Monday, August 10, 2020

Never Navios, Part II

Last November, I outlined all the reasons one should never invest in Navios, before proceeding to invest in Navios and lose money. Welcome to Chapter II.

The main problem is Angeliki Frangou. Unfortunately, she's the CEO. "Arms-length transaction" is not a term that appears in her dictionary, and she just so happens to own the company that collects inflated external management fees from Navios. One time she created so much shareholder value that the fire department showed up. The other problem is debt, which Navios owes to the tune of over a couple hundred million in outstanding credit facilities. In-chartered tonnage adds even more leverage - all on a market cap of only $80 million. Oh, and there's a $650 million bond issue maturing in 2021.

Why would anyone buy stock in a company like this? Who knows. I bought the bonds. I've been buying over the past month or two for 57 cents on the dollar. I get that dollar back when the bonds mature next year, and I earn 8.125% interest on the face value of the bond in the meantime. Covenants are fine - even pension fund patsies are reluctant to lend 8 year money to a financial forest fire without a few guardrails.

Why are the bonds so cheap? Well, Navios is leveraged at 10x adjusted EBITDARC*, the bonds are under review for downgrade by Moody's, and the sector has somehow managed to underperform the airline ETF in 2020 (though it's hard to tell since the shipping ETF folded). Regardless of the reason, these bonds Coronacrashed along with the rest of the market and stayed there.

Frankly, I know more about 18th century German choral composition than credit analysis, but I do know that plugging in vessel values from the active secondhand market leaves positive value for the equity. It's even pretty cheap if you squint hard enough. If you want to get fancy, you can buy 24 shares of stock for every bond, creating the whole company at a fire sale price. On any given day, this adds $100-130 to the cost of your bond - depending on how pessimistic the market is on tankers. I'm content to buy the bonds at 570 and wait 15 months to double my money.

Despite the negative press covfefe, it's not all bad in tankerland - current rates mostly cover operating costs during the seasonally weakest month of the year. Demurrage terms and time charter rates are pricing in a recovery starting in October (which coincides with the beginning of the strong season). In the meantime, I expect demolitions of older vessels which are no longer economical to maintain.

What if I'm horribly wrong? Middle aged tanker values can fall 25-30% and I still break even. Tankers are already valued in the neighborhood of depreciated replacement cost, so if vessel values fall 30%, what does that imply? Unless they repeal the laws of supply and demand, I find it hard to imagine a world where these bonds are worth less than I'm paying, and you could do worse than buy a pirate fleet for 70 cents on the dollar.

What is a note worth? If you are one of the three people who believe the normal distribution is a good fit for the shipping industry, you can plug the capital structure into the formula for Brownian motion and it will spit out some number in the 800's. You could make a case that Covid-19 renders the historical volatility of tanker assets over the past century irrelevant, and if you shoot me an email, I'll be happy to buy your bonds and spare you the extra "risk".

Where in the world is Navios going to get the money to pay off these bonds? Angeliki will think of something. She may not be the reincarnation of Henry Singleton, but she has extensive experience heading failing companies. Right now she's in the open market buying back bonds at 60 cents on the dollar out of cash flow (much of which is contracted). I wouldn't put it past her to pull off some crazy last ditch refinancing, but if push comes to shove, she can always do "whatever it takes" to preserve the family piggy bank and print equity like there's no tomorrow.

Disclosure: I own a material position in the Navios Maritime Acquisition Corporation 2021 First Priority Ship Mortgage Notes.

* Earnings Before Interest, Taxes, Depreciation, Amortization, Riots & Covid-19, adjusted for stock-based compensation and nonrecurring special charges that repeat every year. The company's debt to 2019 adjusted EBITDARC ratio of 10x represents an improvement of eight turns over the prior year.

Wednesday, April 29, 2020

Basic Arithmetic

It will not surprise anyone that I like tanker stocks.

I won't rehash why I own tankers. I won't mention that a number of boats are approaching geriatric status. I won't mention that an international sulfur cap, combined with the requirement to install ballast water cleaning systems, will force owners of these ships to invest millions of dollars to stay up to code - or melt them down for scrap (not to mention the cost of special surveys). Since I'm not mentioning any of that, I'm going to talk about short selling. I've already laid out the case for owning tankers. Now, I'm going to argue that selling them short is absurd.

I can see why a daring hedgie might be tempted to short tankers. What better hedge to put on against a global collapse than a cyclical industry with high fixed costs? Want shady related party transactions? You've come to the right place. When a noted Scandinavian scammer shows up on CNBC pumping with all he's got, the opportunity seems almost too good to be true. Could this make up for your losses in Tesla? What could possibly go wrong?

Well, a few things. First off, tankers don't care about what the stock market does - the price of a commodity is determined by supply and demand. 2008 was the most profitable year for tankers in decades - not because the VIX was at 10 (it wasn't), but because there was simply too much oil. That was then. Now, we're all working in our pj's watching the biggest glut in the history of oil pile up off the coast of LA. The difference is that in 2008, the shipyards were working like sixty, flooding the high seas with vessels. Today they're empty.

The supply of tankers has been increasingly tight for a couple of years - a powder keg in search of a spark. The contangovirus was the latest match. As a professional hedgie, this can't have escaped your notice, but perhaps you didn't think through the implications. Tankers get paid to resolve geographical imbalances between supply and demand. That means every time something crazy happens in the world, revenues go ballistic - just as the rest of your book is imploding.

How ballistic, exactly?

Short sellers would be well advised to review Carolyn Wheater's foundational work:

Practice makes perfect, so why not work through some numbers? Let's say you buy a middle aged VLCC for $50 million over the weekend, and rent it out for the going rate of $130,000 a day. After factoring in ordinary course embezzlement, you have a little over $10,000 in operating costs. If I recall correctly, there are 365 days in a year. You don't have to be Brahmagupta to figure out that $120,000 x 365 works out to around $45 million.

Repetition is key, so let's run through another example, this time with a ship a fraction of the size. Last I checked, a middle aged MR was going for around $20 million. MRs are substantially cheaper to operate than VLCCs, but you can assume operating costs of $10,000 for simplicity. One poor soul recently paid an MR $100,000 a day for a voyage in the Mediterranean. It's your turn to do the math.

Now, there's nothing wrong with a 100-200% cap rate, but what happens if it's financed with 50% debt? What if tankers on Wall Street go for 50% off the Main Street price? It is and they do.

These rates are not sustainable for the long term. But as Obi Wan might point out, it only has to keep up for a few months for tankers to make more money than you can possibly imagine. If you're short a tanker stock that earns its market cap every few months, does it really matter whether the company has an SaaS recurring revenue model for sustainable growth? Remember, all it takes is one good quarter to pay for years of operating expenses.

Some of these tanker stocks have doubled since my podcast in March, but frankly, I'm surprised they're not up more. VLCCs are getting fixed on voyages in the low $100,000's as I write this, and they're filling more boats with oil every day. Despite all this, someone has been shorting tanker stocks (rather unsuccessfully) all the way up, and in size too.

Here's the best argument any short seller has given me: "rates will go so high that tankers will bankrupt all their customers." The risk of explosive profits is palpable. Also popular: "they'll just build more ships" In what shipyards? The ones shuttered due to Covid-19, or the ones they demolished to make room for condos? As everyone knows, the boom is going to be over before your ships arrive in 2023, so why bother? Besides, why would anyone with a prefrontal cortex order a ship today when it will probably be obsolete in 10 years anyway?

If you think I'm "not getting it", you're right. I don't understand the allure of shorting an asset earning triple digit unlevered cash flow yields while trading at large discounts to NAV - particularly when NAV is understated and growing rapidly. Until someone explains it to me, I'm going to hold on to my tankers. If my math just doesn't add up, feel free to shoot me an email at my name @

None of this is a prediction; I'm just observing what is already happening. Looking to the future, I have a hunch that tankers will earn elevated returns for years, as there are plenty of decrepit gas guzzlers that will make prime scrapping candidates when rates cool off.

In conclusion, if you're short, this is is probably a good time to cover. I don't have enough fingers to count the number of ways to lose money even if you're right.

Disclosure: I normally would put the stocks I own here, but I figured it would be faster to list all the tanker stocks I don't own: NAT

Tuesday, March 3, 2020

Captain Cook

There is a time to take naps. Today is not that time. It's time to buy Canadian biotech penny stocks.

When you lose a tooth, the bone supporting it from underneath recedes, foiling any secret pacts you had with the tooth fairy for a replacement cuspid. Even worse, your face sinks in, making you look creepy and deterring prospective employers. That's where Lattice comes in. Lattice makes the scaffolds for the bones to regrow. When they asked folks for bone donations, the folks said, "over my dead body". The fine fellows at Lattice took them at their word, and looted their corpses for profit.

Not too long ago, Lattice was losing money on everything from breast reconstruction allografts to spinal fusion surgery. Their tech was supposed to make them a lot of money, but they didn't count on competition. When Guy Cook (hereinafter "Captain Cook") realized the numbers weren't working, he took an abrupt right turn and shifted focus to dental. It's working. Gross margins flew from 20% to north of 50%. Lattice went from losing millions of dollars a year to making a little bit of money. In 2018, Lattice earned revenues of $1.2 million. In 2019, Lattice earned revenues of $2.2 million. I'm no statistician, but that's what I'd call a favorable trend.

Here's what's happened:

In 2017:

Relocated factory to Montana - saving a million bucks in annual rent.

Completed debt for equity swap at 15 cents a share.

In 2018:

Completed debt for equity swap at 10 cents a share.

Exited competitive, low margin businesses - now they only sell to dentists

Invented AmnioBoost

In 2019:

Revenues took off - from $1.2 million in 2018 to $2.2 million

Gross profit margins leapt from 20% to 50+%

They have loads of other products too, and while I don't pretend to understand what any of them do, they're repurposing all of them for use in dental allografts. They aren't selling these yet; they're building inventory and working out the logistics. To deal with logistics hangups, Captain Cook came up with a new liquid nitrogen shipping container, and let me tell you, there's nothing I like more than Saltine crackers doused in liquid nitrogen.

What would you pay for a company with expanding 50% gross profit margins, and accelerating double digit revenue growth? The stock market says 0.77x last year's sales. The past is behind us. Think about where this will be in a few years. They crossed break even this quarter - if you're willing to overlook a few noncash accruals. The company expects revenue to grow 40% this year. What happens after they smooth out the logistics and roll out the new products?

I would be remiss if I didn't mention that the company is insolvent. They owe money to everyone and his uncle, and they've been in default for years. They auditors worry over whether it can continue as a going concern. I intimated in my last post that Navios is the biggest cash combustion corporation on the NYSE. Well, the only reason Lattice doesn't qualify is that it's traded on the Canadian Venture Exchange. The stock has fallen approximately 99.99% since 1997. It's safe to say that they don't have many happy investors. That's why you get to buy it for less than next year's gross profits.

The balance sheet is a mess, but this is not what it looks like. If you owe the bank a million, the bank owns you. If you owe the bank a trillion, you own the bank. Cap'n Cook has the upper hand. Can the bank really foreclose on a stack of assorted office stationery and a pile of bone powder? If they foreclose, they lose. If they extend and pretend, they might win. Lattice has been insolvent for years, perpetually bleeding cash. Why would they run into trouble now that they're growing rapidly and finally profitable?

Lattice is working on converting a big chunk of their hefty debt load into equity - likely at a substantial premium to today's stock quote. The Venture Exchange blocks debt to equity swaps at less than 5 cents a share. I've chatted with Captain Cook, who confirms that swaps will take place at a minimum of 5 cents a share. The stock trades at 2 cents and a market cap of $1.6 million. Supposing they need to convert $4 million to equity (probably on the high side) @ 5 cents, the market cap is really $3 million, or less than 1x this year's sales. Not bad for newly stable company growing at 40%.

The Cap'n owns a third of the company. He wants the stock to make money at least as much as we do. I don't know what Lattice Biologics is worth. I suspect I won't go wrong buying it at 2 cents. Last but not least, all these numbers are in Canadian dollars, which are worth 27% less than real dollars.

Caveat Emptor: Lattice Biologics is an insolvent Canadian biotech penny stock.

Disclosure: I own shares of Lattice Biologics.

Tuesday, February 18, 2020

Tanker Tuesday

It's Tanker Tuesday.

It's no secret that tankers are collapsing, and I've never felt more alive - though that could change in a jiffy depending on how the coronavirus plays out. I would love to tell you why tanker stocks are crashing, but to be honest, I have no idea.

Maybe it's that charter rates have collapsed over the past few weeks. December charter rates have averaged miles above the other 11 moths since prehistoric times, and 2020 is no different. Despite rates holding up longer and stronger than in the same period last year, we're supposed to believe that tankers are headed for the rocks.

I'm taking the other side of that bet. Running a shipping company is simple. If there are 100 cargoes and 99 tankers, it's a boom. If there's demand for 99 voyages and there are 100 tankers, it's a depression. In the 2000's, there were nowhere near enough tankers, and the guys who owned tankers made a lot of money. Naturally, they spent all of these profits on building new boats. After all, when you own a floating ATM, what could be smarter than building more? Trouble is, a shortage is only a shortage when there's not enough to go around, and they built so many tankers that they were back to losing money. An understandable mistake, but that didn't make them any less broke. Fast forward to today, and they've gotten so disciplined about ordering that the shipyards have gone broke too. Tanker stocks are trading near all time lows. We've had too many tankers for a decade, and everyone who's ordered a ship in the past decade is either shell shocked or bankrupt. But things are getting better.

All of those boats built in the 2000's are getting older, and tankers don't last forever. IMO 2020 is increasing fuel costs, and environmental regulations are forcing shipowners to install expensive ballast water treatment systems. No one wants to invest millions of dollars to upgrade a ship that only has a few wheezes left. This means increased scrapping of older vessels.

Look at the shift that's taking place with product tankers. Oil majors hate chartering product tankers older than about 15 years, creating a two tier market that results with substantially lower charter rates for older vessels. Many product tankers this age leave the clean market and trade as crude tankers - reducing the supply of clean tankers. Take MRs, for instance. The number of MR product tankers turning 15 started to exceed deliveries a couple of years ago. This trend accelerates dramatically starting in 2020.

On the other side of the equation, oil demand grows at a few percent a year. In addition, IMO 2020 is replacing high sulfur bunker fuels with low sulfur fuels, disrupting supply chains and increasing the demand for tankers to move everything around. If that weren't enough, China just announced that it had agreed to import enough extra oil from the US to give full time jobs to every single VLCC supertanker scheduled for delivery this year.

Despite growing demand, the supply of new vessels is extremely limited. Deliveries (as a % of the fleet) will run at well under half of the 10 year average, and ordering remains muted. Drydocking from scrubber retrofits is pulling ships off the water, reducing supply. Vessel quarantines and floating storage of bunker fuels are reducing supply still further.

Supply is shrinking and demand is growing. Financing for new ships is restricted, and a lot of these tankers are getting pretty rickety, just as new regulations are pushing obsolete tankers to the scrapyards like old ladies off cliffs. Tankers make the world go round, and when there's a shortage of something the world can't do without, it's usually fun for whoever owns it.

A month ago, I was up 50% on my tanker stocks. I held all the way up and all the way down, and now I'm buying more. Product tankers are especially well positioned. Saudi Arabia will finish a large refinery this year, which will produce refined products for export on clean tankers. Most importantly, we need product tankers to move marine gasoil and components for low sulfur fuel blends, which are in demand as a result of the IMO's new 0.5% sulfur cap. I'm buying.

As always, shoot me an email if I'm missing something obvious. Remember, if I lose all of my money making obvious mistakes, the bank will kick me out of my house, and if I get kicked out of my house, I won't have time to write this neat blog. Before firing away, check the FAQ below to see if someone else has already deployed your email's evil twin.

Disclosure: I own shares of STNG, DSSI, EURN, and TNK.


Isn't the party over with COSCO ships returning?

COSCO sanctions only added fuel to the fire. COSCO sanctions started in October, but supply had already been tight for a year. Every month in 2019 averaged higher charter rates than in the same month in 2018. This trend has continued so far in 2020, despite COSCO ships coming back.

But wait, what about the coronavirus?

The CCP, a noted beacon of truth, says everything's under control. On the other hand, maybe this is the next Black Death and we all end up as coronacorpses. I've never taken a course in predictive pandemic modeling, so I wouldn't know.

Either way, the Chinese are too busy hiding from the coronavirus to burn oil. It doesn't take a genius to figure out that this decreases tanker demand. But unless China goes back to rickshaws, that demand is coming back. In the meantime, who orders a ship when shareholders are panicking and a coronavirus is set to kill them anyway? Isn't this the impetus for obsolete vessels to finally get scrapped? When demand does come back, I want to be around. Besides, you know those pesky Chinese shipyards that are always building too many ships? Well, the workers aren't showing up. They don't want to catch the coronavirus any more than we do.

I'm taking advantage of the coronacrash to buy any tanker stock I can lay my hands on. STNG is deep in bargain bin territory, despite a fleet comprised entirely of clean tankers, which are experiencing an unseasonal lift in rates even with the coronacrash. Despite a strong balance sheet and a straight shooter at the helm, DSSI trades at half of liquidation value - cheaper even than some of the Greek FraudCorps.

Is there any hope for Navios?

Nah... Angeliki dilutes shareholders for fun. I'm out. It has multiples of its market cap in impending debt maturities. My motto from now on: Never Navios...