David Marcus presented his in-depth investment thesis on dry bulk shippers at European Investing Summit 2017, focusing on four companies: Scorpio Bulkers (NYSE: SALT), Safe Bulkers (NYSE: SB), Navios Maritime Partners (NYSE: NMM), and Songa Bulk (Oslo: SBULK).

Dry Bulk Shippers: The low-hanging “easy money” has already been made. However, dry bulk names are coming off an extremely low base. David has higher conviction today than when his firm started investing in the space in light of the lower risk profile today: (i) secondhand asset values and charter rates (spot and one-year time charters) have both increased; (ii) the new vessel order book is historically low; and (iii) there is supply visibility. David also sees improvement in structural demand. Despite fears of China slowing down, dry bulk demand has been growing steadily. Demand growth is underpinned by domestic Chinese stimulus (One Road and One Belt) and regulatory policies that favor low-cost suppliers of high‐quality iron ore and coal. Australian and Brazilian iron ore exporters still have cost advantage over Chinese producers. Longer ton miles bode well for dry bulk. In general, management insiders have been recent buyers of dry bulk shippers’ shares.

Scorpio Bulkers: Founded in March 2013, Scorpio owns and operates modern mid‐ to large‐size dry bulk vessels (Kamsarmax and Ultramax). The company is incorporated in the Marshall Islands, headquartered in Monaco, and also based in New York. Management has attempted to replicate with dry bulk its past successes in tankers and LNG. The company was making vessel acquisitions into a worsening dry bulk market, leading to covenant breaches. Scorpio has one of youngest fleets of fuel efficient, mid‐size vessels. All vessels are eco‐design (20% higher efficiency, lower bunker consumption, and high cargo intake). The company has a strong, proven management team, led by chairman and CEO Emanuele Lauro and president Robert Bugbee. A March 2016 equity raise, in which David’s firm participated, provided a two‐year liquidity runway to weather the downturn. Bleak sentiment has led investors to overlook Scorpio’s balance sheet strength. Evermore also participated in a June 2016 equity raise at $3.05 per share alongside management. Proceeds were used to take advantage of compelling secondhand vessels coming to the market from distressed sellers, and extend liquidity to 2020 (more as a preemptive measure vs reaction to market direction).

In the session, David also commented extensively on three other companies owned by his firm, Safe Bulkers (NYSE: SB), Navios Maritime Partners (NYSE: NMM), and Songa Bulk (Oslo: SBULK). In response to a question, David also briefly discussed his positive view on John Fredriksen’s Frontline (NYSE: FRO).

The following transcript has been edited for space and clarity.

Evermore is value with a focus on catalysts. For us, it’s not just about cheap stocks, but making the distinction that cheap on its own isn’t good enough. We want to know there’s a path to getting less cheap, and know what is going to get the value out of the stock and into the investor’s hand. We focus on catalysts; we look at breakups, spinoffs, restructurings, turnarounds.

We love family-controlled businesses where we have dynamic value creators at the top making changes, good investments, creating value, and compounding, yet they’re trading at big discounts. The riskiest investment to us is when something is just a cheap earnings play, because you have to count on them selling more stuff next year at a higher price. That’s rife with potential for missed earnings, which we see all day long — companies missing earnings.

One of the great things I could do over my career was to take a few years when I was running a family office and go sit on boards. I was able to to go from being a stock picker to being an operator — I helped restructure businesses, helped them make decisions that changed the course of those businesses. In some cases, I helped fire managers; in some cases, hire managers.

That gives us a better perspective when we look at companies going through change, as to what can be done and in what kind of timeframe. We focus on areas where other people are not focusing. It’s not about being a contrarian as much as thinking of ourselves as independent thinkers. Let’s have our own perspective, whether people are there or not. Generally, we are going to where it is less crowded.

When I started investing in Europe many years ago, it was because people were not focusing on Europe. There were all kinds of problems twenty-five years ago. Europe has been a great place to invest, and it’s still at the early stages. In the next leg, given the specific individual cases we see, there are more breakups, more spinoffs, more restructurings, and all kinds of M&A activity. This is because we’re in a low-growth environment, so companies are buying growth. We have not even seen the private equity guys come in yet with their cash. Rather, we’re seeing strategic buyers doing bolt-on acquisitions of businesses, product lines, and services.

Perspective on Dry Bulk Shipping

I’d like to focus on an industry that up until a year-and-a-half ago, we never would have looked at — we would have said, “please stop talking to us, you’re wasting our time” — the dry bulk sector.

Historically, we have never invested in this industry, let alone anything connected to it, like containers, tankers, LNG. We typically avoid commodity-type businesses and very cyclical investments. Although energy is a magnet for a variety of value investors, we are not interested. We focus in other areas. When companies have a dependence on the price of oil or other commodity prices — “I need China to do this, or GDP to do that to get real value out” — it is less compelling to us. We want to know there are things the companies themselves can do. That said, there are times when we make exceptions to the rule.

As global special situation investors, we became interested in this industry when it was facing death and carnage. Only 18 or 20 months ago, there wasn’t just blood in the street; there was blood in the water. We were attracted just like sharks would be. There was so much opportunity.

Prior to our getting involved, this industry had sucked in all kinds of investors — through “interesting” situations, capital raises, ships being built, pie-in-the-sky forecasts that China was only going to grow. It didn’t happen that way. Companies had to do massively dilutive financial restructuring to shore up their balance sheets. All the names in the industry were crushed. Stocks were down 80%, 90%, 95%. They generally didn’t quite die, because the banks would extend loans rather than write them off completely. But the stocks were decimated.

We look at these kinds of businesses when panic sets in. Sporadically, you get to a point at which investors are throwing out their gold coins along with their gum wrappers. They want out, and they can’t get out fast enough. They’re not focused on value. They want to move on, go home, and forget they ever invested here.

When we saw that, we were interested. It all began when a banker called us because a dry bulk company was recapping its balance sheet at very weird terms. It had one set of terms for American investors and a different set of terms for Norwegian investors, where the company was headquartered. It was Golden Ocean Group. U.S. investors were to have a six-month lockup while Norwegian investors could sell the next day. We were not interested.

We realized that if the bankers were calling us about a company going through this kind of transition and was desperate for capital, first they had called the traditional investors; then they had called everybody else they knew; then there was a list of “who knows who”. After they made all those calls, they called us, because normally we wouldn’t care about anything like that. It didn’t make us interested in that specific company. But as we started to get other calls, we decided we needed to understand better what was going on. We knew why they were desperate for cash, but what was detracting all the other investors from making the investment?

This industry has more conferences than any other industry we’ve seen. There’s always a shipping conference. There was one this week in New York, and they’re already talking about the next one and the one after that. We constantly ask the CEOs, “How do you have time to run your business?” They’re always at the conferences. In any case, it was a situation in which the more work we did, the more compelling it became to us.

The Baltic Dry Index shows a blended rate of all ship sizes — an amalgamation of day rates into an index. Until 2008 it was pie-in-the-sky, going straight up as though it would never end. It ended in the financial crisis. It ended for many industries, but this one especially was down over 90% from peak to trough. Over the next nine years there were fits and starts along the way, but this was a boom-bust scenario. While the scale of the index chart, due to the large decline, makes the moves in 2013-15 seem small, they were also dramatic. Those were the years when China was perceived as growing forever and shipping owners were ordering new ships faster than before.

Another implosion occurred in 2014-15, as China started to slow down and day rates came down. More than that, the perception of the future of this industry changed rapidly. Why? The owners were ordering so many ships and they had not even been delivered yet, but China was slowing down. So just as the slowdown started to manifest itself, it was still only the front end of deliveries. There was an explosion of supply and a decline in demand.

In the last year or two there has been a bounce in the stocks in the dry bulk index. But while the underlying stocks have moved substantially, they have not moved enough to be appropriately valued. When spot rates drop below asset values, it impacts day rates and cash flows. Companies started to break covenants, the bankers were nervous. Various German banks were lenders to the industry. When the first domino fell, things rapidly spiraled. This predates our getting involved.

During the crisis, we saw asset values at historically trough levels, with five year-old capsize vessels trading at ~50% discounts to their twenty-year average. Spot rates, or second-hand vessels, traded at 35-40% discounts and 55-60% of newbuild prices. At a point in January 2016 day rates hit $1,500 per day. This is so far below the daily operating cost of ships that ship owners start saying, “Wait a minute.” They can handle chartering out ships below cost to keep things going. It costs a lot of money to put your ship in the middle of nowhere and decommission it for a few months. You can’t just decommission it and recommission it; you have to commit to quite a number of months due to the nature of the process and the cost. Even if they are running below operating cost, owners will keep going for as long as possible because they’re hoping for a turn. In this case, the turn didn’t come.

What started to happen was that older ships began to be scrapped. Drydock and maintenance costs were adding up for ships that were not utilized at all; they were alive but not charted out. After the owners had cut the price — and cut, and cut again — scrapping started to grow. Older, less economically efficient ships were being sent to the scrap heap, and that was changing the supply of capacity. It got to a point where there was negative implied capacity growth. It actually shrunk.

There was an inflection point between demand and supply for a brief period because people were scrapping so aggressively. 8% of the total fleet was sent to the scrapper; the number of ships was much reduced. Companies we had gotten to know were cancelling orders, leaving $5-10 million cash deposits with shipyards just to walk away from ships. They took the view that it was better to lose $8 million than to pay the balance of the ship and then have to manage it. It was absolute carnage, devastation, panic. Early 2016 was a nightmare.

Looking at asset values historically, they had gapped up in 2008. Since then asset value in the market are not just below the levels of 2000, but we are actually replicating the levels of 1980. Assets are trading at levels not seen in a long time.

The first conference I went to in this industry was in early 2016. It was amazing. I was there with one of our senior analysts, who has worked in this industry with me from the beginning. Tommy and I were there, and we were the only people smiling. People were practically in tears — the bankers, the ship owners, the CEOs, and especially the CFOs. You could feel it in the room. It was unbelievable.

We walked around and started to meet the owners, the shareholders, the operators. It was quite simple: Whether you had a young fleet of ships, good cost controls, and solid management, or whether you had an old fleet, bad controls, and weak management, your stock was trading at about the same percentage of net asset value. The market was not discriminating between good and bad — the whole industry was simply “dead”.

A quick anecdote related to the mention of “Nevermore” vs. “Evermore” in my slides: We were going to see the CEO of Star Bulk Carriers at the conference. Before we even said hello, he saw my name tag and said, “Evermore!” I said, “Yes?” He said, “I bet you’ve never invested in this sector, and you probably didn’t even look at it until recently.” I said, “You’re correct! What are you, a mind reader?” He replied, “If you had invested any time before today, your name would actually be Nevermore.” His point was this industry had crushed everybody.

That’s when we knew we were on to something. It couldn’t be that the whole industry would go away. The key was to figure out who were the players that would survive, who was trading at the cheapest levels, who was going to recap their balance sheet, and how could we weasel our way into not only buying the stocks in the market but also finding an opportunity to participate in the recaps.

Ultimately, we went from being newbies and knowing nothing about the industry to the other end. We got to a point at which we were helping companies recap their balance sheets. We helped them restructure so they could push out their liquidity windows, giving them a chance to cut costs, refocus their businesses, scrap the ships that needed to be scrapped, and maybe even make a sale. More than anything, it was a chance to buy assets. We were excited about the opportunity to buy second-hand ships and to invest in the companies that would survive — and to take away the lowest-hanging opportunities from distressed sellers. Some companies were doing recap after recap after recap, so we had to figure out what the insiders were doing.

Selected Ideas in Dry Bulk Shipping

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