Thursday, 21 April 2016

Algoma Central vs. the Rest of the Commodity Complex

Most of my recent posts have been observational in nature.  I'm not finding much to do in terms of opportunities, but there is plenty to observe and remark on.

Quick thoughts on Algoma Central as I don't have much time this morning.  They operate a fleet of Great Lakes  / St. Lawrence, and ocean waterway bulk & product carriers.  Their largest segment is dry bulk.  They also have a commercial real estate arm which they are looking to sell.

Here are a few slides from the Q3 conference call illustrating what they do in a nutshell:

They are highly commodity sensitive.  Viz:

On the subject of the Real Estate holdings, from the Annual Report:

The real estate is shown as discontinued operations on the balance sheet, as follows:

If (and I say if with a warning that I have not analyzed the real estate segment beyond reading the annual report), the real estate net operating income is close to $11.96M, and I assume a 10% cap rate, I'd get $120M.  10% is pretty high for a cap rate, considering that other publicly traded REIT's use between 6% and 8% to fair value their properties.  Let's be ultra conservative and assume that $82M as reflected in discontinued operations is the best they're going to get.

On a liquidation basis, cash of $210M + assumed net proceeds of real estate of say $72M = $282M vs. total liabilities of $308M before collecting any receivables.

Here's the recent performance of the equity over the last year:

And here's the performance of Teck Cominco over the same period as a proxy for the iron ore complex as it has recovered from the February lows.

(Side note, Algoma may (or may not) have exposure to Teck Cominco directly in terms of dry bulk shipping)

My overall observation: one of the biggest producers of the products Algoma has the most exposure to in terms of shipping has rallied 250% off of it's February lows while Algoma hasn't budged.  And these same producers whether Teck, or BHP, or Vale are massively indebted and are anything but safe!  Teck is levered up 2:1, BHP 1.33:1, Vale almost 3:1.

So I'm left wondering what's going on.  Surely, if there was any hope of an actual sustainable recovery in the commodity markets themselves which the equities of the most levered up producers are already reflecting, shouldn't some of this euphoria trickle down to bulk shippers such as Algoma?

Obviously, this analysis is simplistic, because I haven't researched the economics of dry bulk shipping in depth.  Perhaps the answer is, dry bulk shipping is fiercely competitive and lease rates among shippers competing for bulk load haven't shown any signs of rebounding.

Concluding Thoughts

I believe that Algoma seems like a less risky proposition for consideration than exposure to the equities of the producers themselves which have already had huge moves off of their February lows. My guess is that this a function of too much money chasing the same trade, and the easy money has already been made.  In the case of Algoma, the company has a series of 6% convertible debentures due March 2018 which trade at par, which comprise about 30% of overall debt, and which the company should have little trouble redeeming at maturity.  The strike price on the debentures is $15.40 vs. $12.60 currently, so if  any recovery in the commodity complex does flow through to Algoma, at par you're basically paying nothing for the imbedded out of the money call.

As far as the rest of the commodity complex goes, it will be interesting to see what happens for the rest of the year.

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