8 Questions for John M. LeFrere

Marine Money president Matt McCleery caught up with veteran Wall Street pro and ship financier John LeFrere C.F.A. of Northampton Capital Ltd. for his take on the current mood on the street and what the savvy shipping company should be thinking and doing. John is on the Board of B+H Shipping and has worked on Wall Street for most of his professional career, where he arranged some of the first shipping equity, and high yield bond offerings, and restructurings. Today’s volatile environment gives him plenty of material to opine on.

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Rankings 2001

Marine Money’s 2001 Rankings Award Winners

Once again we bring you the industry’s only benchmark of a group of predominantly marine public companies. This year Marine Money Ranked 53 companies basis eight ratio and percentage tests (as opposed to 41 companies basis 5 tests for 2000) from data supplied in the 2001 results published in their respective annual reports taken directly from the Balance Sheet, Cash Flow Statement and Income Statement. The purpose of the Rankings is not to foretell the future so much as they are intended to benchmark the past so that one can make an initial investment or performance deci – sion from the result for the individual companies and to get a good overview of the public marine sector and its general attributes.

Any ranking of any subject or entity is fallible.Noteably even in this year’s Fortune 500, Enron finished in the top 10. Of course the Fortune 500 is a measure of size, not necessarily performance and basis their measurements, Enron was still big at the time they were measured. Ranking public marine companies on size simply makes no sense to us. Barring cruise companies, which are really “leisure” shares and offshore “oil service” companies (both of which appear in Rankings), shipping shares are marked by being small to mid-cap stocks with low to no share liquidity. Therefore the way to look at the companies is in an unweighted manner on performance alone.

WHAT WE DID

Below we describe the nuances of the criteria for the rankings but the scoring of the rankings is as follows: Each company had their balance sheet, income statement and cash flow statements tested, as appropriate, by current ratio, profit margin, turnover, return on equity, return on assets, debt to capitalization, debt cover and enterprise value/EBITDA. (See below for definitions of the tests.) The results were placed in an unweighted result rank amongst the 53 tested companies. Hence if a company had the 15th best ROE, then it got a rank of 15 on that item and so on for all eight calculations. The average of the 8 results was that company’s total result and where it placed in order in the 53 companies under its overall average was its final ranking.

WHAT WE LEARNED

Shipping has a long way to go before it can be considered sexy as a whole. In many respects the average result is not poor at all with the average company being a small to mid cap share that is quite liquid (in terms of cash, not share trade, see Shortcomings below) with healthy turnover and a reasonably low share valuation relative of course to the equity market as a whole. The profit margin, debt and returns are less interesting but all within acceptable, but modest, levels. Going into this exercise we expected this kind of result and it should surprise no one except no one has tried to quantify it this way before so it remains, to us, fascinating. The other result of this exercize was the determination that public marine companies from the perspective of reporting and transparency, as a whole and not naming individual companies, are a morass that needs a whole slew of housecleaning before the common investor ever takes it seriously as a viable, liquid share sector. The good companies are penalized because of this condition.

WHY TORM WON While all the top ten companies were given awards at Marine Money Week, there can be only one company in first place. D/S Torm, which has been in the news a lot this year, had a terrific 2001 and it placed in the top ten in six out of eight categories with top twenty results in the remaining two. This yielded a low average rank of 8.375 and it was the only company to have an average rank in the single digits. (See the below explanation of test definitions for an explanation of how the tests offset and compliment each other to understand the depth and scope of Torm’s, and the other top ten’s, victory.)

Does this mean that because Torm had a great 2001 in terms of ratio/percentage test performance that it is bound to have another good year? No. Past performance has little or nothing to do with future results. Yet from the perspective of looking at a company from an investor’s perspective, past performance is often the ice-breaker that allows an investment to move forward. Yes, buy-low, sell- high is the mantra, but good performance should be noted as well as good valuation and in terms of EV/EBITDA trailing, Torm too is a bargain.

Hence the results of the top ten should simply make one take a closer look at companies that were working on all cylinders last year and therefore may well be, now and in the future, doing the same and that one should go long on the shares…or maybe one feels that one or more of the top ten have peaked and should be shorted. For example, 2000′s rankings winner, Coflexip, finished in 45th place for 2001. No matter what you think of the future, the 2001 Rankings results for Torm and all of the top ten should be merely make one wake up and take note of the company now, for whatever reason.

SECTOR RESULTS

We looked at five major sectors of the shipping marine share genre – Offshore, Tanker, Cruise/Ferry, Liner and Multi-Service. Of course there are many ways to interpret where one company falls in the classification but we feel the classes have a wide range and are representative, in general, of the peers. The sectors breakdown as follows:

OFFSHORE: Seacor, Transocean, Oceaneering International, Gulfmark Offshore, Tidewater,

TANKER: Concordia, Maritrans, Tsakos Energy, Knightsbridge, Stelmar, OMI, General Maritime, Overseas Shipholding, Frontline, and Teekay.

CRUISE/FERRY: Royal Olympic, Royal Caribbean, P&O Princess, Gotland, Carnival, and Silja.

LINER: OOCL, Atlantic Container Lines, Wilh Wilhelmsen, CP Ships, Wan Hai, and Evergreen.

MULTI-SERVICE: Neptune Orient Lines, MC Shipping, Stolt Nielsen, Bergesen, Leif Hoegh, CMB, Seabulk, Premuda, Mitsui OSK, HMM and NYK Lines.

For the sector results, there too are few surprises. The dynamics of the different sectors will vary year on year and the Multi-Service sector is the most diverse filled with a number of unique entities. So ranking sectors, except for imaging purposes is little more than that.

Getting a snapshot of a given sector is telling however: The range between top and bottom in each individual category is significant but the overall result of each sector, except the Multi-Service, which is a new sector used as a descriptive device here, is remarkably close, even Liners.

THE FIRST HURDLES

Before we get to discussing the Ranking criterea themselves, it’s worth discussing briefly how a company gets ranked all.

. In order to be ranked, the company must have some sort of a public pulse. For example, Crowley is technically public, but virtually private and untraded and it therefore was not ranked.

A company must provide readable, audited Income, Cash Statements and Balance Sheets from the prior 12 months ending in December. It may be hard to believe but there are a number of companies, especially those who are outside of US GAAP (US GAAP, notwithstanding the recent accounting debacle in the US of late, are the most readable and organized in the world). For some major companies that will go unnamed it is like pulling teeth to find the statements and that is not right for a public company.

The company must be predominantly shipping/marine income based. For example, while we are good friends of Alexander & Baldwin, we did not rank them as large portions of their income are not at all related to their Matson operations.

If your company was not ranked this year, it is highly likely that it was due to the above basic criteria. If you feel a company should have been ranked that has not been, please provide the audited statements required

for 2002 at some point in spring next year and it will be ranked. Also if you feel we overlooked some obvious ones, please inform us and we will rectify them for next year.

RANKINGS TEST RANGE

The rankings tests were chosen somewhat arbitrarily. The first question was whether or not the test was relevant to an asset based public marine entity. We also tried to test the annual reports with a wide array of tests with the desired goal of yielding a result that was a statement on the overall performance and value of the company. We therefore tested liquidity (current ratio), activity (total assets turnover), profitability (profit margin, return on equity, return on assets) capitalization (debt to cap and debt cover) and value (enterprise value/EBITDA).

TEST DEFINITIONS

1. CURRENT RATIO: Current Ratio is calculated by dividing Current Assets by Current Liabilities. Everyone loves to look at the cash of a company but many forget to look at the current liabilities and in not doing so the cash position has no relevance. A result of over one is considered good especially if it is for a company that is facing tough market conditions.

One can argue that a high current ratio well over one for a company facing a very good market environment is not necessarily a good thing. Shareholders should be asking what the company is doing with its current ratio position in a strong market and should advocate its proactive use to enhance shareholder value either by a share buy-back, proactive acquisitions (always tough in a good market), levering up, or by granting a dividend.

Nevertheless, there has to be a winner and a loser so we rewarded a high current ratio with the higher rank without such a sub – jective sensitivity analysis on a company-by-company basis. The thought process here was that the other tests would offset any sensitivity discrepancies in the average result.

2. TOTAL ASSETS TURNOVER

Total Assets Turnover is a measure of activity and is calculated by dividing Net Sales (gross revenue less discounts or rebates) by Total Assets and is pr esented as a ratio. In general, like the current ratio, the higher the number, the better the result. Of course nuances exist whereby a company with a lot of new assets will have a worse result in this test than an equivalent company with similar but older assets trading in the same market at similar rates. Still, there has to be a winner and a loser and, again, the other tests neutralize the subjective arguments against this test as a stand-alone benchmark.

3. NET PROFIT MARGIN

This is probably the easiest measure for anyone to understand and it is calculated by dividing (Pretax) Net Income by Net Sales and presented as a percentage. The higher the number, higher the rank, cut and dry.

4 .RETURN ON EQUITY (ROE)

Return on equity is also cut and dry. It is calculated by (Pretax) Net Income by Total Stockholders’ Equity and presented as a percentage. The higher the number the higher the rank. Noteably, when ROE gets high enough, say 20% or more, competition is likely to be tempted to enter the market so too high a number can be considered a long-term “yellow (not red) flag”.

5. RETURN ON ASSETS
Return on assets is too cut and dry. It is calculated by (Pretax) Net Income by Total Assets and presented as a percentage. The higher the number the higher the rank. Like ROE above, the higher the ROA, the more incentive for competition to enter the mar – ket but this threshold is closer to10-15% for ROA before there is a reason to see a “yellow flag”.

6. . . DEBT TO CAPITALIZATION

“Debt to cap” is calculated by dividing Long- Term Debt by Long Term Debt PLUS Stockholders’ Equity, presented as a percentage and is intended to indicate the relative value of long-term debt as a percentage of perma – nent financing. Obviously, the LOWER the number here, the better the rank.

Yet this test is somewhat subjective and similar to the Current Ratio above in dynamic. If the market for a particular company is very good and it has a low Debt to Cap, the shareholder should ask what plans the company has to lever-up, if possible, to grow in the market for market share and to enhance shareholder value. Theoretically therefore, a company with a high Debt to Cap in a good market with a good profit margin and healthy returns could be penalized for a low Debt to Cap. However, the lower the number the better the better the rank for our purposes.

7. DEBT COVER

This test is presented as a ratio and is calculated by dividing (Pretax) Net Income by the Interest and Principal paid ondebt in the year by the company. This one again is subjective and there can be arguments made that a lower debt cover ratio result does not necessarily represent the inability of a company to pay its obligations. For our purposes, we reward the higher number here for its always better to earn more, net, than one has to pay down.

Noteably here, the numbers found on this subject matter for this test are the hardest to discern, company to company on average.

8. EV/EBITDA

Enterprise Value is defined as a companies’ market cap, plus its longterm debt, less its cash and is meant to express the hypothetical sale value of the company. EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization and is considered a good measure of net revenue against pure expenses that better represents the results of the assets than Net Income alone.

EV/EBITDA, which for our case was the current EV against the trailing 2001 EBITDA, is simply a measure of value of investment (this trailing method is unorthodox, we acknowledge, but it was applied uniformly so it’s a suitable benchmark). Essentially, if one is looking to buy into a company that has an EV/EBIT – DA of 2, then one must spend $2 for every $1 in earnings. This is a lot cheaper than a similar company that has an EV/EBITDA of 10 where one is paying $10 for every $1 in earnings. For our purposes, the lower the EV/EBITDA, the better the value, the higher the rank.

Of course this too is subjective. A low EV/EBIT – DA can be a symptom of a lack of liquidity in the shares and one may be very happy to pay a premium for shares that are trade-able (see Shortcomings below).

Yet, again, the rank in our case is offset and rewarded by good results in the other tests.

HOW THE TESTS WORK TOGETHER

Conceptually, its very simple: If a company has a high Current Ratio, a high Turnover, a high profit margin, high ROE and ROA, a low Debt to Cap, high Debt Cover and a low EV/EBITDA, from 2001 results, then it is highly likely that one should take a closer look at the company now as to its future prospects as well as rewarding the company for a job well done. Results in one or two areas alone will not be enough to win a high, winning, rank. It takes a very high standard of average score to rank well. Torm and the other top ten were able to do that.

SHORTCOMING: LIQUIDITY

One of the main shortcomings of 2001 Rankings and probably of future Marine Money Rankings is the lack of our ability to accurately measure the liquidity of each of these companies’ shares. In many cases the data is just not available for enough of them for there to be a ranking in this category.

This is unfortunate because if one could assess liquidity one could offset the EV/EBITDA result with the liquidity result thereby qualifying the liquidity premium and thus getting a more telling result in the average result.

This does not obviate the rankings result but one should take the rankings result and look at the liquidity of the respective companies’ shares before considering the final value of the company on a case-by-case basis. Rankings has opened the book on the recent past for you the reader. If it looks interesting, youshould did even deeper.

SHORTCOMING: COST OF CAPITAL

Another area where public marine companies should be ranked is against their Weighted Average Cost of Capital (WACC). As these companies are all marked by being owners of long-term assets, knowing their WACC would yield much as to their relative performance, especially sector against sector. Unfortunately, like share liquidity, this is a very difficult number to find for many companies. We do not blame those companies who do not reveal their WACC, it’s a trade secret that need not be revealed to the competition necessarily.

Yet in these times of increasing concerns about the transparency of the business practices of public companies and their boards, clearly stating the WACC in the annual report, if not the quarterlies, should be something that investors demand. Doing so could help transparency and therefore share liquidity much the same as Coca-Cola declaring their issued stock options as an expense in their upcoming filings. Companies do not have to, but they’ll see more benefit from being transparent than obviating an important fact.

Recently CP Ships stated publicly that it planned to lever up to lower its WACC below its Return on Capital Employed (ROCE). We applaud this as a goal and it should be the stated goal of every public marine entity. We assume we will see CP publish the results from its efforts.

FINAL THOUGHTS

We congratulate the winners of the top ten Marine Money Rankings 2001 Awards. The winners are top class companies as are many of the losers who simply had bad years’.

But in determining these awards we found that obtaining, in a timely and orderly manner, the information was cumbersome and when found the data was often poorly presented. That is our overall impression and it’s a pretty negative one, taken as a whole.

Public marine companies have often complained that they are undervalued and have no share liquidity.

This is mostly a function of the fact that the majority of public marine companies are small and in a niche industry that the common investor does not understand, even the institutional investor. There is little that can be done about this dynamic without changing a given company completely.

Individual marine companies do, on the other hand, have a great amount of control over their fate in the sector. If they want to remain public and become more share liquid, they must make their reporting better than the industry as a whole and to a world class standard. They must aggressively go out and attract liquidity (new investors via road shows) and they must coddle their current shareholders with rewards (buybacks, dividends, pro-active accretive acquisitions, and dare we say, earnings).

If these things are being aggressively done by companies and the shares remain trading at or below NAV (which is common in marine) then the shareholders and board should con – sider privatizing the company because being an undervalued public company perpetually is no good for the investors, the company or the industry as a whole – the latter being of least importance, rightfully so, to the company and its shareholders.

If, on the other hand, a public company is facing the share liquidity/trading below NAV problem and is not doing everything under its control to change the situation via transparency and shareholder rewards, then its management is inept or is asking to be bought out, nothing more.

Editor: Dog Days Never Last

Returning to southern Connecticut from a holiday in coastal northern Maine is simply brutal. From kayaking with seals and porpoises at arms length in 3 foot sparkling swells to 100 plus Fahrenheit on the heat index, humidity so oppressive that it’s a challenge to breath and a real world market, both shipping and otherwise, in such a flux, it makes one contemplate the value of the professional pursuit. Of course there is value, and also because just like these, as we Yanks like to say, are the “Dog Days of Summer”, they don’t last forever and often, they are over as quickly as they came..

Case in point may be the brutality of the equity markets on tanker equities over the last few weeks. While the US markets have been brutal to everyone this year and for much of last, tanker shares remained valued for most of this year at levels above their traditional valuations. A number of factors caused this including newly listed companies improving interest in the sector but the overriding one was not that these companies had good stories to tell, but that they were small to mid-cap shares that participated in a deeply cyclical market and thereby, so the theory goes, have some predictable elements which made them attractive in the current market against larger companies with no earnings, convoluted structures and no clear path to profitability or simply companies which were overvalued as virtually the entire S&P 500 was, and indeed is today. Continue Reading

Jefferies Finds Equity in New York

We hear the irritation all the time: “Investment banks aren’t interested in the middle market – and they won’t even look at deals less than $100 million.” So, where does that leave an industry like shipping, which needs to have access to the capital markets especially when commercial bank capacity shrinks? We imagine the question would warm the cockles of the people at Jefferies in New York.

In an era when many investment banks would fire their employees before helping smaller companies in mature industries raise money, maritime business is so important to Jefferies that shipping deals appear by name in the firm’s corporate annual report. In a time when “shipping equity” is considered an oxymoron, Jefferies has been on the cover of every public equity deal in recent memory and is now offering shipowners private equity through the $600 million Jefferies Capital Partners, formerly called FS Private Equity. And in a moment when firms are letting people go, Jefferies have added such maritime names as Roy Furman, as Vice Chairman, Jim Dowling, in private equity and Stephen Gengaro, in equity research.

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The Jones Act Ripple Effect: The Matson Project

The introduction of new tonnage into a Jones Act trade almost always creates a ripple effect that impacts other US-flag markets and sectors. The stone that caused the most recent ripple was thrown when Kvaerner Philadelphia Shipyard decided to build containerships without a buyer. This move resulted in Matson’s announcement last week that they had agreed to adopt the orphan ships, which, in turn, caused Seabulk to breathe a sigh of relief because Kvaerner didn’t build product tankers for competitors such as American Heavy Lift or Keystone.

Financing is never far from new ships, and the most recent ripple resulted in Caterpillar Financial Services closing a lucrative bridge loan for Kvaerner and either JP Morgan or Citibank probably being awarded a mandate to sell another $200 millions worth of Title XI bonds.

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Trust Us: The NYSE and Shipping Boards of Directors

By Matt McCleery with Nora Huvane, Marine Money Research

“‘Business Ethics’ does not have to be an oxymoron.”

Gretchen Morgenson, The New York Times

The bad news is that a crisis of confidence in Wall Street threatens the health of the global capital markets for years to come. Investors have lost faith in everything from analyst recommendations to audited financial statements to the credibility of company officers and directors. The damage could be huge. As we go to press, economic indicators tell us the United States economy is in a strong recovery but the stock market indices are steadily sinking to levels not seen in months. Poor valuations have halted capital formation, which has halted revenue growth and earnings. But the good news, at least for Marine Money readers, is that ship finance may benefit from it.

From opaque and off balance sheet energy trading at Enron to immature Internet technology, most of the flame-outs that have brought about the current market malaise have resulted from investors being unable to adequately understand the businesses they financed. Corporate deception was often enabled by investor inability to identify it.

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Freight Derivatives Trading and Value At Risk in Shipping

By Finn Dalheim

What is happening in the Freight Derivatives Markets?

Ocean freight derivatives markets are alive and growing, in spite of the closure of Enron Online and BIFFEX in 2001. A number of new participants have been coming into the market, and there is strong demand for freight derivatives traders. The main growth has been in OTC (Overthe-Counter) dry cargo swaps or FFAs (Forward Freight Agreements), but tanker swaps are catching up fast. At the end of 2001 Imarex (International Maritime Exchange ASA) launched its first tanker freight futures contracts. With solid backing from major players in the market, including ship owners and oil companies, Imarex is likely to show strong volume growth in both tanker and dry cargo futures during 2002. This will also be positive for the OTC market.

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Wasting Assets: Deteriorating VesselCondition in Shipping Finance

By Capt. Max Hardberger

One of the major factors in the success or failure of a shipowning enterprise is the physical condition of the vessel. But with the utilization of contract management in modern shipping, shipowners increasingly find themselves removed from their vessels. Even further removed are mortgagees, bondholders, or shareholders who have an interest in the vessel, but no ability actively to monitor—much less control—the ship’s day- to-day operations. Often, their grasp of the vessel’s condition, her trading market, and her asset value recede to the background as financial, corporate, and legal considerations take the foreground.

Consequences of Ignorance

The lack of current and accurate information on a ship’s condition and status often results in disastrous consequences for interest- holders. In one illustrative situation, the owner apparently plotted for about six months to abandon his ship, during which period the ship’s debts went unpaid. After the owner received US$500,000 in freight, he had the crew fake an engine room fire during the vessel’s departure from her load port. He then replaced the crew—who were necessary conspirators—with another crew of innocent Russians who knew nothing of the situation. The owner then disappeared with the freight money and the vessel’s profits from the previous six months. He left behind a ship at the end of her certificates, devoid of spares, in wretched condition, and with a trail of debts. The mortgagee was left holding a mortgage secured by a vessel without value. In fact, the vessel’s subsequent auction failed to generate enough money even to cover the court and custodial costs.

The sad truth is that such incidents are not uncommon. An interest-holder usually expresses disbelief after a loss due to vessel condition or mismanagement. He is often astounded to learn that a ship with full certificates and which has been recently trading can become worthless with such amazing speed. However, the warning signs were probably right before their eyes for months, had they known what to look for.

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Highlights From Freshly Minted

June 6th 2002

NIB CAPITAL SECURITIZING $670M IN SHIPPING DEBT

FM has not seen the marketing document and therefore we do not know all the details of the structure on a deal we originally reported on back in October ’01. What we do know is that it will be marketed in 5 classes with ratings ranging from Moody’s AAA, S&P AA+, to Moody’s Baa2 to S&P BBB. [Strong ratings for shipping debt, congratulations! - ED] It will be marketed outside the US to investors in collateralized debt, not targeting the traditional shipping investors, while not excluding them. Spreads will depend on the sale but will likely be along the lines of similarly rated debt and will not be priced at the traditional shipping industry discount. Continue Reading

Three Public Liners, Any Hints on the Cycle?

The fundamental adage of the stock market, indeed any market for that matter, is “buy low, sell high”. As all know in shipping, the liner industry is bogged down in a tremendous slump largely due to similar causes, but also by reasons caused by the individual management of the companies. In this article we take a look at three, primarily liner, companies on three different exchanges and at three different stages in their cycle. From the outset we are not trying to say that all three of these companies are undervalued, simply we are examining each so that one may be able to gain some perspective on liner share valuations. Simply, as the industry is at a low, where can one take advantage of such?

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