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Will a six-year-old bet on dry bulk recovery finally pay off?

The first ingredient of ocean shipping’s ‘buy low, sell high’ recipe is a large pile of speculative cash to gamble on a recovery that remains hypothetical. To score blowout returns, investors must buy ships when most people believe doing so is a terrible idea.

The second ingredient in the recipe is for freight and asset markets to actually rebound and prove the doubters wrong.

Few investors in New York appear to have the stomach for this, making the recent achievement of Eagle Bulk (NASDAQ: EGLE) such a rarity. Eagle Bulk raised cash for growth in the U.S. capital markets while still reporting losses. That used to be a fairly common dish; it isn’t any more.

Losses on weaker rates

After market close on July 29, Eagle Bulk posted a net loss of $6 million or $0.08 per share for the second quarter of 2019, in line with consensus, compared to net income of $3.5 million the year before.

There has been considerable optimism on dry bulk markets in recent weeks, with larger vessels initially leading the charge and progress increasingly being made by the mid-sized vessel categories owned by companies such as Eagle Bulk and Scorpio Bulkers (NYSE: SALT), including Supramaxes (45,000-60,000 deadweight tons or DWT) and Ultramaxes (60,000-65,000 DWT).

There is still a way to go to get to a true recovery, however. Eagle Bulk, which owns a fleet of Ultramaxes and Supramaxes, reported average daily charter revenues of $9,731 per day in the second quarter, down 15 percent year-on-year.

It has locked in 57 percent of available days for the third quarter at $10,285 per day, up 6 percent from the second quarter, but still down 9 percent from rates of $11,281 per day achieved in the third quarter of 2018.

Capital-market access remains tight

On the same day that Eagle Bulk released its quarterly results, it successfully closed on the sale of $114.1 million in convertible bonds, with proceeds earmarked for the purchase of six modern-built bulkers.

The convertible bonds bear an interest rate of 5 percent, have a conversion premium 25 percent higher than the July 24 closing price, and a duration of five years. Eagle’s stock price took a heavy hit as a result of the offering, falling 15 percent since the convertible announcement on July 24.

To put Eagle Bulk’s convertible bond sale into perspective, a FreightWaves analysis of equity and debt deals by U.S.-listed shipping companies shows that only $539 million in gross proceeds have been raised in the first seven months of 2019 – 60 percent from senior notes, 22 percent from convertible bonds, 15 percent from Norwegian bonds and only 3 percent from equity sales.

U.S.-listed ship owners had raised $3 billion by this time in 2018, over five times this year’s tally. Unless there is a startling turn of events, 2019 will go down as the worst year for capital-market access since ship owners came to Wall Street in the early 2000s.

During the conference call with analysts on July 30, Eagle Bulk chief executive officer Gary Vogel explained the rationale for using convertible bonds to raise proceeds for the vessel purchases.

“We considered a broad spectrum, from straight equity to lease financing,” he said. “We felt that the combination of unsecured debt and a higher conversion price than straight equity was a good balance.”

Because the newly acquired ships will not act as security for the convertible bonds, those vessels will remain ‘unencumbered,’ meaning that Eagle Bulk can take out new debt secured against them in the future and buy more ships.

Vogel confirmed that this was a possibility but said that it was appropriate to “take a pause” before more deals, given uncertainty over the effect of the IMO 2020 regulation. Under IMO 2020, ships that do not have exhaust gas scrubbers will be required to limit the sulfur content in their fuel to 0.5 percent as of January 1, 2020.

“We’re constructive on the market but this is a volatile industry,” said Vogel. “You need to be prepared for periods of weakness. We don’t ever want to put this company in a position where the market has to do something.”

Long investor history

The rationale of the lead investors in the Eagle Bulk convertible offering also needs to be put in context. This was not the case of new investors willing to bet new money on the shipping cycle.

Rather, it was a case of old investors who bet a large amount of money years ago on a thesis that hasn’t yet paid off. They remain confident in the company and its management and are now putting in more money in hopes that their eventual returns will improve.

The majority of the convertible bonds were purchased by Eagle Bulk’s two largest equity holders, Oaktree Capital (which bought $45.5 million of the bonds) and GoldenTree Asset Management (which bought $23.6 million of bonds).

Oaktree was one of the buyers of Eagle Bulk distressed debt sold back in the second half of 2013 by the ship owner’s original lender, Royal Bank of Scotland. Eagle Bulk filed for Chapter 11 bankruptcy protection in August 2014 and emerged two months later with its debt converted to equity and Oaktree as its largest owner. GoldenTree bought its stake in 2015-16.

Enhanced fleet profile

Bond proceeds will be used to purchase six Ultramaxes for an aggregate purchase price of $122 million; four of the ships will have exhaust gas scrubbers already installed, allowing them to continue to use cheaper high-sulfur fuel after the IMO 2020 rule goes into effect.

The deal increases Eagle Bulk’s operating leverage, i.e., its exposure to spot rates, by growing the total fleet by 13 percent to 50 vessels, comprised of 20 Ultramaxes and 30 Supramaxes.

It also increases its exposure to IMO 2020 upside. Of its 50 ships, 41 will have scrubbers, with hopes of installing units on 39 ships by the end of this year.

Over the past two and a half years, Eagle Bulk has sold 14 smaller and older Supramaxes, and acquired 20 larger and younger Ultramaxes. “We believe these transactions have transformed Eagle Bulk and significantly improved its earnings capability,” affirmed Vogel.

With that upgraded platform now in place, the six-year-old wager by Oaktree is poised to deliver. The final ingredient, which has remained stubbornly elusive, is for the freight rates and asset market values to cooperate.
Source: Freight Waves

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