142,940,000 | -87,460,000 | -59,720,000 | 1,308,000 | 44,305,000 | 134,460,000 | |
| Assumptions | |||||||
| Fleet Size | 80 | ||||||
| Utilization | 95% | ||||||
| Days | 365 | ||||||
| Operating Days | 27,740 | ||||||
| Costs days | 29,200 | ||||||
| Daily expenses | 4,200 | ||||||
At current rates of $5000 a day the company would generate negative ebitda of $23 million and after interest and principal payments a negative $182 million. Comparing this to an estimated cash balance in Jan 2016 of $250 million dollars after sales of vessels and equity required for new build acquisitions. Clearly the company could only survive for one year under this scenario considering that the company must also maintain 500k of cash for each vessel operating or $40 million assuming 80 ships in operation. So it’s clear to see why the share price is 40 cents and has a equity cap of $90 million versus a book value of $1.4 billion. However, let’s consider various scenarios that could occur that investors are giving zero chance to happening.
First scenario: it’s highly likely that dry bulk ship scrapping will accelerate quickly and dry bulk owners may soon begin laying up ships. This is my third cycle investing in the shipping business over the past 30 years and I have found that shipping has a unique ability to right size itself in the worst of times. Considering this is the worst of times, I’m estimating that owners will soon lay up ships and begin significant scrapping. There are 9600 dry bulk vessels operating in the world with about 1000 vessels on order that are scheduled to be delivered over next few years. Assume 30% of the newbuilds are never delivered leaving 700 new vessels. There are 900 vessels that are older than 15 years, which are likely to be scrapped over next two years. Then assume 5% of the exiting fleet or 480 are laid up within the next few months. If this were to happen it’s highly likely that rates for various dry bulk vessels could rise to $7000 or $8000 a day. Under that scenario you’re looking at an EBITDA generation of between $30 and $60 million
Second Scenario: Chinas domestic coal and iron ore producing companies are loosing incredible amounts of money; some suggest billions in annual operating losses when interest and principal payments are factored in. If china decides to shut down just a portion of these cash burning coal and iron ore mining companies even slightly the demand for imported coal and iron ore combined could move up by 30 to 50 million tons a year. This would have a nice incremental impact on supply and demand for vessels. I am not suggesting this is a high probability but it is possible.
Third scenario: Oaktree capital which owns 50% of the equity in Star Bulk Carriers, has a cost basis of $600 to $700 million for its SBLK shares that are now worth $50 million. At this point investors are fearful that another round of equity offerings are in store or worse a preferred stock offering that Star Bulk Carriers offers to Oaktree, which would prime Oaktree over existing shareholders.
I view this risk at 25% percent given the company’s recent sale of cape vessels. The sale of new building vessels indicates to me that the company is going to “burn the furniture” or in other words use the equity inherent in the new builds to stay alive over the next 2 years. The most convincing evidence that Star Bulk Carriers will try to prevent significant dilution comes from the CEO Petros Pappas .He is sitting on a Capital loss that I estimate approaches $100 million. He received 8.6 million shares in SBLK at $12 a share when he swapped his ownership in Ocean Bulk Carriers for Star Bulk Carriers shares then worth $100 million. Those shares are currently worth $5 million. I am sure that Petros is working day and night to figure out how to recover a portion of that lost fortune. I’m also confident that oak tree or Star Bulk Carriers would not offer him equity grants large enough in the future to make up that loss.
Scenario Four: I believe that after Star Bulk Carriers takes delivery of its Ultramaxes this year it will enter into an agreement with its existing banks to stretch out amortization payments. If you look at the EBITDA table you will see that I have proposed a restructured interest payment to the banks of $80 million of annual interest and $40 million in principal payments as opposed to the $50 million in interest and $110 million principal payments under the current capitalization structure.
Given that’s Star Bulk Carriers’ balance sheet is strong for a shipping company and solvent under rates of 8k to 10k a day, I believe it’s in the banks interest to work with the company, as it will protect their collateral value during this downturn. Over the past three decades it has not been uncommon for banks to stretch out principal payments to owners that have reasonable balance sheets when day rates are at depressed levels. In this scenario, if rates were to rise to $10,000 a day under the restructured scenario, the company would be able to generate enough cash to breakeven after interest and principal payments. If rates were to go above $10,000 the excess free cash flow can be swept to the banks for principal pay down.
The specter of a foreclosure by the banks or another distressed private equity fund buying the bank debt also seems very unlikely. The reasons being that distressed investing hedge funds have been crushed investing in the dry bulk industry over the past two years. Funds that bought the bank debt of genco and eagle bulk and a few other shippers have lost billions of dollars as the shares they received from the debt to equity recapitalization have plunged. This puts SBLK in a better negotiating position with the banks as few distressed investors exist to buy Star Bulk Carriers’ bank debt at the prices the banks would want. In addition distressed investors don’t like to buy companies that have negative ebitda. This scenario raise the odds that SBLK can negotiate a principal reduction plan.
While it’s impossible to know what’s going on in the minds of the banks I think that it is likely some sort of agreement can be reached without Star Bulk Carriers having to raise more equity in 2016 thanks to the sale of its newbuild vessels. Of course this is a moving target as the future is unpredictable. However, if scrapping and lay-ups occur over the next 3 to 6 months rates may move from their current levels to 7 or 8k eight or even 10k.
I believe that SBLK cash balance after the sale of vessels and equity required for new builds in Late February will be around $240 million. With this cash balance if rates were $8000 a day thanks to scrapping and ship layups under my restructured interest and principal payment scenario the company would have to come out of pocket by $60 million for principal and interest payments from its existing cash balance which is doable
At its current price of $.44 the company’s market equity capitalization is $90 million against a book value of $1.3 billion or $6.50 a share. No doubt given the declining vessel values at the present moment the net asset value is probably $1 to $2 a share with that far from realization due to the current rate environment.
However let’s assume a slightly rosier scenario. Assume that over the next 3 to 4 years vessel rates were to climb to $15,000 dollars a day. In that case SBLK would generate $254 million in ebitda, that is $1.20 a share in EBITDA based on 220 million shares outstanding assuming no dilution between now and that date. If this were to occur the stock would trade for at least $4 to $5 dollars a share
To date we have seen the devastating effect that declining dry bulk rates can have on a leveraged balance sheet of a shipping company. The markets are assuming that between now and 2018 Star Bulk Carriers will have to issue a lot of equity capital and that rates will likely not rise. I believe it’s time to consider the possibility that equity capital may not have to be raised in the vicious downturn thanks to the factors I mentioned above. As the saying goes the best antidote for low prices is low prices. Of course if rates do not rise and stay at current levels over the next two years it’s clear that Star Bulk Carriers will be at the mercy of the banks and a large dilution very probable as oak tree steps in to save its investment. Let assume an equity offering of 500 million shares at $.30 cents for $150 million would leave 725 million shares outstanding and assume the banks are given 100 million shares to extend amortization bringing the total to 875 million shares outstanding. As incredible as it sounds if the company were to earn 254 million in ebitda with 825 million shares outstanding that would be .30 cents a share in EBITDA, which would mean the stock, would trade at 1.50 to 2 a share depending on the animal spirits of investors at the time this occurs.
So I have presented four scenarios for an optimistic upside. An investor looking for a possible 10 bagger has to assign his or her own probabilities to the various scenarios. If your scenario is recovery with no dilution you’re looking at a 10 bagger. If your scenario is a China bust continuing and rates staying at current levels for two years or three years it’s a bust if Oaktree does multiple rounds of equity infusions. I am betting that the more optimistic scenario of muddle through and recovery has a greater than 50% chance of occurring. No one at the present time can predict with any accuracy what will happen that is why a 10 bagger is possible. If you’re interested in other potential 10 bagger stocks I suggest you visit my website turnaround stock investing.
