I first bought into this company in June 2006 when the share price was hovering at RM2.00 – 2.10 (pre-bonus basis). Adjusted for bonus issue, I believe it works out to be less than RM1.70 per share.

Maybulk share price has had a nice run throughout 2007 reaching a high of over RM5.00. It started tanking at the end of 2007, hitting a low of RM2.06 in December 2008.

Dividends
In just the last 2 years, I’ve collected RM0.78 worth of dividends… and most of it has been tax free.

Sep-08  Interim Dividend of 10 sen
May-08 Final Dividend of 30 sen
Sep-07  Interim Dividend of 8 sen
May-07 Special Dividend of 18 sen
May-07 Final Dividend of 12 sen

Needless to say I was happy with the company’s management.

So in September 2008 when Maybulk dropped to RM3.00, I decided to add a few more shares to my holding.

A couple of days later on 15 Sep 08, Maybulk announced that it was looking to fork out between RM517 million to RM862 million to invest in a company called PACC Offshore Services Holdings Pte Ltd (or POSH). Maybulk would buy a 22% interest from Pacific Carriers Limited, its own mother company.

SHOCK HORROR!!! I had completely no idea this was coming.

Since then I’ve been looking for an opportunity to sell some of my Maybulk shares. I finally sold some shares at RM2.73 yesterday.

Is Maybulk a Good Company?
I have no doubt that Maybulk has top management in running a dry bulk shipping business. After all that is why I bought Maybulk shares.

Furthermore their acumen in buying and selling ships is exceptional to say the least. But I must say I’m not keen on the POSH acquisition at all. Here’s why:

1. It is a purchase of a minority stake – only 22%. It is not a 100% controlling interest and Maybulk does not have access to POSH’s cash flow.

2. Management never foreshadowed such a large investment in its previous reports. It’s a nasty surprise.

3. From what I read, POSH has quite a bit of borrowings. Furthermore the capital expenditure requirements could be high. An article in The Edge reported of unhappy minority shareholders who helped to shed some light on POSH’s high borrowings and capex obligations.
 
4. Cash is King. Consider the opportunity cost. I’m sure you’ll agree that RM800 million is a lot of money in such times. There’s no shortage of what you can buy now. Now that the Baltic Dry Index is low, why not buy more dry bulk tankers at distressed prices? This is really why I bought Maybulk shares in the first place. If I want oil & gas sector exposure, I’d certainly be buying some other share and not Maybulk. Even if no suitable investment opportunity is found, I would have preferred if Maybulk continues to pay 25-30 sen dividend every year which it could well afford to do for many years even in this distressed environment. This would make it a very enviable company which stands out from the crowd. Management would look very smart to me because it shows they are concerned about capital management and removing excess cash from the balance sheet.

5. Related Party Transaction – Any concerned investor cannot help but wonder what is really driving this deal?

So I’m somewhat surprised when TheEdge included Maybulk as one of its’ 20 stock picks for 2009! It quoted a report by OSK Research:

“Considering the acquisition and lower earnings, OSK Research believes Maybulk could still afford to maintain a dividend yield (based on its share price of RM2.31) – a return that is substantially higher than fixed deposit. Furthermore, the 22% stake in POSH, a provider of offshore support vessel services for the oil and gas industry, could be a re-rating catalyst for Maybulk’s share price in the future”

Hmmm… I’m glad there are some eternal optimists around.

For now I’d be happy to offload more shares if it does run up again.

Remembering Warren Buffett in this Lesson
As I thought about my little loss on this investment, some of Warren Buffett’s investment tenets came to mind. Buffett applies three tenets about a company’s management:
1. Rationality
2. Candor
3. Resisting the Institutional Imperative

The third point is the one that struck me. It refers to the lemming-like behaviour of managers to blow large amounts on acquisitions because everyone else is doing it and the market is demanding it.

If a company generates high returns, management has a duty to reinvest those earnings back into the business for the benefit of shareholders. If the money cannot be reinvested at such high rates of return, it has 3 options:

1. Ignore the problem and continue to re-invest at lower returns
2. Buy growth (acquisitions)
3. Return the money to shareholders, who then have a chance to re-invest the money elsewhere at higher rates.

In Buffett’s mind, only one choice is rational and that is option 3.

As we attempt to assess a company’s management, the decision made at this crossroad provides us with a good clue. The choice management makes will prove either valuable or disappointing for shareholders long before the results appear in an annual report.

The Baltic Dry Index is a price index compiled by the Baltic Exchange in London. Each working day, the Baltic Exchange canvasses hundreds of brokers around the world for prices to move dry bulk cargo, for example iron ore, coal, copper and grain (there are 26 such items). The prices are then combined to form the Baltic Dry Index (BDI), which appears in shipping publications such as Lloyd’s List.

I’ve come to learn that the BDI is an excellent indicator for economic growth and production.

Why?

BDI doesn’t deal with container ships carrying finished goods.

It deals with the precursors to production – ships carrying iron ore, building materials, cement and coal … raw materials so to speak.

If shipping rates for dry bulk are low (as they are now), it means less cargo is being moved around. We are in for declining global production.

Check out the BDI chart below.

(Source: Bloomberg, click picture to enlarge)

See the spectacular rally from 2006-08? The index peaked at just under 12,000 points.

To give you a feel, the cost of chartering a Capsize bulk carrier was around US$235k per day in May 2008. Now it is less than US$10k!

Up until 2008, China was importing huge amounts of raw materials and churning out exports.

But now the world’s factory is in trouble. Raw material imports have collapsed as a result, and so have shipping rates for dry bulk.

When will the Baltic Dry Index Recover?
The shipping industry relies heavily on Letters of Credit (LC). As liquidity tightened worldwide, so has the issuance of LCs. To cope with this, the market is beginning to see an emergence in export credit (exporter issues a loan to the buyer via export credit agency).

But this will not make much difference to global trade because Export Credits are risky for exporters compared with the traditional LC.

The deflation in commodity prices is now causing companies to use up existing raw material inventories rather than replenishing stocks. Why buy today when it will be cheaper tomorrow?

Eventually inventories will run low and factories will replenish.

As this happens and as global credit markets unlock, we will see stabilization and a marginal recovery in shipping costs.

But is unlikely we will see the Baltic Dry Index anywhere near its peak in the near future.

BDI is Highly Responsive to Shipping Demand
The supply of bulk cargo ships is tight and inelastic – it takes two years to build a new ship. A demand increase can push the index higher quickly. Even more so, significant increases in demand can push the index sharply higher. That was pretty much what happened between 2006 and 2008.

Furthermore ships are not taken out of circulation during slow periods (due to the high cost of docking). A drop in cargo rates does not change the number of ships in operation.

Even a slight change in the demand for dry bulk shipping results in a significant change in the BDI.

BULL or BEAR? Look to the Baltic Dry Index
I don’t know why they don’t teach BDI in economics. It could have saved me a lot of money!

If you’re looking for a clear indication of a market bottom, forget about GDP, Unemployment, Inflation etc. Just this morning we hear of US unemployment reaching 7%. There are still massive layoffs so don’t be surprised if it trends higher. Bottom line is that all the major economic indicators are backward-looking.

If you want a forward-looking indicator to know when business earnings will trend higher, look for the Baltic Dry Index to start trending noticeably higher. I suspect it will be quite a while yet.

Unlike the stock market, the BDI does not have any speculative element. People don’t book cargo ships unless they have cargo to move. Furthermore BDI is not a “tradable” index and that makes it devoid of any speculative element.

The BDI reached its record high of 11,793 points on 20 May 2008. Just 6 months later in Dec 2008, it had dropped to 663 points (down 94%). Current rates are cutting close to operating costs (vessel, fuel, and crew). But it does look to have stabilized at 700 – 800 points.

I have included the Baltic Dry Index in our Indices page.