Model Portfolio teriksen:ESVF

The shares closed today (August 4th) at under $10, which I feel is under valuing the business. I try to look at the business a couple of different ways.

Liquidation Value

Not that I think they would liquidate the company by selling off all the vessels, it is helpful to know what the ships would be worth on the market. Based on their purchase prices and recent sales that I have seen, I value their eleven vessels at just over $800 million. If I add back cash of $40 million and subtract debt of 213 million it leaves a residual value of about $628 million, or about $12.75 per share. They have agreed to buy two additional vessels, which I will assume are at market prices. So under this scenario, buying at $10 gives me a decent margin of safety.

Operating Value

Dry bulk shippers have only traded in U.S. markets for a few years. Share prices have been quite volatile, which is understandable because shipping rates have fluctuated widely. One can easily see this by looking at the BDI shipping index available at Bloomberg.com. The index started 2007 around 4,400. It peaked at just over 11,000 in November of 2007. By January of 2008 it had fallen under 5,700, only to rebound to above 11,000 in May and June. It has since fallen again, and is currently at 8,280.

The reason for the volatility is usually attributed to general economic conditions, and issues related to China slowing imports during price negotiations and possibly during the Olympics. I will admit I have no idea which direction the index will go in the short or long run. Thee are just too many factors to predict accurately. What I do know is that the general economic conditions will eventually change. Since Star Bulk has mostly fixed charters, I have time to wait.

Star Bulk currently pays a 35 cent quarterly dividend, for a yield of 14%. I estimate cash flow at $0.50 per share in Q2, and climbing to over $0.70 per quarter in Q4 as two new vessels are delivered. So the dividend is well covered. Starting in the summer of 2009, cash flow will depend on what rates they get as some of their existing charters near expiration. Since most of their charters are at below market rates it is unlikely that they will be lower, but you never know.

I try to be conservative in my future assumptions. Dryships has a nice chart that shows current charter rates for dry bulk ships for various terms of six months to five years. This allows me to calculate what future predicted rates are for future years. For example, for Capesize vessels, it results in year one rates of $170,000 per day; year two of $100,000 per day; year three of $75,000 per day, and years four and five at $40,000 per day. This gives me a figure to use for future years once the current charters expire. In theory, Star Bulk could charter those future years now.

Using those figures still results in solid cash flow in excess of the dividend until about the fourth year out when rates are much lower. Does this mean there is long-term risk? Probably, but the overall risk is reduced by the cash flow between now and then. Projected free cash flow (net income plus depreciation) between Q2 2008 and Q2 2011 is just over $8.50 per share. That is nearly equal to today’s purchase price of $10.

So I’m adding to my position at these prices, with a current sell target of $13 to $15 per share. If prices fall further I may also buy their warrants (SBLKW) which give holders the right to buy at $8 per share before December 2009, but do not participate in any dividends.