Star Bulk Carriers (NASDAQ: SBLK) shares are up 30% since management reported first-quarter 2019 earnings in late May. With the company expanding its fleet and working quickly to install emissions equipment, is this run a sign that the future is starting to brighten and there's more upside to come? Or is Star Bulk's swift advance fully pricing in the good news management talked about on its first-quarter conference call?
A good end to the year
In late May, Star Bulk Carriers CEO Petros Pappas stated during the first-quarter conference call that "we remain optimistic for the end of the year and expect that the combination of lower supply and recovering demand is likely [to] surprise to the upside." Further, in the company's earnings release, Pappas noted that "we expect 2020 to be a more profitable year." Since that point, the stock has rallied strongly.
Image source: Getty Images.
Meanwhile, the company also agreed to acquire another 11 dry bulk ships. That will bring its fleet up to 120, with offerings across various ship sizes. In this way, it looks like Star Bulk is expanding its fleet in an effort to take advantage of the better days it sees ahead.
Management has also been working to get ahead of environmental regulations, installing scrubbers on its ships that limit dangerous emissions. These ships are expected to be in high demand because of their cleaner environmental footprint.
However, the really interesting thing here is that Star Bulk is working fast to get this project done. It wants to have its entire fleet fitted by January of 2020 so it doesn't have to pull any ships out of service during what it expects to be a good year. To achieve this, it has brought forward planned ship maintenance from 2020 into 2019 and even started some of the work at sea to speed up the process. Notably, financing for the cost of these upgrades has already been secured.
The first quarter is a seasonally weak period, and the company's financial results weren't great. It lost $0.09 per share compared to an $0.18 profit the year before. But that's not a shocking outcome, given the purposefully increased maintenance effort during a seasonally weak quarter. Investors, who have pushed the shares up sharply, have clearly given the company a pass and are focusing more on the future.
Supply and demand
Star Bulk runs most of its fleet at spot rates, so it takes whatever the going price is at the time its ships get booked. This is both good and bad. The good side of the story is that demand and charter rates can move swiftly, so when the industry is really hopping, Star Bulk gets to take advantage of the upside very quickly. If it locked in rates with long-term charters, its results would trail behind the uptick even though revenues and earnings would be smoother over time.
On the negative side, its revenues and earnings can be volatile because shipping rates and demand can move swiftly to the downside just as they can move swiftly to the upside. Essentially, buying Star Bulk is a bet that the bulk shipping market will, indeed, improve as CEO Pappas is expecting.
This, however, isn't a given. At this point, industry watchers are expecting demand to be decent in 2020 and new ship construction to be modest by historical standards. That clearly supports the company's aggressive moves to prepare early for a strong year next year. But demand for the products that dry bulk carriers move around the world is economically sensitive. Essentially, slowing world economies would lead to less demand and, likely, weak spot prices.
The problem here is that there are clear signs that the world is, indeed, slowing. China recently reported its slowest growth rate in decades. Europe's growth has also been languishing at low levels. And while the United States is showing relatively strong growth at the moment, the current expansion is among the longest in history, and the Federal Reserve is now talking about the need for reducing rates to help keep the party going. Even if a recession, local or global, is avoided for a little bit, there are troubling economic signs out there.
With this as a backdrop, the question to ask yourself is "How confident am I that Star Bulk's outlook is spot on?" If this highly cyclical industry gets blindsided by a global economic slowdown, the company's effort to bulk up for a strong 2020 could actually turn into a painful hit. And its focus on the spot market will ensure the pain is swift.
For risk-takers only
Investors are clearly excited by what they are seeing at Star Bulk and in the bulk market. If the company's expectations play out, the 30% advance since first-quarter earnings could be just the start of a very good run. However, if the economic outlook isn't as good as expected, the company could end up running headlong into a wall. Unless you have a very strong conviction about the future, economically speaking, you should probably stay on shore and let others jump aboard Star Bulk Carriers. In other words, most investors should avoid this stock.
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