Diana Shipping: Fixed Income Opportunity In 9.85% YTM Bond (DSX)

Introduction

Diana Shipping (NYSE:DSX) is an owner and operator of 43 drybulk vessels, with an average age of ten years and diverse sizes.

The way this Company is managed is conservative, as management is focused on signing time charters to ensure cash flows and limit spot exposure. This leads to a limited upside for shareholders but ensures debt repayment, thus being great news for bondholders.

From the Company’s last Conference Call:

“We intend to keep chartering our vessels in a similar way by staggering maturity, locking in cash flows, and positioning us in a manner that allows us to participate in the market in a balanced way.”

The bonds

These bonds was issued in 2021 with a nominal value of 50.000 USD and 8.375% bi-annual coupon payment. It was issued to refinance a previous issuance of 9.5% senior unsecured bonds. The ISIN code is NO0011021974.

Management owns 21M$ of the total of 125M$, which brings in some additional protection.

The bond is callable in whole or in parts in June 2024 at a price equal to 103.35% of the nominal value; between June 2025 to December 2025 at a price equal to 101.675% of the nominal value and after December 2025 at a price equal to 100% of nominal.

In addition, the bond carries the following covenants:

• Minimum Liquidity of 10M$
• The Tangible Net Value of the Company shall exceed 25% of Total Assets;
• Net debt to Total Assets shall not exceed 65%.

In contrast to investing in equities, when we invest in a bond like this, we mostly have to take care of the risk of default, i.e. get certain that the company will be able to repay/refinance the bond at expiration. In order to get that certainty, we will take a look at the company’s assets and the free cash flow generation expected.

The fleet

As we can see below, the total scrap value of the fleet is 376M$, which exceeds the net debt of the company (349.5M$ in Sept 2022). This is an extreme assumption as the company’s vessels are worth much more than their scrap value because the average age of the fleet is 10 years. Even in a depressed market, vessels are worth.

As mentioned before, Diana is characterized by a low LTV among the shipping industry, which stands at a mere 32% at today’s vessel prices and TC coverage, which stands at around 40% for 2023.

After the Q3 results presentation, Diana entered into 6 additional TC contracts and has paid 30M in dividends.

In addition, the company has entered into a Sale & Leaseback agreement for DSI Andromeda for a total amount of 29,85M$ (valued in the model 26 M$). Not only this unlocks cash for the company but points out that the valuation used in this article is conservative. This is a tool that could be used in the future in case of liquidity needs, for example for debt repayment.

The value of the fleet could go down but there is already a certain amount of pessimism in prices, due to the lower rate environment that has prevailed during the last months.

It can be expected that vessel values will pick up once the market recovers, but as mentioned before, this investment does not require from that to be successful.

Drybulk market

Shipping is a perfect competition market, there is no competitive advantage apart from access to capital. And even in a high-interest rate environment, access to capital is normally not a restriction for buying vessels.

Supply growth is driven by the order book, which stands at a 30-year low of 7%, and owners are reluctant to order new vessels because of high newbuilding prices, increasing environmental regulation, uncertainty about the propulsion system of the future, and low freight rates.

In addition, high-interest rates make financing less attractive in an industry that needs financial leverage to be interesting from a return perspective, as it requires higher freight rates for breakeven.

Environmental regulation will force up to 70% of the drybulk fleet to take efficiency measures and/or reduce their speed from 2024, thus reducing even more vessel supply.

On the other hand, demand has slowed during 2022 mainly because of lockdowns in China, as this country accounts for around half of the drybulk demand.

China has started to move on and even if it takes some months to regain the growth path, perspectives are optimistic for the end of 2023/2024. In the medium-term demand should be more or less related to GDP growth.

Consequently, we have a very restricted supply and muted demand that should pick up in some quarters from now, which implies good perspectives for the sector. Nevertheless, as it is shown below, the model has been built with very conservative assumptions, not expecting any improvement in the sector.

Debt profile

The free cash flow calculation shown below includes debt amortization (grey). Maturities (yellow) refers to debt secured by vessels and will be progressively refinanced, as a vessel normally carries debt attached to it as if it were a mortgage.

Free Cash Flow

Freight rates considered in the model, whenever there is not a time charter contract are the following, in line with FFA curves. A mentioned before these rates may increase, especially at the end of 2023.

With these assumptions, and after debt repayment FCF for 2022 would be 117M$, 45M$ next year and close to 0 for 2024-2025. So even in a pessimistic environment, the company would be able to repay around 130M$ in debt and generate around 165M$ in cash, accounting for nearly all their net debt (349.5M$).

Conclusion

What could look like a risky investment (drybulk, unsecured, no rating) is in reality a great opportunity with high yield and a very low-risk profile, both from an asset and a free cash flow perspective.