Genco Shipping & Trading Ltd (GNK). Dry bulk cargoes have continuously increased including commodities like iron ore, coal, grain, and other materials, would this be the best time to consider shipping companies in our portfolio?
Genco Shipping Value Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.
Genco Shipping Investment in Enterprise Value
The concept of enterprise value is to arrive at a cost to purchase the entire business. In other words, the Enterprise Value (EV) is the present value of the entire company. Market capitalization, on the other hand, is the total value of the company’s equity shares. In essence, EV is the company’s theoretical takeover price, since the buyer would have to buy all of the stock and pay off existing debt and take all any remaining cash.
The market capitalization was erratic in movement. The total debt was 86 percent of the enterprise value, while its cash and cash equivalent were 10 percent. As a result, enterprise value was greater by 76 percent against the market capitalization. Let’s say you are the investor, you would be paying 24 percent of the equity and 76 percent of its total debt if you decided to buy the entire company of Genco Shipping & Trading Limited.
As additional information, the takeover price of Genco Shipping and Trading Ltd to date April 23, 2013, would be $1.5 billion at $36.21 per share. The market price to date was $1.59 per share.Genco Shipping was too leveraged.
Benjamin Graham Stock Test
Net Current Asset Value (NCAV) Approach
Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. Graham reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20 percent. An outside study showed that from 1970 to 1983, an investor could have earned an average return of 29.4 percent by purchasing stocks that fulfilled Graham’s requirement and holding them for one year.
Net Current Asset Value (NCAV) Method
Benjamin Graham’s Net Current Asset Value (NCAV) method is well known in the value investing community. Studies have all shown that the Net Current Asset Value (NCAV) method of selecting stocks has outperformed the market significantly.
The reason for this according to Graham is when a stock is trading below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value and therefore, the stock was trading at a bargain and worth buying.
The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value.
The net current value approach of Benjamin Graham indicates that the stock price of Genco Shipping was overvalued from 2008 up to the trailing twelve months because the stock is trading above the liquidation value of the company. The 66 percent ratio represents only 18 percent of the market price. It indicates that the stock of GNK has not passed the stock test by Benjamin Graham because the price was expensive.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
Another approach by Benjamin Graham is by calculating market capitalization over the net current asset value of the company. The result should be less than 1.2 ratios. Graham will only buy if the ratio does not exceed 1.2 ratios.
Market Capitalization / NCAV = Result (must be lesser than 1.2)
Further, the MC/NCAV approach of Benjamin Graham tells us that the stock of Genco Shipping is overvalued because the ratio exceeded the 1.2 ratios of 2008 up to the trailing twelve months. Therefore, the stock did not pass the stock test by Benjamin Graham and is not a good candidate for Buy.
Benjamin Graham’s Margin of Safety (MOS)
The basic meaning of “Margin of Safety” is that investors should only purchase security when it is available at a discount to its underlying intrinsic value or what the business would be worth if it were sold today. It requires knowing when the buying price is low in absolute terms, rather than merely relative to the market as a whole. This formula is measured by the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between these two values is called the margin of safety.
Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.
Using the formula Margin of Safety = Enterprise Value – Intrinsic Value
The result of the calculation of margin of safety was 36 percent average of 2008. The average did not pass the requirement of Benjamin Graham of at least 40 percent below the true value of the stock. The intrinsic value was $84.96 average while the enterprise value was $48.37 average.
Going forward, the formula for intrinsic value was:
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The explanation in the calculation of intrinsic value was as follows:
- EPS: the company’s last 12-month earnings per share;
- G: the company’s long- term (five years) sustainable growth estimate;
- 9: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but we changed it to 9); and
- 2: the average yield on high-grade corporate bonds.
The table above for intrinsic value tells us that the average earnings per share were $0.94, while the sustainable growth rate was 0.60 percent. In addition, the annual growth rate was 10 percent average.
The earning per share represents the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock.
The formula for earning per share was:
Sustainable Growth Rate
Sustainable growth rate (SGR) shows how fast a company can grow by using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know the dividends paid. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.
Sustainable growth rate = ROE x (1 – dividend-payout ratio)
As shown above that the average return on equity was 3.42 percent. The average payout ratio was 23 percent. Genco Shipping paid its dividends in 2008. A zero payout ratio the succeeding periods up to the trailing twelve months.
Return on Equity
Return on equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates.
Another way of calculating the sustainable growth rate. This is by using the average approach. The average approach takes into consideration the prior period’s performance of the company. Comparing the results using these two approaches the results presented in the table below.
By using the relative approach, the result of the margin of safety was higher, than by using the average approach. Because the margin of safety in 2007 was zero percent, it takes into consideration the prior periods performance.
As we can see, the intrinsic value line was erratic in movement, ups, and down trends from 2008 to the ttm. While the enterprise value remains stable in its movements at an average rate of 2 percent. In 2009, the intrinsic value soared up high at a rate of 764 percent, then it dropped by -96 percent to 2011, then went up a little again then another down.
Genco Shipping Relative Valuation Methods
The core concept of relative valuation methods for valuing a stock is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.
Price to Earnings/Earning Per Share (P/E*EPS)
The stock price of Genco Shipping was overvalued because the P/E/EPS ratio was lesser than the price. The ratio represents only 22 percent of the price. Further, it indicates that the stock price of GNK was expensive using the P/E*EPS method.
Walking forward, there is another way of calculating this metric and that is by using the average approach.
The Enterprise Value (EV) /Earning Per Share (EPS) or (EV/EPS)
The use of this ratio is, to separate price and earnings in the enterprise value. This metric will tells us the the price (P/E) and the difference represents the earnings (EPS).
The EV/EPS method tells us that the price (P/E) that was separated from the price was 31 percent and the earnings (EPS) was a 69 percent average. The result of this method is either over or undervalued. It depends on upon the analyst’s own discretion. This is the price that the investor is willing to pay in buying the stock of Genco Shipping.
Enterprise Value (EV) / Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings. This metric is useful for analyzing and comparing profitability between companies and industries. It tells us how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.
It will take 12 years to cover the costs of buying the entire business of Genco Shipping. In other words, it will take 12 times of the cash earnings of the company to recover the purchase price. It is used to measure the profitability of the company. Twelve years to generate cash to cover the costs is a long period of waiting.
The stock price was overvalued and there was no margin of safety. Therefore, I recommend a HOLD on the stock of Genco Shipping and Trading Ltd.
Research and Written by Cris