Tuesday, October 15, 2019

Vernebeltland

Quite a ways from these parts, across the Misty Sea, lies the dark and dusky country of Vernebeltland. Few know of it, and those who do speak of it only behind close doors. Respecting the quiet people of Vernebeltland, I have kept the ancient tradition of silence. But now that I've started a blog, I'll spill the beans free of charge. The contented inhabitants of this lowland go daily about their affairs, dutifully smithing and fletching and trading amongst themselves. But once a year, at the Royal Repast, all good elves assemble to rejoice in dance and song, trusting in the Shining Protector, S. E. C.

The ground beneath Vernebeltland lies fallow, a legacy of centuries of toil and overuse. The discount rates used by the clever farmers of Vernebeltland are too low, and the only way to earn a decent living is to venture into the gloomy land of Finsternis, whose glowering crests deter the faint of heart. Finsternis is a maiden land, overflowing with milk and honey. Those who dare to enter number few, but riches abound beyond the giddiest fancies of any on our side of the Misty Sea.

A bit of history is in order. The tree dwellers of Finsternis have been the subjects of the elven tree masters of Vernebeltland since time immemorial, and are duty-bound to offer all the bounty of the land to the Vernebeltlanders. In the Olden Days, the tree dwellers of Finsternis grumbled against the reign of S. E. C., saying, "Why must we bear the hideous burden of preparing quarterly scrolls for your Awesome Majesty? Would it not be enough for us to report these things to our masters, the Vernebelt Elves?". S. E. C. showed mercy, declaring, "Mark my words, O rebellious people, and mark them well. I shall cordon Finsternis off from the rest of the land, and dub it Section 12(g). You may lay your scrolls aside, but abide by one law: Thou shalt continue providing timely and accurate reports to the Vernebeltlanders."

At first, the tree dwellers did so happily. As time wore on, however, the tree dwellers forgot their vows, and grew lax in reporting the bounties of Finsternis to the Vernebeltlanders. This grieved S. E. C., who bellowed in his wrath, "O wicked tree dwellers, I shall forbid the Vernebeltlanders from entering again into your land until you resume reporting its abundance."

This saddened the Vernebeltlanders. Unable to sustain themselves from the foodstuffs of Finsternis, the elves of Vernebeltland starved. Vernebeltland was no more. The tree dwellers rejoiced, keeping the fruits of the land to themselves for all eternity.

This concludes the lore of the country across the Misty Sea.

When the Securities Exchange Commission proposed a rule that would prohibit brokerages from quoting "dark" stocks that don't file reports with the SEC or OTC Markets, the sorry plight of the Vernebeltlanders instantly came to mind. An echo on this side of the Misty Sea would come close to giving me a heart attack.

If the SEC goes ahead with this rule, over $1 billion worth of dark stocks will become untradeable overnight, not including the countless Pink Sheet and exchange listed companies that will choose to delist and go dark as a result. If the rule goes through, owners of such stocks have no way of protecting themselves. The closest to "protection" against the rule that shareholders will get is panic selling before the effective date of the rule. The extreme illiquidity of the affected stocks means that such selling could result in prices 75% or more below today's levels. When considering the many small public companies this rule would incentivize to go dark, it's easy to envision investor losses approaching $1 billion. It is both silly and wrong to punish "everyday Joe" investors for actions perpetrated by their fiduciaries against the everyday Joes. Back where I grew up, we generally punished the criminals instead of the victims.

Rather than ruining the numerous OTC stock investors who specialize in dark companies, a wiser course of action would be to:

Impose heavy civil penalties and a bar against serving as a fiduciary in any capacity on management wantonly withholding financial statements from shareholders in violation of state law.

Streamline the process of requesting and collecting financial statements from errant companies.

The $1 billion of theoretical losses the rule could cause is twice the aggregate market value of:

Build-A-Bear Workshop
Tandy Leather Factory
OTC Markets

I highly recommend you read David J. Flood's post on the proposal at Elementary Value. For more commentary on the rule, check out Dan Schum's post over at NoNameStocks.

Please tell the SEC what you think. Families are counting on you. It's a cinch to leave a comment. Instructions are here. My comment is here. All comments can be found here.

Saturday, October 12, 2019

The Money Graveyard

Shipping is where money goes to die. Who cares whether you charter your ship from Frontline or General Maritime? One guy's boat is as good as another's. I'm no economist, but if there's one thing I remember from Econ 101, it's that the price of a commodity is determined by supply and demand. The trouble is, the supply of ships almost always exceeds demand. That's great for customers, but not so great for shipowners. The worst part: the unions don't care whether you're losing money hand over fist. You still have to pay the same wages.Your boat guzzles the same amount of gas when customers are paying $5000 a day to charter your boat as when they're paying $50,000 a day. On top of this, boats only last so long, and you eventually have to replace them. You would have to be crazy to get into a business like this.

So, why would anyone buy a boat? Well, you don't have to use your own money. You can raise a couple hundred million from investors, buy a few tankers, and pay yourself $10 million a year. When your company goes bankrupt, rinse, wash, and repeat. But why would anyone fall for this? When times are good, times are really good. When demand outstrips supply, customers scramble to charter boats at any price. China isn't going to cancel its national infrastructure program just to save a few dollars per ton in transportation costs. In shipping, costs are fixed, and when charter rates skyrocket, the added revenue falls straight to the bottom line. Multiply that by high financial leverage, and you have an explosive cocktail.

After a decade of bankruptcies, shipowners have finally given up on ordering new ships. The ships built in the last boom are now old and decrepit. Ships don't last forever, and you have to scrap them sooner or later. Environmental regulations are getting tougher and tougher, requiring ships to spend millions of dollars apiece on Ballast Water Treatment Systems (BWTS). On top of this, the International Maritime Organization promulgated a regulation that will require all vessels without scrubbers to burn fuel with 0.5% or less sulfur content, starting January 1st. Putting my logic hat on, when 40,000 hulking ocean vessels switch from high sulfur bunker fuels to low sulfur alternatives, low sulfur fuels will become pricey in a heartbeat.

That's a lot of money. If there's one thing shippers can't afford right now, it's losing money. Despite raising diluting shareholders into smithereens, many shipping companies are teetering on the brink.When IMO 2020 adds a few million to your 20-year old Capesize's annual operating costs, there's only one thing left to do: Give up! Selling vessels for scrap instantly stanches the bleeding. The proceeds are available for debt repayment (or, more commonly, executive compensation).

It's awfully hard to move stuff around in a boat that's in a million pieces. Lower supply results in higher charter rates with demand held constant, but global demand increases at a few percent each year. That's why charter rates overshoot any reasonable equilibrium when supply finally gets taken out.

Meanwhile, a certain inhabitant of a white building is ramping up a trade war with China. This will disrupt trade routes and lead to circuitous workarounds to reduce the effect of tariffs. If you paid attention in geometry, you know that the shortest distance between two points is a straight line, and the longer the distance, the more ships you need.

If this weren't enough, remember: emerging markets are the future. At least, they were 10 years ago - I think they still are. Africa has had a hard few centuries, but it will have its day (2100, 2200, I promise! It's coming). In a decade, India is going to be bigger and more prosperous than it is today. All of this growth takes steel, coal, and oil, and I don't think they'll be importing it with drones. What's more, oil demand growth is coming from east of the Suez, while all the marginal supply is coming from places like Brazil, the US, and West Africa. Longer distances mean more demand for tankers.

With this backdrop, you might assume that shipping companies trade at substantial premiums to NAV, discounting future profits. In reality, they trade at huge discounts across the board. You can buy companies at 4x cash flow with revenues on long-term contracts, and you can even buy companies with the potential to dividend out multiples of the market cap over the next couple of years.

With Basel IV forcing banks to require significantly more collateral on loans to shippers than in the past, major shipyard bankruptcies, a wide array of prime aged purchase-and-sale candidates, and boats trading at discounts to replacement cost, new orders will be minimal going forward.

By the way, guess who's going to be carrying all those compliant fuels? Product tankers.

Needless to say, I own loads of STNG, the largest, most efficient, lowest-cost operator of product tankers. How much money will STNG make? I don't know, but oodles is a definite possibility.

Pick your spots. Don't hold on too long - and don't sell out too soon. It looks like we're in for a fun ride.