Editors’ Note: this is the transcript of the podcast we published yesterday. We hope you enjoy it.
J Mintzmyer: Welcome to another episode of Value Investors Edge Live. This morning we have Star Bulk on the line, Hamish Norton, the President, along with Simos Spyrou and Christos Begleris, CFO is to discuss with us the Star Bulk company prospects, capital allocation as well as the overall dry bulk markets.
Before we begin, just a quick disclosure. I am personally long shares of Star Bulk (NASDAQ:SBLK).
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Hamish Norton: Thank you.
Simos Spyrou: Good morning.
Christos Begleris: Good morning.
JM: So first of all, as we start this discussion, we’ll start with the broad overall dry bulk market. I know we had a lot of strength into the summer. We had some headlines the last few weeks about hitting multi-year highs. I believe it was eight year highs in capesizes. As we start to enter October, we’ve seen some of the Baltic Dry Index start to come down a little bit. We’ve seen the capesize rates go down, I think they went down from about $35,000 last month to about $24,000 now. In your view, how is that DRY BULK market shaping up? Is it — is this trend sustainable or have we already surpassed those peaks?
HN: We think the strength has a good bit of life left in it. We actually have Constantinos Simantiras, who’s Head of our Market Research department on the line. And maybe he can say a few words.
Constantinos Simantiras: Yeah, sure. Hi, everybody. So you know we — the market during the last couple of quarters started to strengthen and reached record highs. The main reason behind it is we have identified that its supply related, it’s preparation for the IMO, taking a lot of tonnage for scrubber installations. And at the same time the dry bulk market’s a very seasonal market and especially this year with all the accidents and the various typhoons in Australia and Brazil that affected the close during the first half, we saw a strong resumption of volumes. And you know, this combination of lower supply and various inefficiencies and under supply in the Atlantic led to a strong year, higher.
But at the same time the market reached record highs during the third quarter. But when we monitor the demand side, we see that the volume compared to last year actually slightly down. So in our opinion, what is going on right now is the normalization, breather let’s say, where rates are correcting and for a couple of –potential for a couple of weeks, month, month perhaps as the supply normalizes, but we have strong indications that demand will be very strong during the fourth quarter as we have a lot of iron ore still that has to get — to be moved.
At the same time we had bauxite during August and September being low and now how this is nicely picking up and as we approach the winter, we will also see more coal volumes coming up as consumption for thermal electricity picks up.
So we are also entering the second stage of the IMO where we will see further disruption on the supply side, we will also see a lot of vessels trying to getting off-hire to sweep and clean their tanks. And then we also expect that we will feel some positive effects from slow steaming economics because we expect a strong increase in bunker cost. And in order for us to maintain the same speed, the freight market will probably have to find the trade equilibrium higher, which we expect that this pressure will provide strong support for the market.
But as you know, dry bulk market is very, very volatile. And let’s see how it will play out.
JM: Yeah, thank you very much for that color. I really do appreciate it. It’s interesting to note that you said the demand volumes are actually a little bit lower year-over-year. We see the tightness in the market and July, August and September all have a very strong rates. So you also mentioned kind of IMO 2020 and some of the scrubber installations. How is that developing so far? Have you started to see any sort of distortions in the market? I know, obviously, there’ssomesupply coming off due to the scrubber installations. Have you seen anything else related to ship patterns or trade or anything like that?
CS: Just as a quick comment that the main thing that we’ve been observing as from a research point of view is that we see strong supply shortages in the Atlantic, which is related to vessels repositioning to the Pacific for scrubber installations. And Hamish you can take the rest of it.
HN: It looks to us like the shortage of vessels due to scrubber installations is probably not getting better until second or third quarter of 2020.
JM: Yeah, it’s very interesting to see that supply offtake is going to be is be persisting right through the second quarter of 2020. You know, I know your scrubber program was kind of ahead of the curve, if I remember correctly, the majority of those were on track to be completed by the end of 2019. Is that still the case, are we seeing any sort of delays there?
HN: Right, it’s basically still the case. We were certainly delayed relative to what our initial plans were. But our initial plans had enough breathing room in them that we’re still going to have almost all of our scrubbers in by year end.
In our last investor, call, quarterly investor call, we had a chart which is still on our website in the presentation showing the scrubber installation schedule. And basically, we’re going to get all the scrubbers in except for those on a few of the Delson [ph] fleet vessels that we acquired relatively recently.
JM: Excellent, Hamish. So is it fair to say the majority of those should be done probably January, February of next year at the very latest? And if so on that also, has there been any sort of we’ve seen a lot of news reports about scrubber failings or issuesor additional off-hire. Have you had any issues with your fleet in terms of technicals?
HN: So yeah, the Delson ships, those Delson ships that won’t get scrubbers by year end should have them by end February.And we have not had any unusual technical problems. And there has been publicity about at least one or possibly two scrubber failureswhich were fairly spectacular.But we haven’t had any issues. And we don’t frankly anticipate significant issues. The scrubbers are pretty simple things.And the issues in the past were around corrosion not in our fleet, but in other people’sfleet and the corrosion stemmed from having either, not the right steel alloy in the scrubber or incorrectcoatings or coding preparation.
And we’ve learned from other people’s mistakes, and I think we’ve done it right.
JM: That’s good to hear it, like you said the scrubber news was quite spectacular. And I think it was on the headlines of a few shipping news organizations the last couple weeks. And I know you have one of the largest scrubber programs in the global fleet. So definitely wanted to reach out and talk about that.
A lot of the scrubber installations are taking place in the Pacific Basin, which is resulting in a lot of the fleet getting shifted over in that direction. How are you doing as far as your fleet? I know your installation started a little bit earlier. Have you been able to position some of your fleet back to the Atlantic where the rates have been higher or in that regard, how are the rates looking or what is thebetweenthe Atlantic and the Pacific.
HN: Okay, so first of all, the vast majority of our scrubbers are getting installed in China. A few of them are being installed in Greece, but the vast majority in China because it’s less expensive.That being said, of course 40% of dry bulk cargos and up in China anyway. And when we’re talking iron ore, it’s even a higher percentage than that. So capesizes, for example, you know, end up in China at a tremendous part of the time whether they’re installing scrubbers or not. And then they either ballast back to the Atlantic or back to a loading board in the Pacific.
Most of our capes are in the Pacific on some of them are going back to the Atlantic. Rates are higher in the Atlantic by $4,000, maybe $4,500 a day. But of course, that’s offset by the extra cost of balancing back to the Atlantic. So I mean, we’re basically profit maximizing. And what that results in is that a lot of the ships stay in the Pacific but we’re moving them slowly to the Atlantic as it becomes attractive to do so.
It’s basically business as usual, frankly.
JM: That’s good to hear, Hamish, it’s good to hear that the scrubber installation hasn’t skewed too much the fleet. I know, as some of the companies we’ve talked to and we’ve looked at, their fleet is getting kind of skewed over to one side of the trade pattern, if you will, but I know your fleets a lot larger and you did start that program a lot earlier.
You mentioned China a couple times if of course for the scrubber installations, but also as part of this trade pattern. Have you seen much of an impact because the US-China trade war in the United States, a lot of retail investors are looking to shipping are located in the United States, the US China trade war has been a major topic. Have you seen much impact on your specific fleet and specific trades? And just for everyone listening on the call and for later when we put out the recording, how big is the US China’s trade in terms of dry bulk. What percentage of the global market are we talking about here?
HN: It’s really a tiny fraction of global dry bulk trade. Basically, the only Dry Bulk cargo that China gets from the United States in any quantity are soybeans or worse soybeans. And soybeans as a whole are pretty small fraction of global drive bulk trade. And it’s actually not even the trade war that’s affecting soybeans slowness. for the most part, it’s actually the African Swan fever, which has caused the reduction in the herd of pigs in China by about a third.
And the soybeans, that China imports are used mostly to feed pigs. And the pigs are eating about a third fewer soybeans because there are fewer pigs. If they needed the soybeans and they didn’t want to buy them from the United States, they would get them from Brazil and Argentina, which is actually in many cases more ton miles. And so we would be fine. But, there’s simply a reduced demand for soybeans and yet we see these rates.
So movements of iron ore, coal, other grains basically unaffected by the trade war. And in fact, to the extent the trade war has an effect on the Chinese economy, the Chinese government’s economic stimuli tend to be focused on real estate and infrastructure which basically cause more steel to be produced. And of course, steel production is directly helpful to drive bulk. It involves increased iron ore and coal movement, which are the two largest cargos.
So I mean that — the short answer is that the trade war really doesn’t have a direct effect on us.
JM: Yeah, thanks. I appreciate the color. It’s a common question here, especially with the US-centric, Euro-centric investors where US trade war is like the topic of the day right. And people think they think, [indiscernible] China, which might be true for particulars, but driving markets a small percentage of the market.
I’ve heard 3% passed around a few times in terms of how large soybean trade is perhaps even in order estimation, but [Technical Difficulty] it’s a pretty small factor. And also for the couple there on the swine flu, I think that’s kind of you reported United States as well.
And a little bit to iron ore, you mentioned how that was changing. I know we had the valve disruption, early in 2019. And across the rates. We started to come back on line in [indiscernible] and that was kind of the bullish headed. We’ve also read a little bit of stuff about the China activities, the 70 year celebration and stuff like that. And there’s been some more focused on air quality and perhaps some steel restrictions. Have you seen anything like that in the markets?
HN: Basically, air quality issues causing imports to be reduced?
JM: Yeah, that’s correct. Has that been a major factor for the dry bulk market for you yet or is that [indiscernible]?
HN: I mean, it frankly doesn’t seem to be a major issue right now and, we’re actually seeing strong imports of iron ore and anticipate increased imports of coal because of the need to generate electricity and heat and in a situation where there’s reduced hydro electric output. So it’s basically a seasonal increase in the demand for coal. Constantinos Simantiras, so I don’t know if you have something to add.
CS: Yeah, actually the Chinese over the last five years, especially during October, November, where they have all these — they have various events, where they direct guns to the steel mills to cut down on production for a couple of weeks to improve the air quality. This has been the case, but usually involves with smaller regions and certain cities, it doesn’t impact the nationwide output where the numbers are really big.
JM: you still headlines and you wonder what the actual freight market impact is? I know we’ve seen the capesize rates falling back down, so kind of the last question was maybe that was the cause or something else. What do you think is the cause of this recent decline in the capesize rate? And it’s been pretty dramatic. I mean, we’re still at high levels, but it’s fallen from about 35,000 down to about 24,000 recently.
HN: Let me let me answer that. The reason is a normalization of supply in the Atlantic. And as we mentioned in the beginning of the call, demand volumes over the last couple of months have not been very high. So you have demanding relatively weak, the supply side is normalizing right now, but this is short-term related because you have the really large amount of VLOC vessels being stuck in the Pacific for retrofits and shortages of vessels, which created a shortage of larger vessels in the Atlantic. Now we see a small wave of VLOCs arriving in the Atlantic towards the mid and October. And as these vessels — these vessels will help Brazil push their exports higher but at the same time they are causing a slight decrease in demand for capesize.
But this is very cyclical. And as we enter the November-December period, where we expect that the Brazil and Vale will have to export — will have to increase weekly volume by approximately 40% from where they stand today in order to reach their low end of their annual target with the revised lower.
We expect a new round of tightness to take place especially towards November, December. So it’s possible freight rates run — increased probably too high towards July or August. They’re now normalized and we’ll see how high they will get over the next season of tightness which should come over the next two months.
JM: Excellent, yeah, let’s hope they tighten up quickly here in the next few weeks as you get ready to report your earnings you have a nice backdrop there and let’s hope that scrubber induce tightness remains strong into 2020 there.
I think we’ve done a pretty good job of covering kind of the big picture macro environment in dry bulk market overall. Let’s pivot a little bit into Star Bulk’s specifics. So I know you’ve mentioned in the past that you’d like to bring back dividends when the rates improved. Are we are quite there yet? Could we expect the dividend maybe by the end of the year or early 2020 or is that a little bit premature at this point?
HN: We need to have a Board decision, but I would not be surprised to see a dividend policy announcement late in the year or early 2020, with possibly a dividend followingearly in 2020.Certainly that’s been our intention, and it remains our intention.
JM: Excellent. It’s good to get to see that that’s still on the plate. In regards to dividends that kind of brings us into a big picture capital allocation, right. So are we looking at maybe more vessels coming into the fleet? Or are we looking at dividends? Or do you still consider stock repurchase to be attractive? Are we repurchasing debt? Like what is kind of the priorities at this point now?
HN: Okay, so first of all, we haven’tbought vessels in a way that would slow down a dividend now for — a couple of years at least. The Fleet acquisitions we’ve made recently have been using our shares and have not frankly either increased or decreased the leverage ratios at Star Bulk really at all.
They’ve basically been geared toward increasing our market cap, increasing our public float, increasing our liquidity without really making a bullish or bearish bet on the market, and without impacting our ability to pay dividends, and I don’t think we want to do anything that would impact our ability to pay dividends.
In terms of dividends versus stock buybacks, frankly, I think management of Star Bulk anticipates that the share price will probably trade more in line with our views of value as we start to produce significant cash flows and start to have a dividend. So that — probably a dividend will be more attractive for everyone, then stock buybacks.
And I don’t think for the foreseeable future, that we’re going to be borrowing money to buy ships. Although we may make fleet acquisitions using our shares.
JM: It seems last year we had three or four of those transactions where you used shares to acquire ships on a NAV-to-NAV basis. I mean is that something you see going forward or is there still some appetite thatyou think maybe some private fleets that would like to join the Star Bulk umbrella, or do you think maybe we’ve hit the numbers?
HN: Well, we still see situations from time to time. And it’s very hard to tell whether those result in deals or not. So when we find out you’ll find out.
SS: When it comes sort of, to fleet transactions, there are three important criteria that basically drive our decisions or Board decisions. Number one, I mean the quality of vessels, those must be vessels that we like and improve the average profile of our existing fleet.
Number two, I mean, the leverage should be at the same levels as our overall leverage if we’re transferring debt, or we would raise debt at senior levels to our current sort of overall leverage of the company. And then number three, it’s scrubbers I mean those vessels would have to be effectively scrubber fitted in order not to dilute the earning potential of our fleet and the earnings per share of our fleet. They should be accretive on that basis.
JM: I know it’s kind of an estimate at this point, but what sort of delta are we expecting in TCEs?
HN: Okay, so this is the $64,000 question. And we don’t expect a TCE differential to be $64,000 a day, that’s for sure. Although it will exceed that on our whole fleet, of course. There are a couple of things that go into many things that go into that calculation of charter rate differential. One and maybe the most important is the difference in price between high sulfur fuel that we can burn using scrubbers and low sulfur fuel that ships without scrubbers will need to burn which will be more expensive fuel.
The next thing basically is how much fuel we will burn using scrubbers and how much fuel a ship will burn if it uses expensive low sulfur fuel, which will actually be a bit less fuel, because those ships will go slower due to the high fuel costs.
And then the other thing to take into account is if a ship is on a time charter, it’s the charterer who pays for the fuel and therefore the charter who gets the direct savings and there has to be a negotiation in a time charter to transfer those savings to the ship owner. So there is a forward market in high sulfur versus low sulfur fuel and for 2020 that forward market is roughly a difference of $240 a ton. But that forward market changes all the time.
And our fleet burns roughly 1.2 million tons of fuel a year. And you can get a very rough approximation to the savings we will have by taking the fuel we burn and multiplying it by the spread between high sulfur and low sulfur fuel prices. That doesn’t take into account ships that might be on time charter, doesn’t take into account the fact that ships that are burning high sulfur fuel will go slower and burn less fuel. But it’s sort of gives you a ballpark estimate.
We will try not to put our ships on time charter, but to use voyage chartering, which will basically mean the fuel is for our expense. And therefore we will be the direct beneficiaries of the fuel price differential. So, but very roughly, take the forward market and multiply by 1 million or million 1.2 million tons.
JM: Thanks, Hamish. I busted out my calculator as you were talking and I believe I rounded out to about $3 a share in potential fuel savings. So yeah, that’s certainly significant. You mentioned that you’re not really looking into having any charters because you want to keep the fuel benefit for yourself. Have you seen some offers for reasonable charters or is there still kind of that huge bid ask spread between what the charters are willing to pay and that kind of spreads anticipating and what you guys are looking at on your end?
HN: Well, I mean, we do have a couple of time charters on ships with scrubbers, and the significant majority of the profits seem to go to the owner on time charters that are negotiated recently.But not 100%.
HN: For the most part.
JM: Yeah, I understand some of those terms might be more confidential than others. But can you speak in generalities about the structure of the contract is, is that sort of like an index linked contract with a mechanism for the spread of the fuel or is ita fixed rate or what sort of contract structures are those?
HN: Well, I mean, I know about two charters that we have on ships with scrubbers that go into 2020. One of them is index-linked where basically 100% of the differential in fuel prices goes to us. And another one is fixed rate. But we’re in excess of 70% of the fuel price differential goes to us. But again, we are intending to use time charters frankly as little as possible. And we are beefing up our capacity to use the voyage market.
CS: And also this may be worth adding. Compared to 12 months ago, when we started having discussions with various charterers, we see the big charters more willing to share a larger percentage of the profits due to the scrubber due to the spread. So one year ago, charterers were greedier and were trying to sort of absorb 50% at the time of sort of the spread. Today, we see them much more willing to give a larger percentage to us.
JM: That’s good to see. It would make sense that the end customer would like to hedge away a lot of that fuel risk and exposure, maybe not 100% but they that they would be willing to give a large percentage and the 70% structure certainly makes sense to me and the other charterer, the one that’s index linked with 100% of fuel savings, obviously sounds even better. So if you can get more deals like that, that would be fantastic.
HN: Well, I mean, we’re actually, I think, happier to do voyage even than a time charter with a 100% sharing on an indexed basis. And the reason is basically, that if a charterer who pays for the fuel and tells you how fast to run the ship is giving the owner a 100% of the fuel savings. The charterer is in effect paying for the expensive fuel and will run the ship more slowly as a result then it would be economically optimal to do if you own the ship and were paying for the fuel yourself.
So there are some very subtle effects going on there. But it’s actually better economically to run in the voyage market with a scrubber almost no matter what.
JM: Interesting, it brings up inangle that I hadn’t really discussed before, the exact economics of because you’re dividing the total revenue from the voyage by how many days you’re on the water. So if you’re your voyage is faster because of the cheaper fuel than your TCE would therefore be higher. Star Bulk is it looks like you’re well positioned for the 2020 markets and the dry bulk markets themselves are doing very well. But even with that said, we talked about fuel savings and I understand it’s napkin math, right. But we talked about fuel savings of around $3 per share with that current spread.
But Star Bulk trades that just a significant discount to NAV and I know different analysts have different numbers for NAV, but we see you guys at more than a 30% discount. And that’s before giving you any sort of credit for this scrubber enhanced fleet. Now if we start thinking that earnings are going to be $2 or $3 per share higher, which I understand is just an estimate, but that makes that discount even wider. So why do you think that Star Bulk is trading at this discount, given how you’repositioned and are you doing anything to try to improve those valuations of the shares?
HN: Well, let’s answer your second question, first. We’re trying to run the company the best way we know how and produce as much money for our shareholders as possible. And that’s basically all we can do, along with explaining to people what we’re doing.But in terms of the share price movement that’s up to you guys.
SS: And just to add to what Hamish has said, we have purchased about 3 million shares effectively since the beginning of the year.And what’s interesting is that we have used essentially proceeds from vessels that we have sold to buy back those shares at an even higher discount to NAV to what we are actually trading today. So where we see opportunity, and in a way that does not compromise the overall cash balance of the company, we will try to improve the value of our shares for our shareholders.
JM: Yeah, excellent. And yeah, we’ve been we’ve been fairly long-term, I guess you could say medium term shareholders of Star Bulk. So we’re well aware of the operational results and positioning in the 2020. It just is interesting to see the market applying these 30% or 40%, discounts, what have you to the NAV, ahead of these things. And yeah, we saw those purchases and are huge fans of those that, you mentioned that you’ve only done repurchases from proceeds from selling vessels, which is prudent and made sense when profits went very large.
But turning into Q3 and going forward, there’s going to be a significant amount of free cash flow. Is there a chance that you might use some of that free cash flow to continue to repurchase shares if we keep seeing these discounts?
HN: Well, it’s a chicken and egg problem. Our suspicion is that when people see an imminent dividend that, that may persuade certain people who have been avoiding dry bulk investments to come in and that might push the share price up to a level where frankly dividends made sense. As I say it is a bit of a chicken and egg problem, but we suspect that the dividend will probably correct this issue.
JM: Yeah, we certainly hope so. And if you are paying out a significant portion of your cash flows, that’ll be a very large dividend, especially in 2020 here. Is there a specific percentage or a rough estimate of how you want to split those cash flows between debt reduction on one hand and dividends on the other?
HN: It’s a topic that’s under debate right now, and no conclusion but I think you’ve hit the nail on the head in terms of the two uses for cash, which are basically debt reduction net debt reduction and dividends.
JM: Excellent Hamish, I think dividends will definitely help the perception of the markets. It’s been a really dry spell for us for a while. I would just kind of, I guess advocate a little bit as a shareholder here, that if we keep seeing these huge NAV discounts, I would much prefer to repurchases than dividends. I know all investors are different. But as far as dividends and taxation, that sort of thing, when you get a NAV discount, you’re getting a much better economic return from repurchases.
HN: If the cash flows are what we expect and the dividend is in the range that is reasonable, if there’s still a NAV discount, I will be somewhat surprised, but if there is we will be rational about it.
JM: Yeah, definitely makes sense. Let’s return to the historical days where we had NAV premiums and get Star Bulk shares where they belong. Interesting.
Well, thank you very much Hamish, I think this was a lightning call for us especially on the dry bulk markets and I appreciate you answering the questions on capital allocation as well. And thanks for everyone for joining us this morning. I appreciate your time.
HN: Thank you.
JM: Thanks for listening to our live discussion with Star Bulk Carriers, featuring Hamish Norton President, along with CFO Simos Spyrou and Christos Begleris, as well as Constantinos Simantiras, Head of Star Bulk market Research. As a reminder, I am long shares of Star Bulk Carriers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: J Mintzmyer is long SBLK. Hamish Norton, Simos Spyrou, Christos Begleris, and Constantinos Simantiras are employed by SBLK. Nothing on this podcast should not be taken as investment advice.
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