Swimming With Vultures

 | Oct 22, 2012 | 4:00 PM EDT
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It was an almost perfect weekend around Chez Melvin. I say almost because the one fly in the ointment  was that on Friday, after my column was published, I bought a shipping-related stock for the first time since my ill-fated foray into Paragon Shipping (PRGN) a few years ago. To say I was a tad early with that purchase is a huge understatement. Since I bought the shares, everything that could go wrong, or that management could do wrong, has happened. I still own the stock, but I do not expect to see my cost-basis until the Cubs win the World Series. Paragon was just the latest of my disastrous adventures with shipping stocks.

However, my inner vulture is very much on alert when it comes to shipping stocks. As I mentioned on Friday, Wilbur Ross has been very active in the sector. Blackstone (BX) and KKR (KKR) have ventured into the fray as well, buying tankers. We are seeing shipping-related bankruptcies and debt reorganization in the sector. There is  a good chance that Overseas Shipping (OSG) will file for bankruptcy before too much long, adding to the carnage in the group.

The group has suffered form an enormous over capacity for both tankers and dry bulk vessels. Combined with a global economic slowdown that drove shipping rates dramatically lower, shipping stocks have seen a perfect storm the past few years. The Baltic Dry Index has fallen by more than 30% this year and a gut-wrenching 90-plus% since the 2008 peak. Shipping is a very capital intensive business and most of these firms are highly leveraged and struggling to survive.

I almost have to be interested in a group this devastated or turn in my vulture card. I have started buying with shares of Taskos Energy Navigation (TNP) based on Standard & Poor's recommendation and my own follow-up work. I have calls into to people who understand the dynamics and financials of the group far better than I. I am perusing the ratings services for their thoughts on the group. Later today, I shall force myself to engage in the process of reading older bankruptcy cases involving shipping concerns. There is a huge opportunity in the shipping sector but given the amount of leverage used by these companies, it is not without substantial risks.

If you are going to look at the shipping companies, you have to consider the entire capital structure. Much of what Ross has purchased in the shipping industry has been through the bankruptcy courts. With earnings for most shippers well below the break-even point bankruptcy and reorganization value s will be critical to evaluating these companies. I may not have any interest at all in buying equity in Overseas Shipping, but a quick glance at the balance sheets shows that it has a little more than $400 billion in assets and roughly $2.2 billion in debt. With the bonds trading at $0.50 on the dollar and plunging, this is worth further investigation as a filing could drive bond prices well below recovery value.

I am keeping an eye on Matson (MATX) as well. The stock had a strong initial pop after being spun out of Alexander & Baldwin (ALEX) earlier this year. The stock has since surrendered all its gains and now trades well below the initial price. The company is the largest U.S. carrier in the Pacific and has a 67% share of the Jones Act protected trade between the mainland and Hawaii. The company also ships to Guam and China and has been outperforming its competitors in these markets. The near-term picture will not be very bright for the company but in a sustained global recovery, this company and its stock could do very well.

My record with shipping stocks is far from spectacular. However, the group is so beaten-down and distressed, it has to be on my radar screen. I will stay smaller and move slower than normal but I am starting to dig into the group and plan to evaluate both equity and debt securities. For now, I am sticking with my new position in Taskos and my old battered Paragon shares. This is a long-term and higher-risk opportunity, so it is not for everyone. But there is big money to be made for patient risk-tolerant vultures.

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