This week’s edition of Streetwise examines whether it is possible for a public shipowner to have too little debt. Subscribe to tinyurl.com/twstreetwise.
The shipping graveyard is littered with the carcasses of companies that have found themselves too indebted at a time when market cycles have turned against them.
Restructuring, bankruptcy and liquidation were some of the inevitable results.
But what about the notion of having too little debt?
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Strange as it may sound, the question arose at a recent Marine Money financial conference regarding dry bulk owner Genco Shipping & Trading. the ultimate goal of achieving zero debt as a public enterprise.
The goal is aligned with the new owner’s high dividend policy, with the intention of continuing to reward shareholders, regardless of what rates the dry bulk market might bring.
Under this model, Genco hopes to abandon the traditional method of valuing shipping companies based on net asset value and instead move to a stock that is priced based on dividend yield and cash flow.
This is a feat that has never been attempted before by a dry bulk shipowner.
The problem arose when a zero debt target was criticized as a “lazy” approach to management by Flex LNG chief executive Oystein Kalleklev, who was sharing a panel with Genco chief executive John Wobensmith.
Kalleklev later told TradeWinds on the sidelines that he couldn’t imagine relying solely on the cost of equity – which can go up to 12% or more – when he could easily get loans at a rate of $ 2. % to 3%.
So sharp elbows aside, who is right on the matter?
Streetwise found that there was some disagreement.
For example, a finance veteran with experience on the shipowner side argued that Genco had this right.
“Basically I think it’s a good idea,” he said. “It’s just a challenge for an existing business to get to that level.”
Although he agreed that equity can seem more expensive at a price between 8% and 12%, “the problem is that the value of equity sometimes turns negative and equity usually does not survive that” when the debt is too high.
This usually happens in trough cycles to which shipping is particularly sensitive, the ship finance expert said.
Shipowners can also issue extremely expensive “bailout equity” at these times, greatly diluting shareholders.
Another problem is that pricing models say that the value of debt relative to equity is attributable to tax deductions from paying interest charges.
“But shipping companies don’t pay taxes,” he noted.
A final factor is that the cost of equity becomes cheaper as debt goes down, the financial expert said.
“The experience of the public market is that if you can get zero debt, the stock market likes it and will give you a better valuation,” he said.
Still, an equity analyst has taken a stance that leans more toward Kalleklev’s position.
Under-leverage is possible
“At some point you can be under-leveraged,” he said.
“We are seeing more and more dry bulk and container companies with debt reduced by 20% to 35% after taking advantage of strong markets and that is a very good thing.
“But I agree that you don’t need to hit zero. I’d rather a company with 20% debt use cash to buy back stocks when they’re undervalued.”
The analyst cited inflation as another concern.
“If you think interest rates are going up, why don’t you see some loans now 2-3% above Libor when debt is cheap?” ” he said.
Genco may need to sort it out, but the trip could take some time.
The shipowner is aiming for zero “net debt” by the end of 2023, hoping to get rid of the rest – if it can – some time later.