Fool.co.uk - Investments

It's the end of everything we know. The world economy has collapsed and will never recover. Banks have given up lending completely. World trade has been abandoned. It's time to stock up on tinned beans, buy a gun and start digging a shelter in the back garden.

However if, like me, you don't subscribe to that view of the world then there are bargains around that investors may never see again.

I wrote recently about private investors' tendency to lose money by buying high and selling low. One such company that fits that profile is Hellenic Shipping (LSE: HCL). Hellenic's business model is very simple; it owns dry bulk ships and charters them out. These are the large Supramax and Panamax vessels which carry wheat, iron ore and coal around the world. Hellenic now has six vessels with a total freight carrying capacity of 372,000 tonnes.

Twelve months ago Hellenic was riding high on the boom in shipping rates, as world trade surged on the back of insatiable Chinese demand for raw materials. The Baltic Exchange Dry Index (BDI), a measure of spot shipping rates, increased five-fold to over 11,600 in the space of just a few years. Taking advantage of investor appetite for the sector, Hellenic floated in November 2007 at 212 pence.

You'd have to have spent the last year in a monastery not to know what happened next.

As evidence of economic woes mounted, world trade and charter rates collapsed. In the space of six months the BDI plummeted by over 90 per cent to below 1,000. Hellenic's share price was crucified, falling in just three months to 55p. Six (Stockholm: ECOVB.ST - news) months later it's still just 59 pence.

Investors would be mad to touch such a basket case now, surely?

The investment case

Remember the objective is to buy companies when their prices are low.

Eventually world trade will recover and with it freight rates. In the good times, just last year, Hellenic achieved underlying earnings of 66 pence per share. That equates to a historic price earnings ratio of less than 1.

Indeed unnoticed to most investors, freight rates have already started to improve. The BDI has crept back to 3,700. It's too early to say this is a sustained recovery but confidence it at least returning to the sector.

Cashflow and debt

The major issue in any recovery situation is whether the company can survive to the good times. At the end of December 2008, Hellenic had net bank debt of US$92.9 million. That's significantly greater than its market capitalisation of US$44.5 million. Clearly the market has some concerns.

However, it's no way near as bad as it looks. Payment on Hellenic's bank loans of $147.5 million are staggered until 2015 with annual debt payments in 2009 of $21.1 million, falling to $18.0 million in 2010 and $12.8 million per annum thereafter. Offsetting these loans is $54.6 million of cash which, in an emergency, could cover loan repayments for at least three years.

However, that really won't be necessary. Hellenic has very strong cashflow. The biggest cost Hellenic incurs is the depreciation on its ships, which is a non cashflow item. Unless Hellenic buys additional ships (unlikely in the current environment), it incurs little capital expenditure. It also carries little working capital and, due to its residency in Jersey, pays no tax. In 2008 net cash generated (before acquisition of new ships) was an impressive 129 per cent of profits.

Brokers 'seem' to be forecasting profits of around $13.4 million in 2009 and $6.0 million in 2010. I estimate that this equates to cashflow of nearly $50 million in the next two years (since depreciation should be around $15 million a year). That's easily enough to cover loan repayments and will more than halve current net debt.

Visibility of earnings

What underpins all of this is Hellenic's visibility of earnings. Hellenic prudently took advantage of high freight rates last year to lock in the rates on a number of vessels. Charters on two of Hellenic's six vessels run into 2011, with another two well into 2010. It's not hard to find out how much Hellenic are getting for their vessels; they publish updates on a regular basis.

As a result, baring any catastrophe, Hellenic's forecast earnings are pretty well guaranteed for 2009 and 2010. Indeed the 2010 forecasts look particularly conservative and, with three of its six ships still on existing charter rates then, I'd expect a similar outturn to 2009. That would put Hellenic on a prospective price earnings ratio of under four for the next two years.

Even though the World Bank is forecasting a return to robust growth in world trade in 2011, I don't expect Hellenic to repeat their 2008 earnings per share of 66 pence. However it's entirely possible for them to achieve at least 30 pence a share. With much of its bank debt repaid, or covered by cash, a highly cash generative business like Hellenic would look an absolute steal on a price earnings ratio of 2.

Risk

Hellenic is not without risk. Chief Executive and cousin to the Greek president, Fotini Karamanlis, owns 70 per cent of the Company with her brother. The shares are illiquid, poorly followed and hard to trade. The recovery in world trade may take longer than even the World Bank is expecting. So I'm not betting the house.

Steve owns shares in Hellenic Carriers