Dry bulk headlines are ebullient. The Baltic Dry Index (BDI) closed at 2,170 on July 19, its highest level since December 2013 and up 260 percent from early February. But the BDI doesn’t tell the whole story.
Some pockets of the dry bulk ocean shipping market are rising more slowly than others, but these too are now moving along the same upward trajectory, as seen in the latest quarterly disclosures of Scorpio Bulkers (NYSE: SALT).
The BDI’s resurgence is primarily fueled by surging charter rates for larger bulkers – Capesizes with a carrying capacity of 100,000 deadweight tons (DWT) or more. This vessel category, which carries iron ore and coal, is being buoyed by a specific driver – the rebound in long-haul Brazilian iron-ore exports to China.
Mid-sized bulker sizes such as Ultramaxes (60,000-65,000 DWT) and Kamsarmaxes (82,000-83,000 DWT) carry a wider variety of cargo than Capesizes.
Rates in these categories did not start their upward climb in earnest until this month, meaning that companies such as Scorpio Bulkers that specialize in these vessel categories suffered continued weakness throughout the second quarter.
SALT results
On July 22, Scorpio Bulkers reported net income of $35 million for the second quarter of 2019, compared to $0.8 million in the second quarter of 2018.
However, $53.1 million of gains in the latest period stemmed from the company’s ownership of 11 percent of the stock in related-party Scorpio Tankers (NYSE: STNG) – shares that were purchased in October 2018.
Excluding the non-cash items, including the gains from STNG, Stifel shipping analyst Ben Nolan calculated that Scorpio Bulkers had an adjusted net loss of $9.7 million or $0.14 per share in the second quarter of 2019, which was better than the analyst consensus forecast for an adjusted net loss of $0.19 per share.
In the months of April to June, Scorpio Bulkers’ Ultramaxes earned an average of $8,993 per day, down 22 percent year-on-year.
Its Kamsarmaxes earned $10,830 per day, down 16 percent year-on-year.
Rates rapidly improving
Following the release of its earnings report and the conclusion of its conference call with analysts, Scorpio Bulkers’ stock was up around 7 percent in mid-day trading on more than twice the average volume. Investors appear to be looking towards the third and fourth quarters, given what’s currently happening with bulker rates.
The company has 42 percent of third quarter revenue days for its Ultramaxes already locked in at $9,603 per day, up 8 percent from the second quarter, and 42 percent of third quarter revenue-days for its Kamsarmaxes booked at $12,656 per day, up 17 from the second quarter.
During the conference call, Deutsche Bank analyst Amit Mehrotra described these third quarter rates as “underwhelming.” Scorpio Bulkers president Robert Bugbee countered, “The reason bookings to date are underwhelming is that they obviously reflect where the market was weeks ago.”
He continued, “The market in the second quarter was lower than where we are now. Right now, Kamsarmaxes are trading at $17,000-17,500 per day and Ultramaxes are at $12,500 per day and both are moving upward. We’re also moving into what is normally a stronger period for dry cargo, which lasts through the beginning of the next year, until the pre-Chinese New Year period.” Consequently, the full third quarter rates, including the 58 percent of revenue-days still to be booked for both vessel classes, should be considerably higher.
The company’s optimism on the coming months is underscored by its decision to charter in four Kamsarmaxes for durations of 24-27 months. These contracts will allow the company to have more exposure to rising rates and it to pocket the difference between future market rates and the rates the ships were chartered in at.
“We’re adding more risk because we’re expecting we’re going into better times,” said Bugbee.
Stock still trades at a significant discount
The problem for investors seeking to bet on dry bulk rates, and for executives like Bugbee (who is himself a significant investor in Scorpio Bulkers’ stock), is that equity prices have not been following the same pattern as rates. This disparity has led to the creation of other investment options, including an exchange-traded fund called BDRY that owns freight futures.
According to Bugbee, “We are aware that our stock is trading at a significant discount” in relation to net asset value (NAV). NAV is the market-adjusted value of the fleet assets, plus cash, minus debt and other liabilities.
On the call, Bugbee maintained that the NAV of Scorpio Bulkers was at around $9.50-10 per share “and rising.” The company’s stock is up almost 80 percent since early March, with most of that increase coming this month, but it’s still trading at a discount to NAV.
Bugbee said that the company’s NAV should rise “because there is strong cash generation and [ship asset] values are going up.” Furthermore, around 20 percent of Scorpio Bulkers’ NAV relates to its investment in Scorpio Tankers in the product-tanker market. That segment is expected to see significantly higher rates due to the global cap on sulfur content in marine fuel starting January 1, 2020, which is expected to create higher demand for the transportation of fuels aboard product tankers.
Bugbee highlighted the discount to NAV when explaining the company’s recent decision to sell two Ultramaxes built in 2015, the SBI Electra and SBI Flamenco, for a combined price of $48 million. “When we can secure sales at NAV, this will ultimately help close the gap [between the stock price and NAV],” he explained.
In other words, if the stock market is effectively valuing a public company’s ship at $20 million on paper and a buyer will pay $24 million for the physical asset, the cash proceeds from the sale should theoretically make it more difficult for stock investors to ignore the value.
Asked by Evercore ISI analyst Jon Chappell whether more ship sales could be on the horizon, Bugbee responded, “Maybe. We have to see what happens with the whole dry cargo stock market. Stocks are trading significantly below NAV. Normally, you’d expect with spot rates strengthening that stocks would react fairly quickly, and that all dry cargo stocks would go up. That would be the traditional pattern. But given how persistent this dislocation has been, maybe it will take more time. If so, then we’ll just sell a couple more ships.”
