The bulk shipping industry has been under pressure recently, as global recessionary sentiment has resulted in pulling back of volumes, and with Eagle Bulk’s (NYSE: EGLE) assets, and current financial position, the company is too cheap to ignore.
US container volumes in December, witnessed a slight decline, of 1.3%, compared to, November, and for the year the total TEU, or (twenty-foot equivalent units) decline came in at 21%. While this decline may seem excessive it is largely based on a previously high base, where post-pandemic opening led to a surge in consumer sentiment. A number of large logistics firms such as Flexport have started laying off employees citing both excess employees and an increased level of automation contributing to the layoffs. The theme seems to be quite a common one, with many key global ports increasingly witnessing a decline in volumes, ports such as the one run by Singapore’s Temasek.
Cass Freight Index, which is considered the most important barometer for the shipping index, by many executives, has also been showing a decline in reading.
“Among the main issues with the potential for further disruptions cited in the report were COVID continuing to be a factor, the ongoing decline of Chinese-origin imports into the U.S., with a 0.5% decline, from October to December (as well as steeper declines out of South Korea, down 15.1%, and India, down 10.6%), and the unresolved West Coast labor situation).” (Source: Descartes Shipping Report)
Meanwhile, freight rates have also been under pressure, dipping from 14-16,000 USD to 12,000 USD on average, in terms of FEU, the Asia-West coast witnessed the biggest declines. Prices have likely bottomed out for now, as the current prices are a happy medium between the excessively low prices that plagued shippers previously and the excessive prices which were severely affecting consumers. For the likes of Eagle Bulk shipping, which has pointed a rosy picture for the next quarter, this should see revenue moderate along with cash flow. This reduction in both volume and prices should affect the dividend, which currently stands at around 15%. While management has reiterated another significant payout, between the reduction in debt, and the lower cash flow operations, the dividend may be lower than previously projected.
Prices have been under pressure and:
“The Baltic Exchange’s main sea freight index was unchanged on Monday, languishing near the multi-year low touched last week, as a slight uptick in rates for larger vessels countered a fall in the supramax segment. The overall index, which factors in rates for Capesize, Panamax, and supramax shipping vessels, was flat at 946 points. The Capesize index gained 12 points, or about 1%, to 1,311. Average daily earnings for Capesize vessels, which typically transport 150,000-tonne cargoes such as iron ore and coal, were up $104 at $10,874.”
Since the company is highly dependent on US shipping, and with interest rates as high as they are, China continuing to face issues with COVID, revenue is likely to remain muted for a while. The China re-opening scenario should help the company slightly, as imports surge into key ports, due to increasing demand for everything from agriculture to finished products.
Where Could Eagle Bulk Shipping Revenue Head?
The likelihood of revenue coming in substantially higher in the next quarter remains low, the current quarter saw $184 million in revenue, and the next quarter could see similar levels or potentially a slight increase in revenue. The total revenue for the fiscal year is expected to come in around $750 million, and 2023 could see similar levels of revenue as headwinds continue to take hold. The company has continued to expand its fleet recently, acquiring the Ultramax Bulk Carrier, and this should help with revenue. But considering the headwinds, it could even out. On the higher end, mid-single-digit growth is likely, but margins may rise, and cash could improve as we move into the latter parts of 2023.
The company has been focusing on deploying capital increasingly to expand its shipping lines, and that could further hamper cash flow in the short term, but the significant increase in CAPEX we witnessed in 2022 is unlikely to reoccur. The company’s decision to expand shipping could also be coming in at the wrong time, with a global slowdown on the cards. That slowdown will certainly affect trade and bulk shipping, and that could mean overcapacity, only further reducing cash flow, as upkeep costs weigh in on the company. How management proceeds over the next 12 months will become increasingly important.
The company’s financial outlook should improve as key costs such as fuel and labor should even out. This should help improve cash flow, and when combined with capital expenditure, which should remain largely flat or slightly higher for the year, as the base effect from 2022, wears off. Furthermore, the company is trialing new bio-fuels, which could help both the environment and cash flow. Although controversies remain about the sustainability of biofuels, investors might welcome the change.
The current financial status of the company is relatively strong, and with a P/E of 2x, investors might think that the company is very cheap, but analysts similarly expect further pressure on revenue, as volumes and prices come down. The reality is the forward P/E is likely to be around 4-5x earnings, and it’s possible if revenue falls significantly, although unlikely at the moment since the global economy has not declined, therefore, it is likely to see shipping volumes remain intact, and in turn, forward P/E may not decline as much as analysts currently expect.
Investors can take solace from the fact that the global economy remains relatively lukewarm for now, but as interest rates continue to rise, corporations will slowly start to lay off staff. This is likely to put pressure on consumer spending, and could bring down imports, and put pressure on shipping rates. Should this happen, this may lead to a decline in margins to the extent that, that cash flow turns negative, at which the stock may decline further. But the decrease is likely already baked into the current valuation, and investors are more likely to be bullish moving forward, especially if the next couple of quarters aren’t as negative as the current sentiment surrounding shipping suggests.
What Risks Does The Company Face?
-Interest rates continue to rise, as inflation remains sticky or rises, leading to credit risk.
-Higher rates lead to a slowdown in the economy, and consumer spending, leading to lower shipping volumes.
-Significant declines in cash flow from adverse events lead to default.
Summary:
For now the outlook for the shipping industry remains strong, and issues of a slowdown are likely baked into the current set of valuations. Investors can wait and watch for now but could choose to go long once there is more clarity, but can also build a small position if global shipping volumes remains strong.
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