The Stalwart

Dryships, The Saga Continues

Apologies for those who find the subject of Dryships, well, rather dry. This is a follow on from the post "Never Enough Lessons on Forward PE". I basically added a comment on seeking alpha explaining what one starting point might be for valuing a highly cyclical, asset-heavy company like Dryships, and wanted to include it here at The Stalwart.

As for how might someone value dryships? Well let's think as if one were actually in the industry looking to expand your fleet. An industry player can either buy ships in the market or buy a company that owns ships. If you get far more ships for your buck buying DRYS than buying int he market, then I think that's a decent starting point, but we must be very careful since even dry bulk (and rig) asset prices can fluctuate quite substantially. Thinking from an industry buyer perspective would be simply thinking about the value of a dry bulk company as the actual players in the industry do. I promise you they don't forecast 1 year of earnings and then calculate a multiple. Wall street analysts frequently do, and companies put simple multiples in their investor presentations, but trust me actual shipping players don't make decisions like this. DRYS has rigs and bulk vessels, plus perhaps some additional value from its organization and customer relationships. But you would probably want to be getting DRYS at a price where you were getting its assets at a good discount to market prices, as this would give you some cushion. (these asset prices can fall, so good to have a margin of safety). Just don't forget that DRYS has a lot of debt, so you would want your adjusted NAV (adjusted to include a margin of safety vs. asset price declines) to be much higher than Enterprise Value (not market cap).

Again, I have never owned Dryships nor have been long or short the stock in any manner.

Never Enough Lessons on Forward PE

Never enough lessons on forward PE, especially for cyclicals. Today dry bulk shipper Dryships hit an all-time low of US$21.8, down from a peak of US$120, and down from the US$64 back when Barron's called the Buy on the stock. Everyone is wrong at times, and being wrong for decent reasons is fine. But in a previous post in April, we outlined that we mostly took issue with Barron's completely missing some of the most important issues with dry bulk commodities transportation stocks such as DRYS and worst of all arguing for the stock given a very low forward PE, which was completely ridiculous given that the bulk shipping industry is prone to earnings swings of +/-80% within short, unforeseeable periods of time. The below was our previous excerpt from Barron's:

Global trade might slow this year, but it will come back eventually, and DryShips' profits -- and shares -- should move up over the long term, even if 2008 growth turns out to be lower than Wall Street expects. At its recent quote of 64, DryShips stock was trading at a price/earnings ratio of 3.5 times consensus analyst earnings estimates of $18.18 a share this year and about 5 times the $12.22 forecast for 2009. DryShips also trades at a more than 50% discount to its peers, although rivals generally seek long-term contracts, which are less volatile.

And then our following criticism.

This article fails to mention that dry bulk spot rates are extremely volatile and forecasting where they will go is subject to massive room for estimation error, even for industry veterans. Thus forward PE can be very deceptive and is a silly way to look at the companies. Last year Clarksons research surveyed a large collection of readers to forecast where rates would go in 2007 and EVERYONE was wrong by a large margin. (they spiked massively) They can also spike massively downward in the same fashion... If forward earnings ends up being 80% lower, which historically isn't a crazy notion at all if you look at a rate chart, your PE will be 5x what you thought it was. Thus using forward PE is pretty silly given its forecast error range is so wide as to be near meaningless.

Well this post came under some fire from commenters on Seeking Alpha for either a) being written by an author looking to push the stock down (we wish we had that level of influence on The Stalwart) or b) not understanding that without earnings forecasts and resulting forward PE's, then there wasn't a way to make an investment case:

If you think "... using forward PE is pretty silly given its forecast error range is so wide as to be near meaningless" then you must think there is no meaningful way for an analyst that follows DRYS to do his job (to forecast earnings). THAT'S silly.

There are many tools for analyzing a company beyond just forecasting its next year's income. And for highly cyclical ones with little visibility forward earnings barely deserves to ever a tool, and is usually much more dangerous than useful.

DRYS is now at US$24, down massively due to, well, the fact that the Baltic Dry Index, which is an index for bulk shipping rates, has fallen from a peak of 11,500 just earlier this year to below 3,000 currently, for a 74% decline in just a few months. The rates for DRYS bulk ships have fallen in a roughly similar fashion. This dramatically changes the earnings forecasts of analysts across the board for 2009 and onward, though even these new earnings forecasts remain rubbish given the fact that rates are so volatile and for the most part"unforecastable" for dry bulk shipping. They could cut their earnings drastically, only to see a surprise rate rally in 2H09. Dryships 2009 earnings forecasts have dropped 25% already, though this to me looks timid given the drop in rates seen. DRYS is now at a 2009 PE of 2x, but again, if the current rate situation were fully reflected in analyst numbers would have to come down substantially further, as much as to say make the PE 15x or worse.

Now maybe DRYS is decent here, I haven't done a full analysis of the company's assets (at US$24 maybe the scrap value of its fleet could be enough to argue for value, potentially), nor intend to in this space. But the point is more about using forward earnings as a justification rather than whether buying DRYS at $64 was correct or not. At the very least, the Dryships debacle is another great example of forward PE's being undependable for this industry and many cycical industries. What's even more shocking is that some top-tier transport analysts use forward PE's when arguing for these types of stocks and some fund managers don't bat an eyelid upon hearing such justifications. Highly cyclical companies with low earnings visibility = companies where forward (forecast) PE is essentially meaningless.

A Loophole So Large, You Could Fly an Airbus Through It

Lots of leg room here. Due to use-it-or-lose-it rules for slots at Britain's Heathrow airport, it looks like the British airline bmi might fly empty "ghost-flights" rather than give up highly valuable Heathrow slots it owns.

Britain’s third-largest airline, bmi, will fly near-empty aircraft from this autumn to preserve multimillion-pound take-off and landing slots, The Times has learnt.

The rise in fuel prices and an expected slump in passenger numbers after the summer mean that many airlines will have to cancel flights, but bmi does not want to lose its coveted slots at Heathrow, which are valued at £770 million. ...

The decision by bmi to fly “ghost flights” - short-haul trips with only a handful of passengers - is one of a series of plans being drawn up by airlines. Senior industry figures admit that other carriers will cancel domestic flights at short notice and gave warning of chaos ahead for business travellers. Rather than withdrawing from uneconomic routes, the tactic of cancelling individual flights is another way of retaining landing slots. ...

Tim Bye, deputy chief executive of bmi, told The Times that his airline would prefer to cancel uneconomic flights, typically those in the middle of the day from London to the North of England and Scotland, but “we have to fly that service eight out of ten times”. Under “use-it-or-lose-it” rules that govern the allocation of the much-sought-after slots at Heathrow, airlines must use their scheduled slots 80 per cent of the time - or forfeit them. ...

Theresa Villiers, the Shadow Transport Secretary, said: “It is imperative that the system for running slots does nothing to push the airlines into flying empty planes. Besides damaging the environment, it makes absolutely no economic sense.”

Well, it probably does make economic sense for the airline, given that they are choosing to do it. Perhaps Heathrow's use-it-or-lose-it rules are more the problem. Rather than attack the airline, probably more constructive to review the rules. Or at least let them not fly and then just say they did...

Free* Flights: Just Pay For Gas

Other folks with more experience in the world of airline miles, rewards points and free flying may be able to speak to this better. But it seems that $140 oil has diminished the value of free trips for frequent flyers. Per Gary Leff, it seems that United is now charging a $25 per-flight surchage on domestic rewards flights. Anyone experienced this yet on United or another airline?

A Celebrity-Run Airline

Of course it's a European reality TV show. They love that stuff there, don't they? From the Guardian:

ITV2 is to launch its own celebrity-run airline for a reality show that will see 12 famous faces take on roles such as cabin crew and complaints handlers while real passengers pay to fly to destinations including Ibiza.

The eight-part series, which is being likened to a celebrity version of the ITV docusoap Airline, will see a plane chartered from an established airline and rebranded CelebAir, the name of the ITV2 series. CelebAir will have its own ticketing website and backroom operation.

It'd be cooler if the celebrities were in more mission-critical roles, like manning air traffic control, scheduling and stuff like that. It'd be great if they brought that show here, but it might hit too close to home.

The Great By-Products Of Aviation Regulation

In these times when everyone (rightly) bitches about the state of the domestic civil aviation industry, calls to bring back the glory days of airline regulation grow louder and louder. As bad as things have gotten, it's hard to see it happening, but who knows?

What did airline regulation bring us that was good? Higher prices, yes, but sustained profitability too! Oh and because there were very few opportunities to compete, companies competed on whose stewardesses dressed the sexiest.  But everyone knows that.

Anyway, cool piece in the WSJ about what KLM did to get around regulations that limited its ability to lavish gifts on first and business-class passengers back in the 70s. Apparently (and they still do this today) they got to giving out fancy, collectible bottles of booze in the shape of famous Dutch houses:

For 56 years, KLM has handed out a coveted souvenir: small ceramic replicas of historically significant houses filled with Dutch gin and topped with a cork. Many people can't get enough of them. The rarest houses -- given only to honeymooners -- can trade for upwards of $1,000.

"It's crazy the lengths we'll go to," says Ms. de Boer, a South African who has collected some 300 houses and displays them at home in a house-shaped cabinet. On her recent trip, she asked the flight attendant to start distributing houses near her seat, in hopes of getting first dibs.

Apparently some aren't so expensive, though I'm not totally confident about the authenticity of these eBay listings. But at least they give a good picture of what's for sale here.

So yeah, bring back regulation. No more competition on price and routes, but some hella cool bottles of gin.

 

Remind Me To Fly jetBlue As Much As Possible

Sitting in a Virgin America flight on the runway, listening to trippy music and seeing lots of purple. Fine enough, but getting through check-in was a total pain. Totally unlike the dedicated jetBlue terminal at JFK, which is almost* always a breeze.

Anyway, heading off to Los Angeles for work conference, and then to Omaha to check out Warren Buffett's Woodstock for capitalism courtesy of a Stalwart reader who hooked me up with a pass. Will be bloggering as much as possible, and when not doing that, also twittering (check me out).

I'll be in Omaha a couple extra days, so if there are any readers of The 'Wart who want to meet up, let me know. Any of you going to the event? Also, 'Wart readers in LA: shoot me an email.

Will be back in touch when I'm on the other side of the continent in just 5:27 according to the pilot.

Airline-In-A-Box!

The eternal misery of the aviation sector -- currently in full throttle -- is no accident. Despite the fact that running an airline might feel like a "heavy" industry of sorts, it's actually very easy for new entrants to attack the major players, and to establish an instant competitive advantage. Consider a few factors:

• Jet fuel is a huge cost of running an airline and large airlines don't have competitive advantage in sourcing jet fuel. Everyone pays the same pay.
• Upstart airlines can start with a young fleet that is cheaper to maintain than an old fleet.
• Upstart airlines can operate with a single kind of craft, again making it cheaper to maintain and source spare parts.

So once you get the capital formation part done, all you have to do is come up with a hook (TVs, more leg room, better food, etc.) and then pick a route or two (NYC-Miami, NYC-Peoria) and get going. Unless we return to a period of iron regulation, where new airlines are prohibited by law from competing, or we enter a new era of energy efficiency and planes that don't need repairs, then the cycle will continue.

Are you interested in starting a fleet? Should I start StalwartAir? That has a nice ring to it no? Anyway, as I ponder this big business move, I checked out an awesome resource from Boeing called StartupBoeing, a complete guide to starting an airline.

Starting an airline is tough.  Running a profitable airline is even tougher. From startup airlines to established industry leaders, the process involves constant learning and adaptation.                            

Few businesses have as many variables and challenges as airlines. They are capital-intensive. Competition is fierce. Airlines are fossil fuel dependent and often at the mercy of fuel price volatility. Operations are labor intensive and subject to government control and political influence. And a lot depends on the weather.

But the intrepid entrepreneur is not alone.  The StartupBoeing team assists entrepreneurs in launching new airlines. From concept through launch, StartupBoeing

offers guidance, review, analysis, data, resources, contacts, and referrals to qualified startup airlines.

Check it out. They offer guides on everything from market analysis, to plane selection and finding mapping tools. It's almost a turnkey, step-by-step guide to starting an airline, kind of like VeriSign's e-commerce store in a box.

That being said, I might choose to wait until energy prices come down a little bit. It's tough to make money when oil is at $115. Plane Buzz helps run the numbers:

Plugging the cost per gallon of jet fuel into a simple matrix that calculates the fuel burn of a commercial jet airliner is a simple matter. Then it becomes a exercise of masochism; how bad you want to make yourself feel?

Oil at $150 a barrel means jet fuel at ~$3.60 a gallon, and that means a 737 burns up almost $3,000 an hour for fuel alone. At an 80% load factor with 130 coach seats that means almost $30 per onboard passenger goes for fuel on a one hour flight. (Check my math; [5500 LBS/hour for a 737-300 x 6.84 gallons of jet fuel per pound = ~800 gallons/hour] x $3.60 = $2,880 / 104 passengers). Plug your own numbers in for your favorite aircraft, and adjust the fuel burn numbers for a longer average stage length if you'd like.

Using my simplistic model, outside of fares, a lot of things get smaller when oil gets that expensive; fewer short flights in a 737, fewer passengers (due both to higher fares and less service) flying on even fewer airlines, and the ATC and Airport Security problems diminish (there is a silver lining).

Play it forward - how high can the price of oil go? $150? $200? Higher? The absolute number doesn't really matter. The price of oil will be what the buyer is willing to pay and what speculator thinks it will be worth in the future. Oil price volatility is the new "re-regulation", forcing airlines to remove themselves from markets that don't make economic sense and presenting a significant barrier to entry to the industry for new carriers.

How Frontier Went Down

I was confused about this, but am no more... Felix Salmon explains how credit card holdbacks sunk Frontier Airlines last week, pushing, the CO-based operator into bankruptcy.

FYI

A Wikipedia List of airline mergers.