Tanker Values, Again!

Just when the Captain thought that we all had figured out that vessel prices were in a precipitous fall and ship brokers were busy slashing their price list for vessels on their weekly reports, there you have a company like SK Shipping ordering allegedly three VLCC vessels this week at Hyundai Heavy (HHI) at $100 million each with a 2013 expected delivery date. The exact details of the transaction are not well known, but even the facts that a) someone places an order for more VLCCs in the present market and b) at a price of $100 million per vessel are extraordinary by themselves.  The Captain does not know the intent and the logic behind the buyers' decision in terms of employing the vessels such as whether the buyers have secured a long term employment contract or a contract of affreightment for the vessels, but this order, if true as reported, basically turns any attempts for vessel valuations, especially for modern expensive vessels, on its head.

VLLCs, of all vessels, in the last year have more or less been operating below cash break-even and it seems that several owners for such tonnage have been under pressure.  After more than six months of any meaningful activity in the second hand market, in the last forty days there have been several transactions of approximately ten-year old VLCCs at approximately $30 million, take or leave a couple of million, and thus there has been a realization that asset prices have dropped by more than 40% for such vessels since the early part of 2011.  At the face of a weak freight market and extreme difficulty at securing sufficient / competitively priced debt financing, and despite the fact that resale VLCCs were sold more than six months ago, it has been estimated that modern VLCCs, whether resales or newbuilding contracts, had to have dropped lower by a lot as well.  Most ship broker reports post VLCC newbuilding prices at $90 mil, take or leave a few million dollars, and much lower from Chinese yards.  But again, the SK Shipping order, is more or less 10% apart from the brokers' estimates, and it is even more impressive given that the yard where the order has been placed is a highly reputable, brand name yard and not in an immediate need of orders.

As a matter of reference, there are approximately 570 VLCC vessels today on the water with about 145 more of them on order; that is an outstanding orderbook of 26% of the world fleet; in more tangible terms, a brand-new VLCC is planned to be delivered every five days for the next two years.  And, for CAL2012, TD3 paper market from AG to Japan trades at about $8,200 pd at present, just at about the vessel daily operating expense.  And, in general, in terms of obtaining debt financing for a modern VLCC, the major quantitative terms might stand at about 50% leverage of the present FMV and on average 400 bps above cost of funds, if there is still a bank to consider financing such a vessel.  The present order therefore of SK Shipping for these three vessels at $100 million each shows a great degree of faith in the market and runs directly against any consensus estimates for the shipping and tanker markets, and the VLCC market in particular.

And, one of the major implications of such newbuilding order, still if true as reported, it's that the 'intrinsic' and replacement cost of vessels still remains high.  No matter how low second-hand values have moved and how much eager buyers of distressed assets salivate about the prospects of 'vulture' acquisitions, modern tonnage is only available at strong prices, even stronger than the freight and financial markets may suggest.  And, such transaction provides for a solid benchmark in setting vessel valuations for documentation purposes at levels than are still within line of recent history and without causing undue concern to lenders and borrowers.

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Mirror, mirror on the wall, which shipping sector is the fairest of them all? (Tonnage demand economics)

While tonnage supply is easily understood and fairly quantifiable (after all, it typically represents existing vessels on the water and legally contracted vessels to be built, with a few exceptions such as ‘slippage’, ‘substitutions’, ‘cancellations’, etc.), forecasting shipping demand is the shallow reef where economists’ models casually shipwreck, and correct estimates thereof have been the source of great a many fortunes in shipping!

Large vessels like VLCCs, VLOC/capesize bulkers and post-containership vessels are susceptible to high volatility in their trading earnings, as they are disproportionally exposed to macro-economic and geopolitical events.  For example, it is a well-established fact that wars and armed conflicts, as repulsive and condemnable as they are, usually prove to be good for shipping.  Furthermore, since whole countries and economies depend on big vessels to feed industrial production with raw materials, their existence is noticed by governments and regulators, business conglomerates, etc   The Chinese, for example, have passed a directive over the last few years that most of the crude oil imported to China has to be carried on Chinese ‘controlled’ vessels by 2015.  Since the third quarter of 2011, already the majority of oil imported to China has been on Chinese ‘controlled’ vessels, a full three years ahead of schedule.  In a well oversupplied market such as the VLCC sector at present, the execution of such a directive exacerbates an already difficult market inequilibrium.  It’s a similar picture for the capesize market where the Chinese, as the driving force for iron ore and coal imports, have made it clear that they will not tolerate commodities exporters and independent owners to ‘dictate’ the market (the ‘China-max’ VLOCs spat with Vale comes to mind.)  

At the other end of the spectrum, smaller sized vessels such as panamax crude tankers, MR product tankers, handysize dry bulk vessels and handy containerships see their trading earnings range within a ‘reasonable’ range, usually no much below cash break-even in a bad market and a quintuple multiple of the vessel daily operating expense in a good market, almost most of the time.  Even during the bleakest days of 2008, handysize dry bulk vessels were busy and operating at cash break-even levels.  Usually smaller sized vessels have many trading routes to seek employment, many cargoes to move, many ports (even shallow or under-developed ports) to call, many charterers to attract to, many more localized pockets of economic activity to exploit …

Given that the consensus estimate for world economic growth is subdued over the next two years, ranging from 1.5% to 5% depending on the optimism of the model, smaller sized vessels seem to have the best prospects.  It does not seem that there will be any imminent outbursts of industrial production and productivity that will drive through the roof rates for macro-economically driven big vessels.  And, given that small vessels already trade on a cash flow positive basis in today’s depressed freight market (it has not been the case for VLCC and capesize vessels for almost a year now), with a favorable fleet profile, both in terms of newbuilding deliveries and demolitions due to aging, one is tempted to say that small is beautiful, whether tankers, dry bulk or containership vessels! 

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Mirror, mirror on the wall, which shipping sector is the fairest of them all? (Tonnage supply economics)

Looking forward, ahead of the present slump in shipping, the Captain is often inquired on the market segments that are in best shape, comparatively speaking, to fare bravely the market and the sectors that likely will recover first.  Hope springs eternal, as they say, and the present anemic freight market notwithstanding,   there are asset classes that are better positioned to weather the stormy markets.

Looking at vessel supply data, there is no question that, in general, the asset classes with the bigger sized vessels, whether tanker, dry bulk or containership, seem to be the most oversupplied.  For instance, according to the Captain’s logs, there are approximately 570 VLCCs in existence and about another 145 such vessels on order, so the outstanding orderbook is approximately 25% of the worldwide existing VLCC fleet.  There are almost 520 capesize vessels on order out of an existing fleet of 1,290 vessels (40% outstanding orderbook as percentage of the existing fleet), and 435 post-panamax containerships on order out of an existing population of 910 vessels (48% outstanding orderbook).  Sliding down the scale, panamax crude tankers have approximately 13% outstanding orderbook (53 vessels on order vs 410 on the water), MR tankers stand at about the same with 13% (175 vessels on order out of a worldwide fleet of 1290 vessles), handysize dry bulk vessels equal to 22% (with 670 on order out of an existing fleet of 3,035 vessels), handy containerships stand at only 8% (105 vessels on order vs 1,280 vessels in existence), and finally, stainless steel tankers bear 9% outstanding orderbook (95 vessels on order vs 1,050 vessels on the water.)  It is abundantly clear from the above data that the market for bigger vessels will be affected in the future more heavily by new vessels entering the market than the markets for smaller-sized vessels.

Looking to assessing future tonnage supply, besides the new deliveries that will enter the market, the age profile of the existing fleet, and thus the rate at which vessels are expected to leave the market, by way of demolition, etc, is also a very important factor.  The average VLCC is approximately 7.5 years old, and so is the average capsize vessel; for post-panamax containerhsips, due to the ‘new-ness’ of their design and market economics, the average vessel is only two years old.  However, the average MR tanker is already 12 years old, the average handysize dry bulk vessel about 16 years old, the average handy containership approximately 12 years old, and the average stainless steel tanker around 10 years old.  Again, the data make it abundantly clear that, in general, asset classes of big sized vessels consist of relatively young  fleets (as a result of persistent increased ordering and newbuilding activities during the booming years of the cycle), while smaller sized vessels are in general much older and, one might say, past their prime.

There is no question then that as far tonnage supply is concerned, VLCC, capsize dry bulk and post-containership vessels will likely have to face oversupplied markets for some time to come, and any demolitions will be limited and painful as these fleets consist of relatively modern tonnage.  There is always of course the question of tonnage demand, which can keep busy and absorb tonnage oversupplies, but again, vessel demand is at the mercy of direct market forces, and a subject profound enough to deserve its own discussion in subsequent posting.  

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Searching for the value of vessels in a thinly traded market (Part A)

Valuing vessels, like most other types of assets, would seem to be fairly straightforward:  a review of recent market transactions would more or less provide a very good guide of the value of a vessel.  This method is formally called the market comparable approach, or ‘last done’ in ship brokerage parlance, and it’s usually the number that gets stuck on the so-called desktop valuation certificate.   

Parenthetically, the valuation methodology extends to incorporate the replacement cost method (usually for unique type of vessels with minimal comparative guidance) and of course the income approach method based on the present value of the vessel’s earnings potential (there are variations on the theme of the income approach such as ‘charter-attached’ valuation based on actual employment contracted for the vessel, discounted cash flows (DCF), long term value or value based on the ‘Hamburg Rules’, etc.)

As a matter of industry practice, the charter-free, market comparable approach is typically utilized for documentation and collateral purposes in shipping loans, unless the lenders have financed a vessel / project based on an existing contract, revenue stream and their associated cash flows, and have agreed to accept valuations based on different methodology.  Therefore, deriving market based valuations is of paramount importance, especially at times like presently when asset prices have dropped significantly since the market topped and hovering perilously around the loan-to-value (LTV) covenant triggers.

As important as it is to have accurate market approach valuations, market conditions are not necessarily conducive to such noble aim.  For instance, for modern vessels including prompt resales, there is an extremely limited market.  While older vessels might still trade more frequently, comparatively speaking, and thus there is a better guidance on pricing, for new vessels, where incidentally the stakes are much higher, market guidance is extremely limited.  For example, as of middle October 2011, there are two transactions that took place for prompt resale VLCC year-to-date, one in January 2011 and the second in April 2011; that is, the freshest comparable transaction is already six months old, when all along, freight rates are demonstrably deteriorating and finance costs are getting patently more cumbersome.  To complicate matters more, both of the transactions took around the $105 million mark, which as strong price no doubt in retrospect as it may seem, at least it shows convergence to a concentrated price level.  However, in the first transaction, the banks privately forced the sale of the two vessels from a weak owner (whose equity  was completely wiped out from the sale) while the same banks extended 100% financing of the purchase price to the new buyer at, more or less,  the bank’s cost of funds.  In the second transaction in April, the buyer has a strong reputation for quality vessels, unrestrained access to the financial and capital markets and an operating profit business model in mind (as opposed to an asset play mentality).  However, strictly speaking, neither of these transactions fulfills the definition of fair market value (FMV), especially the part of willing seller and willing buyer neither under compulsion to act and with knowledge of all pertinent facts.    

So, how one values a prompt resale VLCC these days?

As recently as in September 2011, the Captain attempted to market for sale a prompt resale VLCC with approximately $95 million asking price, and some indicative offers received were in the $75 million range.  Is the price still at $105 million from April as ‘last done’, or the sellers’ asking price at $95 million, or the price from ‘bottom fishers’ at $75 million?  To spice things up, such a vessel has a $130 million cost basis, earns about $10,000 pd in the spot market at present, and based on standard financing assumptions, the daily bank note of interest and principal repayment would be close to $35,000 pd.

Figuring out the value of a prompt resale VLCC, or any other type of modern tonnage for that matter, in the present market! That is the question!

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Do current tanker vessel prices present value investments?

The fact that tanker freight rates have been below cash break-even for several quarters so far, it has significantly contributed to the decline of tanker asset prices.  Nominally, there has been an approximate 15% drop in tanker prices for very modern vessels (less than three years old) in the last twelve months, with the stated proviso that it has been a thin secondhand market for such vessels and each transaction seems to have its own idiosyncrasies based on the specific buyer, the specific seller and the specific circumstances of each transaction.  

However, prices for older tanker vessels have fallen precipitously in the same timeframe.  In general, double-hull tanker vessels 19+ years old, especially for those with imminent survey position, are valued more or less at salvage value, a drop of more than 50% within a year.  Two quick explanations for such a dramatic drop can be pointed to the facts that a) there is complete lack of debt financing for older tonnage, especially for tankers in a weak freight market when shipping lenders only pursue strategic clients and assets, and b) charterers discriminate against older tanker tonnage since they can charter modern, high quality vessels still at extremely competitive prices.  In general, tanker vessels have a design life of twenty-five years, so, theoretically at least, a twenty-year-old double-hull tanker has five years of economic life remaining.

While a prospective investor evaluating shipping projects may opt to reject an investment of a modern tanker vessel as still too expensive, by historical standards, or an investment in a ‘vintage’ tanker vessel due to perceived unfavorable risk-to-reward ratio, how about investment projects of tanker vessels between 12-15 year of age?  Recent transactions of such vessels substantiate a drop of asset pricing of more than 100% in the last twelve months, and such vessels are still modern enough to be competitively considered by the charterers and also acceptable by the lenders as sufficient loan collateral. 

Consider the following (theoretical) example:  the 1999-built VLCC MT TAKASE (314,000 dwt) was sold in early October 2011 for $28 million, a purchase price that implies $8 million premium over salvage value (40% premium, in percentage terms) given that the vessel has about $20 million scrap value at today’s market levels.  Based on thirteen years of remaining economic life for the vessel, it requires less than $2,000 per diem to amortize the purchase price; assuming 10% overall cost of capital and approximately $9,000 pd for vessel daily operating expenses (VDOE), then the break-even point stands at approximately $18,000 pd.  Even at today’s abysmal freight market when spot rates for VLCCs are less than $15,000 pd, a straight three-year charter can nominally be secured at approximately $28,000 pd.  A strategy of securing a three-year charter will ensure that the vessel operates on a cash flow positive basis while the owner is biding their time out of the downcycle, when they can expect a return to normalized freight rates that have averaged more than $40,000 pd over the last decade.  

On to a more practical illustration, Nordic American Tankers (NAT), publicly traded on the NYSE, recently acquired a 1999-built Suezmax tanker at $25 million, a price implying $9 million (or 36%) premium over salvage value.  Based on twenty-five years of total economic life, the vessel still has thirteen years remaining life, thus price amortization equals to less than $2,000 pd; based on 10% weight cost of capital and $8,000 pd vessel daily operating expense assumption, it will take on average $17,000 pd for this project to break even.  At present, a one-year charter for such vessel is $18,000 pd while nominally a three-year charter stands at $22,000 pd.  

No-one claims that these last two examples dictate sure-thing investment opportunities in shipping.  There are risks involved with such strategy, but no less navigable than that in other investment projects in shipping.  Based on peer group analysis, it seems that NAT’s strategy of distinguishing between vessel prices and values is getting recognized.

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

How do you say 'too big to fail' in shipping?

Freight rates in shipping have been at below cash break-even levels, in general, for more than a year now, in most shipping asset classes; this is even more so for bigger sized vessels such as tankers, dry bulk and containership vessels.  When the charter revenue is not enough to cover even vessel daily operating expenses, stopgaps have to be found in terms of vessel operations, chartering and routing, vessel maintenance and spare parts onboard, among others, in an effort to preserve working capital and cash reserves.

When freight rates are barely sufficient, if at all, in a down market, for operating expenses, return on capital is usually less significant than return of capital; lenders have to make an effort, as painful as it may be, to restructure the loans (usually first preferred mortgages) in order to allow the debtor more cushion for liquidity to sustain the market.  Usually in order of importance, loan covenants may be loosened and so-called soft covenants may be waived altogether, and the terms of principal repayment can be re-negotiated and re-profiled, and finally interest payments might be re-negotiated, although usually spreads have to be higher.

While in previous industry downcycles there was only a shipping crisis, during the present cycle there is a shipping downcycle superimposing on a banking crisis (in Europe and the US), an economic downcycle (‘jobless recovery’ in the US and stagnation in the Eurozone), a financial crisis (mostly in the periphery of the Euroze) and finally a political crisis (mostly in the Eurozone and the political failure to act collectively, decisively and pro-actively).  One can only surmise that this has the potential of an explosive cocktail.

As it is always the case with creditors, repossession of the collateral is an act of last resort.  However, when the nominal value of shipping loans at the top of the market were valued at $500 billion, and there is the distinct possibility of a massive implosion of the industry, given a catastrophic scenario outlined above, the option set for creditors becomes smaller.  Again, while creditors in shipping have been doing their best to avoid direct confrontation and action with borrowers, the anemic freight market and consensus expectations for its continuity in the foreseeable future, will force the hand of shipping lenders, to a limited extent (again, the option set is confined by greater financial and macro-problems).  

How shipping lenders will react is the favorite topic of intense speculation for the last few years.  There are many nuisances that can guide any such action or reaction, but the scale of the problem might indicate that banks might chose to apply one of their protective shields during the financial crisis when certain banks were deemed of too much systemic importance and thus ‘too big to fail’ and accordingly became the beneficiaries of special regulatory and monetary treatment.  Similarly, while all ship-owners may suffer equally from a weak freight market, there are definitely owners who have a better capital and cost structure to sustain the cycle, better access to the capital and financial markets, better access to cargoes and charterers, better quality of vessels in markets with better dynamics, better negotiating power with counterparties, better management teams and reputation, etc Most likely, such owners will be the beneficiaries of more lenient treatment by the banks, including re-negotiation of loans and further restructuring, avoidance of vessel arrests, foreclosures and vessel auctions, etc 

It will seem then than ‘too big to fail’ is a pertinent term in shipping as well…while however shipping is a commodity industry, the term ‘big’ may not necessarily imply seer size in terms of market cap or fleet size or anything strictly quantitative…probably the ‘big’ in shipping will have a qualitative dimension as well… 

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.