Singapore Shipping Corporation (SSC) in the past 2 financial quarters have announced the purchase of 2 10 year old pure car and truck carriers. They will be bringing in US$188 mil in revenue over the duration of the charter. We thought the next deal would be some time away. Turns out we are very wrong.
In an announcement made on the evening of 8th September (details here), they announced the purchase of an US$80 mill new build Pure Car and Truck Carrier (PCTC). Upon delivery, this ship will be chartered to a blue chip shipping major.
The purchase will be funded by internal resources and bank borrowings.
Summary of SSC acquisition trail
2010: US$50 million purchase of Boheme
2011: US$16 million purchase of Sirius Leader
2013: US$12 million purchase of Cougar Logistic assets
2014: US$33 million purchase of 2 x PCTC vessels
2014: US$80 million purchase of 1 x PCTC vessel
Chairman Ow Chio Kiat sold off the majority of SSC’s vessels just before the Great Financial Crisis and peak of the shipping cycle, and return the profits made from selling the ships at ridiculously good prices in the form of a special dividend.
I would think that many have questioned where is the replacement cash flow in the period of 2008 and 2009. The profit statements, excluding these one time sale, do not bring much joy to the investors who just got invested.
They basically missed out on some really great dividends.
With this year’s acquisitions of 3 ships, they possibly have doubled their net profit potential.
In all my simulation, I tried to work out how SSC could have purchased a ship, use the free cash flow from the long term stable charter to pay down the leverage, use the greater cash flow to purchase more ships. My simulation shows that if they manage to get the deals, they can purchase a US$15 mil ship every year.
The model is that beautiful. However, they are limited by the number of deals. You don’t get good deals every time. So the estimation was the cash flow growth for 1 ship purchase every 3 years.
And SSC surprised us by doing 3 in one year.SSC have managed to secure the 3 ships in 10 years ahead of time.
Given the amount paid for this newbuild, it is worth almost 7 x $15 mil ships!
I wonder how difficult it is to secure these ship deals. The standard route would be to procure a new build and at the same time work with these major car carriers to secure the deals. The problem here is that to work with these major car carriers it might not be as easy as we think:
Previously, there was virtually no short-term PCTC charter market, with operators instead engaging in transport using either their own ships or ships of friendly shipowners. Against the rapid increase in completed car movement by the summer of 2008, overseas shipowners that had never owned PCTCs before forayed into the PCTC sector one after another, placing numerous orders for newbuildings with the yards in China, S. Korea and other nations.
Despite speculative owners placing orders in the hope of logging long-term charter contracts with PCTC operators, including Japan’s Big Three, demand for such long-term charters plummeted following the Lehman shock. This consequently spurred a flurry of PCTCs reaching completion as free ships without charter contracts. It is thought that there are currently as many as 20-30 free PCTCs, all of which had been forced into the short-term market, which fetched the owners only low, unprofitable charter fees.
Getting through the door for a much lucrative, secure long term charter looks to be challenging. This provides a glimpse of what Mr Ow have built up through his years in the shipping industry.
There are not a lot of details revealed for me to work with. The length of the charter is not known as well. Given that it is a new build, it is likely that the ship is still in the shipyard, yet to be delivered. We do not know the projected delivery and start of charter.
From my research, past PCTC ships take 2 -4 years to build (see here), so we might see the contribution to cash flows only then. Charter rates are likely to be set only near delivery.
Mr Ow have mentioned a fair bit on the purchase of ships during AGMs. Specifically, SSC would not just purchase a ship just because its new or good price. It has to meet criteria that I can perhaps summarized as follows:
- Long charter duration (15 to 25 years)
- Blue Chip Charterer and not any charterer that will increase counterparty risk (you cannot eliminate counterparty risk totally as well)
- With the above, predictable well hedge long term financing can be secured
This makes each ship rather bond like and less susceptible to situations in the GFC or even after, when FSL Trust’s charterers got into trouble and stop chartering the ships.
With such a criteria, it is likely that SSC have negotiated to meet these criteria. What is more mouth watering is that Boheme, Sirius and the 2 new ships were purchased with 15 year charters but they are second hand ships.
If this is a new build, does that mean SSC can tie up a 25 year charter? Since the duration is long, you need to factor in high inflation risks and a higher discount rate. The long term charter rate could be much higher than the other 4 ships.
I have learnt that it is rather futile to estimate to a high degree of accuracy what are the projected cash flow. Each ship deals can be very different. Al the loan terms, charter terms make trusting my estimation dangerous. And it is not just SSC.
The above snippet was taken from Ocean Yield, a Norwegian shipper yielding 7.5% with some car carriers. I like the way they present the EBITDA Backlog. It gives you an idea the cash flow left. Hope SSC can do something similar.
What we see here is that though clients are the same, the average EBITDA is drastically different.
We can however use a few rule of thumb to assess on a conservative or optimistic basis the likely net profit and cash flow.
Last quarter results happens to be the most pure since it is absent of dry docking, Singa Ace’s contribution since it was sold off. So this includes Boheme, Sirius and Cougar Logistics contribution, net of interest and corporate cost
- Net Profit: US$1.8 mil (Annualized based on Q1 2015 US$7.2 mil)
- EBITDA: US$$2.5 mil (Annualized based on Q1 2015 US$10 mil)
- Boheme and Sirius Total Revenue: US$15 mil
- Boheme and Sirius Total EBIT(Annualized based on Q1 2015): US$5.6 mil
- Boheme and Sirius Average EBIT Margin: 37%
- Annualized Ship ROA using EBIT: 8.4%
Estimating based on ROA
If we conservatively look at what the 3 ships will add in terms of ROA, we might get an idea of how the EPS will look.
The 3 ships will cost US$113 mil in total. The debt financing required is likely to be US$20 mil more for the 2 new ships + 90% financing for the current ship or US$72 mil.
Based on previous 2 years average interest expense of 3.6%, the interest expense for US$92 mil = $3.312 mil.
Assuming they earn a conservative ROA of 7.5%, the EBIT will be 113 x 0.075 = US$8.48 mil.
The net profit estimated will be US$8.48 mil + US$7.2 mil – US$3.312 = US$12.365 mil
The EPS equals S$0.035 or 13.7% earnings yield based on prevailing price of S$0.25.5 share price
This is assuming these 3 ships are a poorer deal compare to Boheme, Sirius and that financing cost are as favourable. I felt that the average ROA for these 3 deals are likely to be higher than the previous 2 ships, but that is just guessing. I am not involved in the deal so this could be wrong. Using 7.5% gives us some margin of safety.
Estimating based on EBIT Margin
SSC revealed for the 2 PCTC ships purchased for the total consideration of US$33 mil that through their lifetime (15 years) their total revenue would be worth US$188 mil. That will average yearly to be US$12.5 mil.
These 2 ships are most comparable to Sirius, since it is likely they are chartering to the same Japanese charterers. From what we are provided Sirius revenue for the last work year was US$4.5 mil while the average of these 2 ships are closer to US$6.25 mil (39% higher). They look at this stage to be more lucrative.
My opinion is that, revenue is what is agreed with the charterers, the cost of operation, which includes the bunker fuel, operating crew, maintenance are borne by SSC.As such, the EBIT margin is very much in SSC’s control. It will be very surprising that SSC will have such different operating profile in the span of 3 years. Cost of operation will go up, but will it be more than 39%? That will be some inflation.
If we use the average EBIT margin of 37% currently to estimate the EBIT of these 2 PCTC, we will arrive at an EBIT of 12.5 x 0.37 = US$4.6 mil
Since we don’t have much details of the new ship in terms of potential revenue earned, we will stick with our ROA estimation of 80 x 0.075 = US$6 mil
The net profit estimated will be US$7.2 mil + US$6 mil + US$4.6 – US$3.312 – US$1 mil (increase in corporate cost) = US$13.49 mil
The EPS equals S$0.0386 or 15% earnings yield based on prevailing price of S$0.255 share price
Ocean Yield’s new Bareboat Charter
From Ocean Yield’s announcement, we know the presence of a 12 year bareboat charter for a new build 6500 PCTC purchased for US$62 mil. The EBITDA for the charter projects to be US$7.2 mil. If I understand the difference, a bareboat charter’s revenue equals a time charter EBITDA. In this case the bareboat EBITDA margin is estimated around 90%. This gives the 12 year PCTC charter revenue to be US$8 mil.
If we project this way, an US$80 mil ship which is 29% more expensive, could fetch an EBITDA of US$10 mil. With a 30 year depreciation of $2.6 mil EBIT might be $7.4 mil vs the previous $6 mil.
I don’t want to go far with this, because ship building cost could have increased, that US$62 mil boat could equal this Us$80 mil boat. Charterers at different time period and different charterers can provide different charter terms and duration. The purpose is to see if our figures are far off.
Final Thoughts on the Earnings
Whichever way I estimate EPS looks to be around S$0.035 – S$0.04.
The assumption is that these 3 ships will do equal if not worse than Boheme and Sirius and operating costs do not have abnormal spikes. In terms of EBIT, its hard for me to imagine 3 newly secured PCTC doing worse than the 2 existing ones. These 3 new ones cost 1.7 times that of the 2 old ones.
The car carrier charter environment must have deteriorated very drastically for these 3 ships to end up as a mediocre deal than the 2 exiting ones.I believe the 2 PCTC previously announced could be secured with much more favourable long term rates. This new ship is a bit of a problem since rates can only be determine once the ship is delivered and ready to charter. By then, could the PCTC market look very different?
I have not carried out any free cash flow projections, but depreciation should be in the region of US$7.55. The depreciation alone is more than enough to pay for the 3.9% dividend. The EBITDA in this is possibly US$20 mil. Since there could be dry dock maintenance capex on average of 1.6 mil per year the free cash flow could work out to be $18.4 mil.
A yearly FCF can buy a second hand ship handily every year,or pay down the debt incurred for the 2 second hand PCTC ships. You can envision that these 5 ships providing the cash flow to acquire a US$15 mil ships that adds $2.25 mil EBITDA yearly this in turn reduces the gearing.
In my last post, I project that SSC will take on US$20 mil more in debt. There is no way they can finance this US$80 mil ship without leverage, rights issue or placement. Rights issue is out of the question since the owners likely do not want to dig in to fund it. Placements are unlikely since they are famously conservative and diluting their ownership will result in more activism, which will step on the owner’s toes more.
A 90% financing deal looks likely and this could net debt to US$110 mil. Post acquisition total assets could reach, $180 mil. Net debt to asset could reach 60%. Net debt to EBITDA could reach 5.5 times. SEB Bank seem to think that a 4 to 5 times net debt to EBITDA range is sustainable if the cash flows look strong due to the nature of the business (refer to references). It also highlight the key risk here (which is the same as SSC):
Ocean Yield is relatively highly leveraged, with 5.0x NIBD/EBITDA at the end of 2012. We expect the company to maintain a high leverage, as it plans to fund its USD 350m annual capex plans with 70% debt. This is however mitigated by the fact that the company’s assets are on long-term contracts and thus give good earnings visibility.Nevertheless, should a counterparty to the bareboat charters fail to meet its obligations, it could have severe impact on Ocean Yield’s finances.
Both are very risk figures whichever way you look at it. If this scares you then perhaps this is a company you want to give it a miss. This sounds like another shipping trust that will be hit when another GFC sail along.
Ocean Yield’s New Build PCTC Financing Case Study
The interest expense currently averages 3.6% of outstanding loans. This looks a high amount and the usually question is whether they are floating rates or fixed rated. By default most of these commercial loans are floating rate, and to be fixed, you probably need to pay a much higher interest expense similar to what Aims Amp and Sabana REIT did, with excess of 4% interest.
Ocean Yield have communicated the following leverage profile:
In terms of financial strategy, the company has communicated that it plans to funds its investments with 70% debt and 30% equity. This is reasonably conservative, if one assumes that the future investments will have similarly long-term contracts against relatively secure counterparties as they have today.
While it should be noted that Ocean Yield looks to be in the growth phase, SSC is in a similar situation, small fleet and trying to grow. In this aspect, SSC’s situation with these 3 ships will be 61% debt and 39% equity.
A reference to recent loans for new builds of PCTC for Ocean Yield will reveal much about, terms of the loan, how they are structured and the covenants:
HÖEGH 4401/ 4402 (6500 PCTC Bareboat Charters Delivered in August 2014)
- The Ocean Yield Group has entered into a USD 92 million pre- and post-delivery term loan facility with Skandinaviska Enskilda Banken as agent to finance the two Pure Car Truck Carriers that will be delivered in 2014
- The facility comprise of two tranches of USD 6.15 million each, which are available prior to the delivery of the vessels, and two tranches of USD 39.85 million each to be made available borrower upon vessel delivery
- The loans under the facility carry an interest rate of LIBOR plus 3.25% per annum. Each loan shall be repaid in quarterly consecutive instalments of 1/60 of the outstanding loan, with the final maturity date falling five years from vessel delivery
- The Company has used interest rate derivatives in order to effectively fix the interest rate under the facility for a principal amount of USD 46 million at an average rate of 1.63% (until April 2018)
- The PCTC vessels will be used as collateral under the facility
- Ocean Yield ASA has guaranteed the borrower’s obligations under the facility. The facility includes financial covenants as to equity ratio, interest coverage ratio and minimum liquidity and equity at Ocean Yield Group level. At all times, the Groups equity ratio shall not be less than 25%, the interest cover ratio not be less
than 2.00:1, the minimum liquidity not less than the higher of USD 25 million and 3% of its net interest-bearing debt, and the total book equity not less than USD 300 million.Further, the minimum fair market value of the vessels shall at no times be less than 120% of the outstanding loans under the facilities. As of 31 December 2013, no amounts had been drawn under the Facility.
- The Ocean Yield Group has entered into a USD 94 million term loan and revolving facility with Nordea Bank Norge ASA as agent to finance the two Pure Car Truck Carriers that will be delivered in 2016
- The facility comprise a term loan facility (facility A), which will be available in two loans in an amount of up to USD 37 million each, and a revolving credit facility (facility B) in the aggregate of USD 20 million
- The loans under the facility carry an interest rate of LIBOR plus 2.85% per annum. Facility A shall be repaid in quarterly consecutive instalments of USD 783,334 and Facility B shall be repaid upon the final maturity date. The final maturity date is five years from delivery of the second vessel
- The Company has used interest rate derivatives in order to effectively fix the interest rate under the facility for a principal amount of USD 47 million at 1.892% (until January 2021), and USD 47 million at 2.128% (until January 2021)
- The PCTC vessels will be used as collateral under the facility. Ocean Yield ASA has guaranteed the borrower’s obligations under the facility.
Based on this 2 recent term loans case study, they seem to debunk the idea that for a new build of US$ 80 mil, SSC will repay it in 7 years. SSC may increase the repayment period to over 15 years or they could stay aggressive. The hedging of interest can’t take forever but judging by SSC short repayment period usually, they may be able to hedge the interest risk over 7 years.
The hedge interest rate is lower than current average interest rate but we won’t know for sure after 1 year of operation since SSC does not provide much of these break downs.
Conservative Nature of Management
Liberty Global, Liberty Media have been good case studies of how scuttlebutt into an owner operator’s management ideas. Deeply invested owners such as the Ow family and John Malone for Liberty group of companies likely do not want to take excessive risks if that would mean permanently impairing their net worth.
It is also important that we learn the thought process that goes into their decision making through the deals that they make and the kind of risk management that they have taken.
Mr Ow have shown that he does not take any deals but only the best deals that the margin of losing is little. A case study would be that, for a long term operator in Australia, why the last purchase have been such a long time ago in early 2000, when recently we see so many listed companies entering the scene after Singapore starts tightening. With his connections he should be able to secure them easily by paying more. It is likely he is so unwilling to go above a certain limit.
Judging by his track record in 2000s, Mr Ow have shown a preference for behind net cash rather than a debt leverage balance sheet.
For him to do this 3 PCTC deals, they are likely to be counterparty that he have assessed to be able to maintain a long term EBITDA, enough to deleverage.
Unlike a shipping trust (well at least before the GFC), SSC does deleverage.
SSC for me is a company that, if you are speculating for share price capital appreciation, you are better off looking elsewhere.The market cap of S$111 mil is so small that non of the big funds will be interested in it. The shares are so strongly held that the share price will stay there for so long.
If SSC was a shipping trust, where they do rights issue or placement to finance new ships, they would be able to pay out my projected US$18 mil free cash flow. The business trust owner would earn a dividend yield of 20% on an average charter of 13 years. It is perhaps they take a more prudent model of operations.
What make SSC different from China Merchant Pacific, a company covered in my previous write up, is that CMP pays out as much of net profit as dividends, still retains depreciation for deleveraging and acquisition. As dividend yield is high, this keeps CMP’s share price attractive, thus they can acquire new roads with a combination of debt and placement.
SSC, on the other hand, likely will not take the placements and rights issue route. The only financing possible is through leverage.To mitigate the risks, they have to actively manage the quality of the charterers.
Instead of high dividends, investors need to sit with a reasonable dividend while the rest of SSC’s free cash flow will be used to deleverage or for acquisitions. Investors review SSC through the quality of their acquisitions, whether the ROIC beats their cost of capital and their risk management.
The acquisitions coincide with what Mr Ow mentioned during the AGM that in the future, the major car carriers such as Mol, NYK, Glovis, Kawasaki and Wallenius, might not have the best of times. The car carriers were fined for illegal cartel price fixing and Mr Ow reflected that the going will be tougher for them and friendly charterers like SSC. This could explain the fury of deals carried out this year.
Mr Ow and his team have stuck to their statements to shareholders that they are on an expansion and secure good vessels and charters. While losing Mr Tay Lai Wat, the Chief Operating Officer was a big loss, the execution of this deal shows that the core team is able to continue to execute well. It provides a good retort to my initial article where I question whether majority of the deal making is carried out by Mr Ow.
A large part of the intrinsic value of SSC lies with their ability to secure better deals than anyone with capital large enough to purchase a PCTC. There are still question marks to whether the window of these major car carriers selling ships to friendly ship owners like SSC have more or less close. Perhaps another deal a year down the road would debunk this theory.
For now, they should more or less put their cash flow to deleveraging. Will dividend payout increase, I think this is unlikely but we shall see.
My past write-ups on this company can be found below:
- Singapore Shipping Corp
- Sells MV Singa Ace
- How much returns can you get from a ship
- Singapore Shipping Corp sells Nanyang Maritime
- Singapore Shipping Corp Full Year Results and Details of New ships
- Ocean Yield SEB Analyst Report