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Amit Amin

EGLE AT A GLANCE

P/E ► 7.48 AVG EV/EBITDA ► 12.9 AVG ROA ► 4.6% AVG ROE ► 7.2% AVG Debt to Equity ► 1.54 AVG Current Ratio ► 2.76 AVG Interest Coverage Ratio ► 2.55 AVG

 

 

 

 

 

 

Eagle Bulk Shipping (NASDAQ: EGLE) owns one of the largest fleets of Supramax dry bulk vessels in the world.^[1] Dry bulk vessels are ships specifically designed to move dry cargo, like steel and coal, across long distances, like from the U.S. to China. Supramax vessels are a class of large container ship with a carrying capacity of 50,000 to 60,000 deadweight tons (dwt)^[1]. Because Supramax vessels are defined by their relative small size, they can access many more ports then their larger compatriots.^[2] Eagle's entire fleet can hold a little less than a million dwt.^[3] The company takes that capacity and charters its ships for periods of 1 to 3 years, and in doing so skirts some of the day to day volatility of the international shipping market.^[1]

Strong growth in China has caused demand for raw materials and ships to transport them to rise.^[4] Eagle hasn’t been able to take full advantage of that, because it locks up its ships in long-term contracts.^[1] However, Eagle has been expanding its fleet, because it expects demand for dry bulk shipping to continue to rise.^[5] Eagle was able to tie up construction contracts before steel prices began their rapid rise, but will have some trouble finding customers for all of its new ships because the entire industry is in rush to build as many ships as possible. Expecting an oversupply of ships in the next two to four years, rates for new long term contracts have begun to fall. ^[5] The question for the future is whether they’ll continue along their descent, or whether unexpected growth in Asia will shore up slack demand and cause prices to reverse.

Company Overview

In 2007, Eagle had a profit margin of 42.57%.^[6] Since its incorporation in 2005, Eagle has used a combination of borrowing and equity offerings to finance rapid expansion. Eagle buys dry bulk vessels and contracts them to customers for periods of one to three years for a fixed daily fee. Because of its rapid expansion and rising demand for dry bulk shipping, revenue and net income have been soaring. From 2005 to 2007, revenue rose 222%^[7], and net income rose 785%.^[7]

Two elements of Eagle's business strategy differentiates it from competitors. First, it tries to reduce volatility in revenue and expenses as much as possible. It does so by entering into long term contracts, and passing on expenses like fuel onto its customers.^[9] Having secure cash flows lets it take on large amounts of debt without having to worry about being unable to meet financial agreements. However, when the market does well for short periods of time, Eagle can't do a thing. In 2008 daily rates for chartering dry bulk vessels was double what Eagle was being paid.^[10] Unless those rate hikes are sustained, it won't mean a thing to Eagle's revenues.

The second way that Eagle seeks to differentiate itself from competitors is by focusing on a subsection of a subsection of the industry. Eagle focuses on Supramax sized vessels, which are a subtype of Handymax vessels. Handymax vessels can pass through all large canals, and can unload their cargo themselves at many docks. Supramax vessels are large Handymaxs'. As of 2007, Eagle had 3 Handymax^[1] and 15 Supramax vessels.^[1] In order to establish itself as a major company in the Supramax sub-sector, it has purchased 35 Supramax vessels,^[11] at a cost of $1.1B,^[12] to be delivered by 2012. By doing so Eagle will have tripled the carrying capacity in dwt of its fleet.^[5]

Trends and Forces

World Economic Growth Impacts Demand for Raw Materials

Strong growth in Asia, mostly in China, has caused demand for raw materials to skyrocket. Unable to extract the necessary resources domestically, China has turned to imports from other countries. With demand on the rise, the Baltic Dry Index (BDI) doubled from 2005 to 2007.^[13]The BDI is a daily average of the prices required by shipping companies on the Baltic Exchange to transport raw materials across the sea. The Baltic Exchange is a global marketplace for brokering dry cargo shipping contracts. More specific to Eagle, the average daily revenue per ship earned by its fleet rose from $20,500 in 2006,^[14] to $23,000 in 2007.^[3]From 2007 to 2008, the Baltic Handysize Index, which is like the BDI but just for Handysize ships, rose 57%.^[15] All of Eagle’s ships are Handysize. To take advantage of rising demand, Eagle has been expanding its fleet. The problem is that every other company in the industry has been expanding their fleet as well.

A Surge in New Shipbuilding Orders Will Lead to a Larger Number of Dry Bulk Vessels

In 2007, there were contract orders for the construction of enough ships to increase the size of the worldwide fleet of dry bulk vessels by 57% within the next 3 years, excluding ship retirements.^[16] There is disagreement in the industry over whether demand will keep pace. According to Pacific Basin Shipping Limited, a dry bulk shipper, there won’t be an oversupply of vessels because shipyards won’t be able to complete all of their orders on time.^[15] Eagle's customers don't agree. For ships that will come into service after 2009, Eagle has only been able to negotiate charters with daily rates of $17,000 to $19,000.^[5], down from $23,000 in 2007.^[3]

Rising Steel Prices Make Future Fleet Expansion More Costly

Rising Chinese demand for iron ore has pushed up dry bulk shipping rates. It has also boosted the value of Eagle’s current fleet. From 2005 to 2007, the market value of Eagle’s fleet rose 247%.^[8] That isn’t because the size of Eagle’s fleet increased or because its fleet was becoming old. Since 2004 the average age of Eagle's fleet hasn't changed,^[8] and since 2005 Eagle has only purchased 5 new ships.^[8] While all of this is a good thing, it also means that shipbuilding costs have been increasing, making future ship expansion more expensive. From April 2007 to April 2008, steel prices rose more than 35%.^[17] Prices for steel plates, which are used to build ships, have risen by up to 83% during that same time period.^[18] Some of that rise will be absorbed by shipbuilders, and some of it won’t. For Eagle, shipbuilders will be paying for that increase. All of its 35 shipbuilding contracts were negotiated in 2007 or earlier.^[19] Future fleet expansion, however, will be more expensive.

Competition

Because of the size and efficacy of the Baltic Exchange, competition in the dry bulk shipping industry is fierce, and is based primarily on price. However, Eagle has an advantage. The average age of a Handymax vessel worldwide is 15 years.^[20] The average age of Eagle's fleet, which consists entirely of Handymax vessels, is just 6 years.^[20] A young, modern fleet is more attractive to potential customers than an old one for two reasons. First, a young fleet reduces operating expenses, like fuel costs and vessel maintenance. Eagle's operating margins are 12.3% higher than the industry average.^[21] Second, older vessels are more prone to having accidents, which can cause delay's, the loss or damage of cargo, and environmental incidents, which can be expensive, and raises a company's cargo insurance rates.^[22]

Eagle has another advantage. While fuel costs have been rising, margins have been falling. Not so for Eagle, which passes on the burden of paying for fuel to its customers.^[9] Eagle’s only major disadvantage is its small size compared to the shipping majors. With its aggressive growth strategy, that's poised to change.

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6} 2007 EGLE 10-K, Item 1, Page 4
2. ↑ Stockfundatalk - Sector Fundamentals: Transportation/ Shipping/ Bulk carriers
3. ↑ ^{3.0 3.1 3.2 3.3} 2007 EGLE 10-K, Item 7, Page 37
4. ↑ The People’s Republic of China’s Economic and Commercial Counselor’s Office - China import growth weak; exports remain strong
5. ↑ ^{5.0 5.1 5.2 5.3 5.4 5.5 5.6} 2007 EGLE 10-K, Item 7, Page 38
6. ↑
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9} 2007 EGLE 10-K, Item 6, Page 32
8. ↑ ^{8.0 8.1 8.2 8.3 8.4 8.5} 2007 EGLE 10-K, Item 6, Page 33
9. ↑ ^{9.0 9.1} Barron’s – How to Beat a Slump
10. ↑ livemint.com - Essar Shipping orders two bulk vessels from ABG Shipyard
11. ↑ 2007 EGLE 10-K, Item 7, Page 40
12. ↑ 2007 EGLE 10-K, Item 7, Page 35
13. ↑ Capital Link - BDI
14. ↑ 2006 EGLE 10-K, Item 7, Page 34
15. ↑ ^{15.0 15.1} Pacific Basin Shipping Limited – Q1 2008 Trading Activities Update
16. ↑ 2007 EGLE 10-K, Item 1, Page 21
17. ↑ World Carbon Steel Transaction Prices
18. ↑ livemint.com - Rising steel prices may eat into Indian shipbuilders’ margins
19. ↑ 2007 EGLE 10-K, Item 7, Page 38
20. ↑ ^{20.0 20.1} 2007 EGLE 10-K, Item 1, Page 2
21. ↑ Yahoo! Finance - EGLE: Direct Competitor Comparison
22. ↑ 2007 EGLE 10-K, Item 7, Page 39
23. ↑ ^{23.0 23.1} 2007 DSX, 20-F, Item 3, Page 4
24. ↑ 2007 DSX, 20-F, Item 4, Page 18
25. ↑ ^{25.0 25.1} 2006 DRYS, 20-F, Item 3, Page 2
26. ↑ 2006 DRYS, 20-F, Item 4, Page 20
27. ↑ ^{27.0 27.1} 2007 GNK, 10-K, Item 6, Page 40
28. ↑ 2007 GNK, 10-K, Item 1, Page 4
29. ↑ ^{29.0 29.1} 2006 NM, 20-F, Item 3, Page 3
30. ↑ 2006 NM, 20-F, Item 4, Page 19