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General Maritime Corp.

April 13, 2011 | About:
inqosi

inqosi

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I have put money into a particular company — General Maritime Corp. (GMR) — which I believe is undervalued and has significant upside potential. Currently trading at $2.37, I believe the stock is worth around $6, at least. Here is why:

Industry overview
:

I first learned about the oil tanker industry in "The Dhandho Investor," a book by value-oriented hedge fund manager Mohnish Pabrai. The book itself is a good, quick read, providing a high-level primer on value investing fundamentals with Pabrai's "twists" — amount to put into any one idea, the concept of probability of outcomes and expected value — based on his experience as an investor and entrepreneur of Indian (sub-continental) heritage. In the book, he discusses how he made north of 55% in a few short months by betting on Frontline Ltd. (FRO), the largest U.S.-based company in the oil shipping industry, back in in 2002-2003.

The oil shipping industry is actually quite interesting. There are 30 or so public pure-play tanker companies, but the size (in revenue and number of ships) of these companies falls off really quickly after the 5 largest. There are under 5,000 oil tankers worldwide, with only ~500 of the largest class (VLCC). These companies' services are essentially perfect substitutes. The customers are large oil companies — think Exxon (XOM), BP (BP), or Shell (RDS) — that want to transport large quantities of oil around the world. Oil tankers remain the most cost-effective way to transport oil across large distances. Competition is based on availability — supply of boats available for a particular voyage on a particular date for a particular length of time. Harking back to my microeconomics class during my salad days in college, this situation suggests a perfectly competitive industry, with pricing driven down to marginal cost. While this may be true on average over time (average returns on invested capital trend toward weighted average cost of capital), pricing is extremely volatile. Pricing — the spot market day-rate to rent a tanker — has a year-to-year standard deviation of over 50% and has varied by as much as 700% in the last 10 years. This is because pricing is influenced by supply of boats and demand for oil transportation, which in turn is driven by oil prices and the supply/demand for oil, which, as we well know, is also extremely volatile. For example, in 2008, spot market rates for VLCCs spiked at over $180,000 per day, then crashed to under $75,000 in three months before rebounding to $160,000 in another three months. For reference, in 2010, VLCC day rates averaged ~$25,000.

In the last 10 years, when day-rates collapse at or below operating costs (~$9,000/day), companies bled money trying to cover interest expense and G&A (for General Maritime, the fully loaded break-even average day-rate across the fleet is ~$18,000). However, when day-rates spike above a level to cover fixed costs, these companies gush cash. Several companies in the industry are set up to dividend out this excess cash when times are flush. For example, General Maritime issued a $12 "special dividend" in 2007 while issuing a cent a quarter in 2010.

Companies attempt to mitigate this volatility by managing supply through commissioning new ships (the newbuild rate), buying or selling used ships (there is an active second-hand market for tankers), and/or scrapping older ships. However, while price and demand can change very quickly, supply is much slower to react given lead-times in all of the above activities.

Finally, the industry is flush with data; there are several industry-specific investment banks and other research providers that publish spot market rates, fleet size by type, new orders, and second-hand market prices for free on their websites.



Investment thesis
:

My investment thesis is pretty straightforward. General Maritime is a pure-play oil tanker company of sufficient fleet size (38 vessels) and vessel mix (spread across largest to smallest classes of oil tankers) that is the most undervalued in terms of asset valuation (details below) and "normalized" (to the extent you can ever normalize earnings in this industry) earnings power value. On either measure, it is currently undervalued by at least ~50%.

The companies in this industry are all suffering because of low spot market rates across vessel classes that have persisted since the second half of 2009. Dividends have been cut and earnings have been negative. I believe that prices are likely to rebound in 2011 and beyond (details below) and even if prices take much longer to recover, downside risk is low. Specifically, rates are near a 10-year low and if prices recover to even 75% of the median spot price of the last 10 years, General Maritime can issue a generous dividend (dividends have averaged north of $1 per share over the five years prior to 2010, not counting the special dividend discussed above), and the stock price will eventually approach intrinsic value. If prices stay low, the company can weather the storm for two years minimum by using cash on hand, cash flow from operations (enough to defray direct operating costs), and by selling (either outright or via sale-leaseback) vessels. Management recently completed a sale-leaseback transaction on three boats, which has provided enough cash for at least the first half of 2011 (not counting cash on hand at the start of the year). Therefore, with a low downside risk of capital loss and a high upside potential via equity appreciation and dividends, I view this as a strong bet.



Valuation:


I valued General Maritime in two ways — asset valuation and earnings power value:

1. Asset valuation: I love heavy industrial companies; given my background in operations, I have additional confidence in my valuation methodology. Additionally, in cases such as this where the company is trading below book value and replacement cost, there is some comfort in knowing that if a company is forced to liquidate, the investor/owner will not lose his investment. Furthermore, in this industry, information is readily available on current and historical second-hand market values, by virtue of an active used market. The low-end of my estimate of liquidation value is $5 per share (low-end of current second-hand market value with a 15% "haircut" in the event of a rapid liquidation). The high-end is north of $15 per share. And please keep in mind that second-hard prices are 20-25% below peak price in the last 10 years, driven by lower spot market rates (meaning, less demand for tankers).

2. Earnings power value: As mentioned above, the EPV is north of $15 per share at the 10-year average spot market day rate and north of $5 per share at 75% of these rates. The big difference in EPV is because of relatively high fixed costs and resulting operating leverage.

I believe the market has overreacted to the recent low rates and the stock is undervalued by ~50%+. When day rates rebound, the stock will approach intrinsic value. Given the company's dividend policy and the fact that 12 leases will be switching from time charters (pre-negotiated rate) to spot rates in the next two years, General Maritime is well-positioned to take advantage and reward investors from any recovery in market pricing.



Macro view:


I am not a macro investor. I think attempting to understand, let alone forecast, macroeconomic drivers is difficult if not impossible. Nonetheless, I wanted to get my arms around how 2010's spot market pricing looked in the context of historical prices; what factors drive prices; and how likely prices were to rebound in 2011 and beyond.

I spent a few nights (yes, I need to get out more) analyzing patterns in spot market pricing, fleet size, new orders, scrap rates, second-hand prices, all by vessel class and the price of oil. Of course, when looking at a large number of variables with a relatively low number of data points (~15-20 years' worth of data — "what's your n???"), false patterns can emerge caused by seemingly non-random samples in a string of random numbers; correlations driven by an outside common factor; or a correlation but no causation. At times, I felt like John Nash in "A Beautiful Mind." For the record, I mean the scene where he sneaks out into the shed and loses his mind trying to find patterns in newspaper articles, not the scenes where he is a genius. Just so we're clear.

Anyway, a few interesting patterns emerge that, while not conclusive (lower R squareds), at least suggest that spot pricing may recover in the near to medium term. In the last 15 years, in periods of decreasing spot market day rates, the total number of new orders decreased (year-over-year), the number of vessels scrapped increased, and the second-hand pricing decreased. It usually took one to two years to rein in suppl; then spot markets tended to recover. Similarly, oil prices appear to be correlated to spot market rates and to second-hand prices; when oil prices are high, spot prices and second-hand values tended to follow. None of this is that surprising; if oil prices drop, then it makes sense that day rates and second-hand values will also drop. And if day rates drop, it makes sense for companies to reduce fleet size (less new orders, scrap older vessels). These factors are at least correlated. Well, in 2010, while fleet size grew by ~7%, most of this was in the smaller tanker classes. In 2009 (latest data available), new orders placed dropped by ~80% year-over-year and 2011 new tanker deliveries are forecasted to be ~25% below the 2010 pace. Scrap rate of tankers increased by 90% 2009 year-over-year, while second-hand values dropped by 25%. In 2010, spot market rates were at ~50% of the median rate in the last decade. Finally, oil averaged ~$60 per barrel in 2010. So far in 2011, oil appears to have recovered to ~$80/barrel. So, between rising oil prices and constricting supply, I believe day rates are poised for recovery.

Risks:

As with all investments, General Maritime has its risks. Spot market rate: The biggest risk is that the day rates stay at the 2010 average level for an extended period of time. While this is unlikely given historical volatility and volatility in drivers, this would mean General Maritime (and all companies in the industry) will slowly bleed cash.

Debt: General Maritime is heavily leveraged, with total debt to assets of ~70%.

Issuing shares: General Maritime issued ~30 million shares in 2010 (increasing float by over 70%). Moreover, one of the covenants in the debt agreements has a provision whereby General Maritime must issue more shares to raise capital in the event certain conditions have not been met, such as EBITDA/debt ratio. This would obviously dilute any ownership interest. General Maritime is poised to issue an additional 23 million shares; I factored the dilutive effects in my valuation.



Risk mitigation
:

I sincerely believe there is no way to predict where spot market rates will go, near term or long term. However, rates are currently well-below historical averages and I think it is unlikely that rates will stay this low indefinitely, given historical volatility, volatility in drivers and global uncertainty as it affects the oil industry. For example, the recent turmoil in Egypt led to rumors that the Suez Canal may be closed, which caused a spike in day rates for VLCCs, since more would be needed to go around Africa if the Canal cannot be used. And with General Maritime's ability to fund operations through cash on hand, cash flow from operations, and sale or sale-leasebacks of vessels, the company can stay solvent for a long time (at least two years just via sale-leasebacks of unencumbered vessels). Therefore, I view downside risk of permanent loss of capital as low.



Summary
:

I view General Maritime as a solid buy. We have a chance to buy $5-15 per share of asset value for $2 and change. We are buying at time when spot rates are very low in historical context, protecting us to some extent against "negative randomness." We know how volatile industry pricing is; any spike in prices — "postive randomness" — only benefits us. While there are risks, I view the chance of permanent loss of capital as very low and the chance of signficant gain — either through capital appreciation or future dividends and ideally both — as high. To quote Pabrai, "...heads I win a lot, tails I lose a little." Sounds like a bet I'd be happy to make every day. I am long General Maritime.

Inqosi

inqosi@gmail.com

Rating: 4.1/5 (13 votes)

Comments

mmel
Mmel - 3 years ago


I think this is an interesting investment idea. I like the idea of playing the volatile fluctuations of the underlying spot market. As Buffett said, I'd rather have a lumpy 15% return than a smooth 10%.

I was wondering if you could give some links to good websites for finding the spot pricing and secondary ship markets? I would be very appreciative.
batbeer2
Batbeer2 premium member - 3 years ago
Nice article and an interesting idea, thanks ! Two questions:

1) What do you think of the CEO; he seems capable but is he working for shareholders or does he just use other peoples money to build himself an empire ?

2) When does the debt come due ?

buynhold
Buynhold - 3 years ago


As of Q4 2010, their LT debt has become short-term, so they have $1.35 billion coming due pretty soon. What is their plan on that? 23 million additional shares is not going to raise enough to cover that.

I see a huge risk of permanent capital impairment here.
inqosi
Inqosi - 3 years ago
Thank you for your comments. Here are the most helpful links on spot market rates and second-hand values I came across:

Weekly reports YTD with rates and utilization: _http://www.pareto.no/no/PF-Bassoe/Weekly-Reports/2011.aspx

Supply, Demand, and Utilization: _http://www.platou.com/dnn_site/Graphs/SDURTANKER.aspx

Second-hand prices (and a wealth of other stats in table form): _http://www.platou.com/dnn_site/Tables/Secondhandpricesof5yearoldTankers.aspx

Current spot market rates (note volatility on VLCCs, which spiked then came back down since I wrote this post): _http://www.intertanko.com/templates/Page.aspx?id=24387
inqosi
Inqosi - 3 years ago
With respect to management, I have not been able to find much. They do not seem particularly shareholder friendly in light of the shares they issued and additional shares they are currently issuing. Also, the latest acquisition of vessels were at prices well north of current second-hand values and seem ill-timed given where rates were and still are (in hindsight). However, this is a cyclical industrial play, and on average, companies earn about their cost of capital. This is not a "great company at a good price" that will reinvest capital at a super-normal rate of return. Instead, it is a good/average company at a great price, in my opinion. Thank you for the comment.
inqosi
Inqosi - 3 years ago
Great question and comments on LT debt. Historically, GMR has been able to roll over debt. I believe GMR will be able to do this again. If the banks call the loan and GMR is not able to find another lender, the company can sell vessels. In the worst case, if the banks force GMR to liquidate, even at currently depressed second-hand values and with a conservative "haircut" for liquidation, equity holders should get their investment back along with some upside. However, the banks are specialized to this industry and my belief is that it is in their best interests to roll-over debt and wait, get concessions on rate and covenants, and also hold on for better rates. Thank you.
dumbchina
Dumbchina - 3 years ago
Ok I'm gonna try and not sound too harsh here, but is your write-up a little outdated?

1) It fails to take into account the company underwent a liquidity crunch in the past several months, as exemplified by

a) relief from lenders on net leverage and minimum cash covenant

b) sale-leasebacks of vessels to repay bridge loan and revolver

c) outright sales of older vessels to generate proceeds to further repay debt

d) delayed 10-K filing, and going concern language from auditors, hence the reason why the debt is classified as short-term

2) This ultimately led to Oaktree investing $200 million in the form of third lien toggle PIK notes, in return for penny warrants for 20% of the company. The company is also in the midst of finalizing the refinancing of a $550 million revolver.

3) They did an equity raise for ~$40-45 million, with the proceeds going towards the payment of the last Metrostar vessel. Recall that this was part of a large acquisition of 7 VLCCs back in June 2010. While it was encouraging that management and directors participated in the offering, they might have done so b/c of the little interest/high perceived risk of GMR at that time.

I'm not disagreeing that the going concern valuation is dependent on shipping rates. But I think you need to put it in the context of everything that has happened. Their fleet size has been somewhat reduced (from 38 to 31 vessels) and the overall fleet quality (age and capacity) has improved. Another fact to consider is they have essentially pushed out amortization of the term loan for 2 years. What happens if the shipping environment remains depressed? Are lenders going to request further vessel sales which would reduce going concern value (and potentially wipe out shareholders in a restructuring)?

Hope that helps.
inqosi
Inqosi - 3 years ago
Not harsh at all, I appreciate your comments.

You are right -- I started analyzing this stock a couple of months ago and wanted to chase down a few questions I had before posting. I did take into account the sale-leaseback, vessel sales, and dilutive effects of additional shares and warrants into my valuation -- I should have specified this in my write up.

Your points are all well-taken. The stock is undervalued if it could be liquidated today or if prices rebound somewhere in the next 2-3 years. The worst case will be if prices stay depressed for 3+ years and the company slowly bleeds to death by selling ships to cover expenses.

I believe that the company can fund its operating expenses via sale-leaseback and/or outright sale of vessels for at least 3 years -- de-levering and reducing interest expense in the process -- before net asset value falls below current market value. This again is assuming that the company sells the vessels at current market prices less a discount.

So, my bet is that spot market rates recover in the next 3 years; if rates do recover, the EPV will be significantly higher than current market price. If rates stay consistently low for 3 years (which I believe is unlikely given volatility in this market), I believe the asset value (after vessels are sold to meet expenses) will still exceed current market price. I view this stock as a bet on a leveraged company in a cyclical industry with low downside risk (asset value protection) and high upside potential (earnings power should rates recover).

I also think rates will rebound to at least a level that can cover operating expenses via higher scrap rates, delayed delivery dates, and dry-docking.

I welcome comments and feedback.

Please leave your comment:


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