30 July 2011

Placing Our Dry-Bulk Shipping Universe Under Review:

We have decided to place our fair value estimates for our dry-bulk shipping coverage universe under review as a result of weaker-than-expected freight rates throughout the second quarter and our expectations that market fundamentals will remain soft for an extended period. We think cash flow generation will eventually come under pressure for each of these companies due to the various levels of exposure to the weakened dry-bulk market. As such, we expect material fair value changes to Excel Maritime EXM, Genco GNK, and Eagle Bulk EGLE due to their significant fleet exposure to the spot market. Although we still believe Diana Shipping DSX and Navios NM are well-positioned for prolonged weakness in shipping, we expect these two will also suffer, as EBITDA is eroded through upcoming contract expirations with charterers. Our long-term expectations generally remain positive, but we caution these firms' near-term profitability headwinds may pose increased risks to their ability to service their obligation schedules.

On Wednesday, Genco reported 2nd quarter results that came in slightly below our expectations, and we project downward revisions to our long-term freight rate assumptions for all asset classes, including Capesizes and Panamaxes, as we expect market fundamentals to remain weak for an extended period. For the three-month period ended June 30, 2011, the company posted voyage revenues of $88.6 million (excluding Baltic Trading), down 9.9% compared to the year prior, and consolidated operating margins of 32%, down from 52% in the second quarter of 2010. Net income attributable to Genco declined to $10.1 million, down 73% from the same period prior, resulting in diluted EPS of $0.29. Although consolidated revenue ($98.5 million) declined year-over-year and operating costs increased sequentially from managing a larger fleet, we're encouraged to see the firm remain cash flow positive and bolster its cash balance to $292.1 million (excluding Baltic Trading) over the second quarter. Additionally, the company took delivery of 2 new vessels over the period, leaving one final newbuild scheduled for delivery with minimal capex requirements.

During the conference call, we like the fact that management reiterated its focus on deleveraging the firm for the remainder of 2011. With the company's upcoming debt amortization schedule at about $19 million per quarter until June 2012, we think the firm's increased cash position calms any concern about potential liquidity constraints over the next several periods. Management also provided their outlook on industry fundamentals and sees a potential pickup in Japanese reconstruction to be a short-term catalyst to demand. Chinese steel production increased 9.2% year over year through the first half of 2011, and the China Iron & Steel Association raised its 2011 crude steel output to 700 million tons from their previous forecast of 660. We think China continues to be the key driver to iron ore and coal activity over the long run, with steady increases to steaming coal imports used for power generation in the emerging economy.

With regards to supply, we think slippages will continue to remain elevated (about 40% in the quarter) as ship owners face financing issues to take delivery of previously ordered vessels.

We think scrapping activity in the second half of 2011 will resemble that of the first half, due to low charter rates and high scrap steel prices extending into 2012.

Management noted that 13.5 million deadweight tons have been scrapped so far in 2011, compared to 5.7 million in all of 2010, and estimates that up to 100 Capesize vessels will be scrapped by the end of the year.

Still, we think overcapacity will continue to weigh heavily on freight rates for some time, and Genco expects it will take 12-18 months for a material recovery.

SourceToronto Star. By Paul Choi. 27 July 2011

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