More selling from the portfolio: Time to weed out "junk"?

We sold our small position in Courage Marine on 18 Jan (18 lots at $0.215), following the sudden spike in the stock. The previous day, the company announced that it had plans to list in Hong Kong, which would improve liquidity and branding. While we still think that the company holds decent value, we remain cautious on holding "junk" in our portfolio for the longer term, and we see the rapid move in the stock price as a good opportunity to monetise our position and lock in profits.

We do not have a terribly optimistic outlook on the BDI; the measure has remained depressed by the weak global trade outlook, while the floods in Queensland will weigh on dry-bulk rates for some time. Coupled with the high price of crude oil, we think that dry-bulk shippers like Courage Marine will have to depend largely on prudent cost management for profit. While the company remains one of the most prudently-financed shipping companies available for investment, we have decided to take profits and raise our cash level to above 20% of the portfolio.

2Q 2010 corporate earnings update - Best World, Courage Marine

Best World International

• Shock loss of $806,000 for 2Q10, down substantially from $3.427 million profit a year ago
• 1H 10 profit of $228,000, versus $5.44 million in 1H 09
• Revenue plunged 52.4% y-o-y, mainly due to 87.2% drop for Indonesia, and 54.5% drop for Malaysia
• Huge amount of cash and equivalents of $36.1 million
• Interim dividend of $0.012, unchanged y-o-y

The latest quarter has been exceptionally poor, largely due to the impact of lowered sales in Malaysia and Indonesia. Indonesia sales have suffered as a result of changes in cosmetic and import regulations, and Management has guided that two key products have received product licenses in 2Q10, and were launched in June. Malaysia sales have also taken a hit from increased competition.

We continue to like Best World International as a proxy to emerging Asian consumption, especially with its presence in Indonesia. Import regulations have hurt revenue in the near term, but we think that things will be substantially better in 2H10 with more product approvals granted. We like the business for its ability to generate strong cashflow, and the quality of management is decent. Management is keenly aware of the near-term negative impact of the news, and to buffer stock downside (and given the huge cash position), an unchanged interim dividend of 1.2 cents has been declared, despite poor 1H10 profits.

Courage Marine

• Posted 2Q10 revenue of US$16,277,000, up 26.6% q-o-q (+168.3% y-o-y)
• Logged US$242,000 disposal gains in 2Q10
• Net profit of US$5,176,000 in 2Q10, up from US$3,025,000 in 1Q10
• Remains net cash, with cash and equivalents of US$21.8 million  
• Utilisation rate about 90% for 2Q10, up from 70% in 2Q09

Courage Marine posted a strong quarter, as the BDI rose to about 4,200 in May. However, the BDI dropped to around 2,000 points in June, indicative of the volatile nature of bulk shipping rates. With the current BDI at around 2,400 points, Courage Marine is looking at a weaker 3Q10.

Management prudence is once again reflected in the latest quarter's income statement. While turnover rose a massive 168% y-o-y, cost of sales rose much less (+68% y-o-y), allowing the company to post a decent profit, even with moderate shipping rates in the quarter. The company's strategy to utilise older vessels is evidently effective, and the even after the recent disposal of a Handysize vessel, the company still has 580,000 dwt in its fleet to capitalise on a rebound in the global economy.

Coruage Marine scraps Handysize vessel

Courage Marine announced that it has sent Jeannie III (a 33 year old, 34,537 Dwt Handysize vessel) for demolition, resulting in proceeds of approximately US$2.6 million. Based on rough estimates, the Jeannie III possibly measured about 5,200 ldt, which translates to a selling price of about US$475 per tonne, up from the reported US$425 per ldt which Courage Marine secured for the disposal of MV Cape Ore in April this year.

The ship is understandably old, and the transaction will actually result in a gain of about US$500,000 for the current year. Once again, the management has shown ability to profit from the disposal of old vessels as steel prices gain, an indication of how the company's focus on older vessels increases business flexibility.

New position: Courage Marine

We purchased 18,000 shares of Courage Marine today at $0.185, adding a new position to the portfolio. The BDI has fallen from its lofty peaks of 10,000+ points in late 2007 and early 2008, and now resides at about 3,200 points (after hitting a low of 663 in Dec 08). Dry bulk shipping rates have been volatile, and it is not surprising that a shipping firm like Courage Marine which depends on spot rates for charters has seen extreme volatility in its revenues over the past two years. Revenue plunged from US$90.5 million in 2007 to US$27.94 million in 2009 as shipping rates collapsed, and baring some exceptional items, the company was loss-making in 2009.

Given the extremely cyclical and uncertain nature of dry-bulk shipping, why then are we making an investment in this particular company? First, while we are no experts on timing the shipping cycle, it is probably more accurate to say that we are nearer the trough of the cycle than the peak. Most shippers are trading near or below book value, and we have yet to see a convincing return of profitability in the dry bulk segment. The time to buy cyclical stocks is when they trade at extremely high PEs, or when they are loss-making; the time to sell is when they trade at low PEs, indicating that peak earnings have been achieved.

Second, we like the company's conservative and unique approach to dry bulk shipping. Typically, companies choose to lock in long-term COAs when freight rates are high (eg. Mercator Lines), and often purchase newly-builds for such long-term charters. While this appears like a safe way to generate income, the approach fails to account for the potential of reneging by the charterer, especially when rates have plunged substantially. More often that not, the shiponwer is left with little choice but to lower the contracted rate, or face the prospect of fighting a long and expensive lawsuit. Courage Marine deals largely in the spot market, and to a lesser extent with COAs.

However, the company's fleet is exclusively made up of old ships - the average age of its fleet is bearing on 30, which is usually when a ship gets scrapped. Because of its focus on older vessels, the company has avoided overpaying of expensive new vessels, and avoids the long delays for newly-builds to arrive. In a prudent manner, the company has expended its fleet from 4 vessels in 2001 to 10 currently, and yet has maintained its net cash position (think Wheelock Properties Singapore), a rarity in the shipping industry where leverage is often used with reckless abandon.

While having a fleet of older ships comes with higher maintenence costs, the company has managed to keep operating costs low (operating costs rose just 65% in 1Q 10, compared to the 158% increase in revenue). Also, since its ships are depreciated on a 30-year basis, the residual book value of its fleet is minimal, compared to the book value of a much newer fleet (eg. Mercator Lines). It is highly likely that some of the older vessels are being carried at minimal value (since their age exceeds 30, there is only drydocking left to depreciate), despite their ability to generate income. At about 1.2X book, we think that the stock is rather cheap.

While most other shippers were attempting to slash their fleet and cancel newly-build contracts, Courage Marine managed to capitalise on the shipping downturn by purchasing several vessels at fire-sale prices (old ones, of course). The low prices paid mean that the company requires little debt (most vessels are funded by internal resources), and even allows the company the flexibility to scrap vessels when steel prices rise (the company scrapped a capesize vessel for a quick profit of US$400,000 in just a little over a month).  

The company has paid out a healthy stream of dividends since its IPO, and even paid out a US$0.00472 dividend for 2009, a year where the company barely broke even. We anticipate that if shipping rates see a rebound, it will not be surprising if the company is able to fund a dividend in excess of 10% (based on our purchase price).