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Spring 2009 

 

 

Overseas Shipholding Group Inc.Equity Analysis and Valuation 

Analysis Team 

William Newland – william.newland@ttu.edu 

Kamil Bachleda – kamil.bachleda@ttu.edu 

Jonathan Farrell – jondavidfarrell@yahoo.com 

Michael Randell – michael.randell@ttu.edu 

Kirby Viktorin – kirby.a.viktorin@ttu.edu 

Steffen Schwartz – steffen.schwartz@ttu.edu 

 

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Table of Contents Executive Summary .......................................................................... 7

Business and Industry Analysis ...................................................... 15

Company Overview ........................................................................... 15

Industry Overview............................................................................. 16

Five Forces Model ............................................................................ 17

Rivalry Among Existing Firms ............................................................. 17

Industry Growth ............................................................................. 18

Concentration of Competitors .......................................................... 20

Differentiation ................................................................................ 21

Switching Costs .............................................................................. 22

Economies of Scale ........................................................................ 23

Fixed-Variable Costs ....................................................................... 23

Excess Capacity ............................................................................. 24

Exit Barriers ................................................................................... 26 

Threat of New Entrants ..................................................................... 26

First Mover Advantage .................................................................... 27

Distribution Access and Relationships ............................................... 27

Scale Economies ............................................................................ 28

Legal Barriers ................................................................................. 29 

Threat of Substitute Products ............................................................. 30

Relative Price and Performance ....................................................... 30

Customers’ Willingness to Switch ..................................................... 31 

Bargaining Power of Customers .......................................................... 31

Switching Costs .............................................................................. 32

Differentiation ................................................................................ 32

 

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Importance of Product for Costs and Quality .................................... 32

Number of Buyers .......................................................................... 33

Volume Per Buyer .......................................................................... 33 

Bargaining Power of Suppliers ............................................................ 34

Switching Costs .............................................................................. 34

Differentiation ................................................................................ 35

Importance for Costs and Quality .................................................... 36

Number and Volume of Suppliers ..................................................... 38

Key Success Factors ........................................................................ 40

Cost Leadership ................................................................................ 41

Economies of Scale and Scope ........................................................ 41

Efficient Production ........................................................................ 41

Lower Input Costs .......................................................................... 42

Little Research and Development ..................................................... 42

Differentiation .................................................................................. 43

Superior Product Quality ................................................................. 43

Superior Product Variety ................................................................. 43

Competitive Advantage Analysis ..................................................... 44

Economies of Scale and Scope ........................................................... 44

Lower Input Costs ............................................................................. 45

Superior Product Quality .................................................................... 46

Superior Product Variety .................................................................... 47

Accounting Analysis ......................................................................... 49

Key Accounting Policies ..................................................................... 50

Operating Leases ........................................................................... 50

Goodwill ........................................................................................ 52

 

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Hedging Activities ........................................................................... 56

Benefits and Pension Plan ............................................................... 58

Assess Degree of Potential Accounting Flexibility ................................. 61

Operating Leases ........................................................................... 62

Goodwill ........................................................................................ 63

Hedging Activities ........................................................................... 63

Benefits and Pension Plan ............................................................... 64

Evaluate Actual Accounting Strategy ................................................... 66

Operating Leases ........................................................................... 66

Goodwill ........................................................................................ 68

Hedging Activities ........................................................................... 68

Benefits and Pension Plan ............................................................... 69

Quality of Disclosure: Qualitative Analysis ........................................... 70

Type 1 Key Accounting Policies .......................................................... 70

Economies of Scale and Scope ........................................................ 70

Efficient Production ........................................................................ 71

Lower Input Costs .......................................................................... 72

Type 2 Key Accounting Policies .......................................................... 73

Operating Leases ........................................................................... 73

Goodwill ........................................................................................ 74

Hedging Activities ........................................................................... 74

Benefits and Pension Plan ............................................................... 75

Quality of Disclosure: Quantitative Analysis ......................................... 76

Sales Manipulation Diagnostics ........................................................ 76

Expense Manipulation Diagnostics ................................................... 81

Identify Potential Red Flags ............................................................... 87

 

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Undo Accounting Distortions .............................................................. 87

Restating Distortions in Financial Statements .................................... 93

Financial Analysis, Forecast Financials and Cost of Capital Estimation ........................................................................................ 94

Financial Analysis ............................................................................ 94

Liquidity Ratio Analysis ...................................................................... 94

Current Ratio ................................................................................. 95

Quick Asset Ratio ........................................................................... 96

Accounts Receivable Turnover ......................................................... 98

Days Sales Outstanding .................................................................. 99

Working Capital Turnover ............................................................. 101

Conclusion ................................................................................... 102

Profitability Ratio Analysis ................................................................ 104

Gross Profit Margin ....................................................................... 104

Operating Expense Ratio ............................................................... 105

Operating Profit Margin ................................................................. 107

Net Profit Margin .......................................................................... 108

Asset Turnover............................................................................. 109

Return on Assets .......................................................................... 111

Return on Equity .......................................................................... 112

Conclusion ................................................................................... 114

Firm Growth Rate Ratios .................................................................. 115

Internal Growth Rate .................................................................... 115

Sustainable Growth Rate ............................................................... 117

Conclusion ................................................................................... 118

Capital Structure Ratios ................................................................... 119

Debt to Equity Ratio ..................................................................... 119

 

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Times Interest Earned .................................................................. 121

Debt Service Margin ..................................................................... 122

Altman’s Z Score .......................................................................... 124

Conclusion ................................................................................... 125

Forecasted Financial Statements .................................................. 127

Income Statement .......................................................................... 127

Sales Forecasting ............................................................................ 127

Expense Structure ........................................................................... 129

Income Statement Restated ............................................................. 129

Balance Sheet ................................................................................. 129

Balance Sheet Restated ................................................................... 130

Statement of Cash Flows ................................................................. 131

Cost of Capital Estimation ............................................................. 142

Cost of Equity ................................................................................. 142

Size Adjustment .............................................................................. 145

Alternative Cost of Equity ................................................................ 145

Cost of Debt ................................................................................... 147

Weighted Average Cost of Capital .................................................... 151

Valuation Methods ......................................................................... 154

Method of Comparables ................................................................... 154

Price/Earnings Trailing .................................................................. 155

Price/Earnings Forecast ................................................................ 155

Price/Book ................................................................................... 156

Price/Earnings Growth .................................................................. 157

Price/EBITDA ............................................................................... 158

Enterprise Value/EBITDA .............................................................. 159

 

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Price to Free Cash Flows ............................................................... 160

Dividends/Price ............................................................................ 160

Conclusion ................................................................................... 161

Intrinsic Valuation Models ................................................................ 161

Discounted Dividends Valuation ..................................................... 162

Discounted Free Cash Flows Valuation ........................................... 164

Residual Income Valuation ............................................................ 167

Abnormal Earnings Growth Valuation ............................................. 170

Long-Run Residual Income Valuation ............................................. 173

Analyst Recommendation ................................................................ 176

Appendices ..................................................................................... 178

A: Sales and Expense Manipulation Diagnostics ................................. 178

B: Restating Financial Statements .................................................... 181

C: Financial Analysis ........................................................................ 183

D: Regressions ............................................................................... 188

E: Method of Comparables ............................................................... 198

F: Valuation Models ......................................................................... 201

Industry Terms Glossary ............................................................... 210

Sources Cited ................................................................................. 217 

 

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Executive Summary  

Analyst Recommendation: Buy (Slightly Undervalued) As of April 1st, 2009

2004 2005 2006 2007 2008

Initial Scores 2.59 2.31 1.88 1.83 1.97

Revised Scores 2.32 1.54 1.26 1.16 1.24

As stated Restated$57.79 $64.19

0.17 0.17

0.08 0.05

Estimated R-Squared Beta Size Adj. Ke

3 Month 0.6674 1.897 0.1847

1 Year 0.6651 1.859 0.1821

2 Year 0.6674 1.892 0.1843

5 Year 0.6671 1.885 0.1839

10 Year 0.6665 1.879 0.1834

As Stated Restated

0.1166 0.1612

0.0412 0.0418

0.1048 0.0879

1.7

WACC Upper WACC Lower

0.122 0.0875

Cost of Debt

WACC (BT)

Published Beta

Return on Equity

Book Value Per Share

1.70 Billion

$20.38 - $ 87.79

Backdoor Ke

Long Run Residual Income

Abnormal Earnings Growth

Residual Income

Intrinsic Valuations

Trailing P/E

Forward P/E

Price to Book

P.E.G Ratio

$36.01

$49.71

$49.15

$63.39

$21.76

$27.59

$25.19

$25.59

$9.44 -----

$78.36 -----

EV/EBITDA

Price to FCF

Dividends to Price

$8.91

$27.80

Discounted Dividends

Free Cash Flows

$47.67

$11.22

$16.87 $16.87

OSG ‐ NYSE (04/01/2009) $24.03 Altman Z‐scores

Cost of Capital

Current Market Share Price (04/01/2009) $24.03

$32.51

($47.53)

As Stated Restated

Return on Assets

700.19 Million

39,590,759

52 Week Range

Revenue

Market Capitalization

Shares Outstanding

Financial Based ValuationsRestatedAs Stated

$26.75

$33.38

$47.52

$32.73

$29.91

$39.22

Price to EBITDA

 

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Industry Analysis

Overseas Shipholding Group is an energy shipping company that takes part in

the transportation of crude oil, petroleum products, and liquefied natural gas. OSG is

one of the largest tanker companies and is competitive both internationally and in the

US Flag markets. OSG’s main competitors include Frontline Ltd, Teekay Shipping

Corporation, and Tsakos Energy Navigation. To remain competitive in this industry, OSG

relies on its diverse fleet of vessels to satisfy customer needs. Below is a table of the

five forces that affect the degree of competition within this industry.

Competitive Force Degree of Competition

Rivalry Among Existing Firms High

Threat of New Entrants Moderate

Threat of Substitute Products Low

Bargaining Power of Customers Low

Bargaining Power of Suppliers High

 

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Since there is not a significant difference between the types of services that each

of the companies in this industry perform, the companies must compete on price to

attract customers in this highly competitive industry. The rivalry among existing firms is

considered high and leading firms in this industry are diversifying the types of services

that they offer to offset the risk that is associated with relying only on crude oil

transportation and also gain an advantage in other market segments. Transporting

petroleum products, liquefied natural gas, and transporting crude oil within the US Flag

market are just some of the additional market segments that competitive firms are

involved in. One of the ways that companies in this industry grow and diversify is by

acquiring smaller companies and their vessels.

The treat of new entrants is considered moderate since it would not be

considered difficult to enter the industry, but it would be difficult to stay competitive in

the long run with the industry leaders who are involved in multiple market segments to

offset risk. High competition in this industry also exists because of the high bargaining

power of suppliers. The largest shipbuilders decide on which business they would like to

accept and building larger vessels can take years to complete. On the other hand, since

there are limited alternatives to transport products around the world, the shipping

industry has a very low threat of substitute products.

The main key success factors in this industry are cost control and differentiation.

Reducing costs is possible by having low input costs and maintaining tight cost controls.

These are very important in this industry where competing on price is the focus to

attract potential customers. Also, differentiation in the energy shipping industry can

include having the highest quality vessels with updated technology for reliability and

safety.

 

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Accounting Analysis

Accounting analysis plays a large role in valuing a company because it

determines whether or not the key accounting policies reflect the company’s true value.

Because accounting numbers are man-made, they are subject to errors and

manipulation, which can portray the financial status of a firm inaccurately. When

compared to other energy shipping companies in the industry, Overseas Shipholding

Group was conservative in their accounting policies and, therefore, was effective in

accurately portraying the company. The key success factors for the energy shipping

industry were cost leadership, including: operating leases, goodwill, hedging activities,

and benefits and pension plans; and differentiation, including a mixture of superior

product quality and variety.

Operating leases are an important key success factor in the energy shipping

industry because vessels have high fixed to variable costs, and managing these fixed

assets through operating leases reduces excess capacity. Operating leases also reduce

the firm’s liabilities, assets, interest expense, and depreciation. Overseas Shipholding

Group would be considered moderately aggressive in their reporting of operating leases

because the lease periods are about as long as the life of the vessels. We believe that a

discount rate for capital leases would be useful in capitalizing existing operating leases.

Goodwill is difficult to account for and even harder to measure in terms of

business activities. It can, however, be used to make a firm look more favorable in

investors eyes. Goodwill is only a small portion of OSG’s assets and the company states

that it impairs goodwill on a yearly basis as required by SFAS 142. Total assets would

be overstated if goodwill is left on the balance sheet and not impaired. Companies that

report goodwill on their balance sheets have more accounting flexibility than companies

who do not. OSG’s goodwill represents only 1.74% of total assets. The company is

considered conservative in reporting net income because goodwill is maintained at less

than two percent of total assets.

 

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Hedging activities are common in the energy shipping industry because of the

unstable nature of the market. OSG participates in hedging activities to reduce future

risks that may be encountered. Many companies enter into Forward Freight Agreements

to reduce exposure to changes in spot market rates. Interest rate swaps are another

hedging activity that allow companies to be unaffected by changing interest rates other

firms may be forced to use. Forwards contracts are yet another hedging activity that

promises a fixed rate in the future, ignoring any fluctuations in the value of foreign

currency. There is a very low degree of flexibility when reporting hedging activities. It is

difficult for a firm to use conservative or aggressive accounting strategies in the area of

hedging because estimates are similar and guidelines are strictly enforced.

Lastly, Benefits and pension plans are recorded on the balance sheet at present

value as liabilities. Because the rates on these plans are primarily created by the firm,

they are subject to human error. OSG has a high disclosure of information regarding

benefit plans when compared with other companies in the industry, which affords OSG

a higher value over its competitors. Because OSG is the only company to disclose its

growth rates, we conclude that they use a conservative approach in presenting this

information.

Financial Analysis, Forecasting Financials, and Cost Estimations

Financial analysis involves examining a firm’s liquidity, profitability, and capital

structure through the use of financial ratios. The numbers computed by using these

ratios assist analysts in comparing a firm to its competitors over a long period of time.

The three types of ratios most used by firms are liquidity, profitability, and capital

structure.

Liquidity ratios measure a firm’s ability to pay off their short term debt

obligations. These liquidity ratios are compared to the ratios of other firms to determine

the credit risk of the individual company. Overseas Shipholding Group’s ratios indicate

 

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that they are the most capable of all the firms to cover their short-term debt

obligations. Profitability ratios measure how effective a firm has been at generating

revenues to create profit during a given year. Overall, OSG had a mixed profitability

performance. The firm’s ability to control costs, such as voyage expenses, has allowed it

to be an industry leader in gross profit margin measurements. Its operating expense

ratio and operating profit margin, however, is consistently below average because of

high charter hire expenses. OSG’s net profit margin, asset turnover, ROA, and ROE

have all been similar to industry averages and show signs of increasing trends, which is

favorable for the company. Capital structure ratios are used to determine how a firm

raises money to fund its investment and operating activities. The debt to equity ratio is

important because it provides insight to the firm’s default risk which describes the

creditworthiness company. OSG’s debt to equity ratio and debt service margin

consistently outperforms the rest of the industry.

Potential growth rates can be determined using sustainable and internal growth

rates after computing the liquidity, profitability, and capital structure ratios. OSG has

been performing around the same level as its competitors, and when it comes to

potential growth, the firm shows nothing that would give investors a reason to believe it

will grow at a greater rate than its competitors in the future. Due to the nature of the

energy shipping industry and the size of OSG, it seems that the firm will continue to

perform at the industry average in the long run.

The cost of capital estimation measures the opportunity cost of an investment

and is also necessary in valuing a firm. Cost of capital is made up of the weighted

average cost of debt and equity. The cost of equity is the minimum rate of return a firm

must offer shareholders for risk compensation. When using the capital asset pricing

model (CAPM) the cost of equity equals the beta of the firm times the return of the

market minus the risk free rate plus the risk free rate. From our regression analysis, we

found our beta to be 1.897 and stable across the time period; meaning OSG’s

systematic risk is not changing over time. Using the CAPM equation and filling in the

beta, the MRP of 6.8% and the risk free rate of 2.87%, we found the cost of equity to

 

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be 15.77%. We found the cost of debt by multiplying the weighted average of the

liabilities by the interest rates assigned to the liability. The weighted average cost of

capital (WACC) could then be found using the cost of equity and cost of debt. OSG’s

size adjusted weighted average cost of capital before taxes is 10.48% and, using the

effective tax rate of 35%, is 9.67% after taxes. Because OSG has large amounts of

long-term liabilities such as leases and tankers, we believe the range of eight to twelve

percent of assets to finance future business is an accurate number.

Before we were able to value the current position on this company, it was

necessary to forecast future financial statements based on the expectations. We

forecasted the income statement by starting off with the expected sales until 2018. It

was necessary to have forecasted financial statements for both as stated and restated

numbers. Since the restated statements capitalized the original operating leases, the

financial position would be different. The significant increases in liabilities after restating

would provide an alternative view when valuing the firm. These significant liabilities

would affect the firm if we consider it as overstated, understated, or fairly valued. After

completing the balance sheet, the statement of cash flows was forecasted by using

previously obtained ratios to link these statements with either the balance sheet or

income statement. We used the CFFO/Operating Income ratio to find CFFO since it

proved to be more consistent over time when compared to the CFFO/Net Income and

CFFO/Net Sales ratios. Also, the cash flows from investing were forecasted by taking

the yearly change in vessels at cost, minus accumulated depreciation. Lastly, we

simplified the CFFF by reflecting only the forecasted cash dividends paid to

stockholders.

Valuation Summary

The analysis that has taken place to this point will allow us to complete the final

step: accurately valuing the firm. To do this, we use the method of comparables and

intrinsic valuation models to compute an estimated price per share on the valuation

 

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date of April 1st, 2009. OSG’s market price per share on that date was $24.03. We used

a 15% margin of safety so if the model price is below $20.43 we considered the current

stock price overvalued and if the model price is above $27.63 we considered the current

price undervalued.

The method of comparables is a simply way of finding an estimated price per

share by using information provided by industry competitors. An industry average is

calculated for various ratios, and then working backwards with OSG’s information it is

possible to find an estimated value for the firm. Based on the P/E trailing, P/E

forecasted, P/B, P.E.G, price/EBITDA restated, and raw EV/EBITDA ratios, OSG is

currently undervalued and based on EV/EBITDA restated, P/FCF and dividends to price

ratios, OSG is currently overvalued. There will not be much weight placed on the

method of comparables because it is not theory-based and not the best way to

accurately value a firm.

Intrinsic valuation models offer theory-based assumptions and provide a more

accurate valuation of a firm. This accurate representation is due to the current

performance of the firm, which is taken into consideration in juncture with industry

trends. Sensitivity analyses are used to explain how changes in the cost of equity or

growth rate affect the time consistent price per share. Forecasted future values were

discounted back to April 1st, 2009 so that we had a time consistence price that could be

compared to the current market price of $24.03. Based on the overall valuations, we

feel that the intrinsic models suggest that OSG is currently a slightly undervalued

company.

 

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Business and Industry Analysis

Company Overview

Since Overseas Shipholding Group’s (OSG) founding in 1948, they have become

“one of the world’s leading bulk shipping companies engaged primarily in the ocean

transportation of crude oil and petroleum products.” (OSG 10-K) They currently

transport both liquid and dry bulk cargoes to both an international market as well as

within the borders of the United States. Most shipping companies are moving abroad to

cut costs and avoid U.S. regulations, but since OSG is committed to maintaining a

prominent presence in the U.S. shipping industry, they are “the only major tanker

company with a significant U.S. Flag and International Flag fleet.” (OSG.com)

Overseas Shipholding Group is headquartered in New York, New York with 10

other offices located both nationally and internationally. They also have nearly 4,000

employees who are based both onshore and offshore. Since November of 2006, OSG

has acquired three well-established shipping and lightering companies including

Maritrans Inc., Stelmar Shipping Ltd., and Heidmar Lightering. This shows that OSG is

beginning to grow and advance within their industry. Since OSG has a greatly

diversified fleet of vessels, it is difficult to place an exact competitor against them for

shipping in general. The closest competitors at this point in time would be Frontline

Ltd., Tsakos Ltd., and Teekay Shipping Corporation.

In order to transport their products, Overseas Shipholding Group relies on an

extremely diversified fleet of vessels. At the present time, they own and operate a fleet

of 112 vessels of varying sizes and types, which makes them the second largest publicly

traded oil tanker company in the world. Operating that many vessels also allows them

to compete in several different markets of energy transportation. Of the total 112

vessels currently in operation, 93 are used specifically in the international market and

the remaining 19 operate in the U.S. market. In order to stay as competitive as

possible, OSG focuses on four market segments instead of just one. Since their vessels

 

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are active in the crude oil, refined petroleum products, U.S. flag, and gas markets, they

can stay competitive even if one of the markets is in a downturn.

Industry Overview

Overseas Shipping competes in the energy transportation industry, specifically,

international flag product and crude carriers and U.S. Flag lightering. The industry is

characterized by economies of scale in moving large amounts of crude oil from the

Middle East, North Africa, The North Sea as well as other originates, to the large

industrialized economies of Europe, Asia and the United States. The business involves

arbitrage trades of moving excess diesel, a byproduct of crude oil refining, to Europe

and returning with excess gasoline. In addition, according to the Maritime Marine Act of

1920 (The Jones Act), any military or precious cargo must be transported on a vessel

constructed, owned by a United States corporation and operated by at least 75%

American citizens. This business is referred to the U.S. Flag ship business and involves

lightering (unloading cargo at a neutral destination and reloading to a U.S. Flag vessel)

operations to bring cargo to United States in accordance with the aforementioned act.

Ever since 1886, oil and gas has been transported on large carriers to

industrialized economies. Recent reductions in inventories by oil majors have prompted

increased demand for energy transport services. Middle Eastern oil producers are

located far from the largest consumers, necessitating long voyages, and thus, more

carriers. In addition to transporting oil and gas to refineries, a myriad of consumer

products are fashioned from petroleum products, most notably, plastic products. These

consumer products require the transportation of oil for use as a raw material, as well as

the subsequent exporting activity that utilizes the product carrier market.

Energy shipping firms connect with customers through the spot market for

various transport distances as well as time charter arrangements. Time charters allow

the customer to use a vessel for a specified period of time for a specified price. The

spot market matches owners of vessels with customers on a short-term, per-day basis.

Overall, the energy shipping industry is an undercurrent to economic growth, through

 

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the needs of transportation, product, heating and other uses, and should be expected

to grow with the world economy.

Five Forces Model

Analysis of a particular firm would be useful for a prospective investor. In order

to effectively value and analyze a firm, a quantitative analysis approach is needed to

consider the industry as a whole. Michael E. Porter’s Five Forces Model allows a

framework for such analysis. The model involves five key components which allow the

analyst to consider the industry’s overall profitability. The first three relate directly to

competition among actual and potential firms. By analyzing the rivalry among existing

firms, threat of new entrants and threat of substitute products, the measure of

competition can be obtained. The last two components of the five forces determine the

industries bargaining power of either suppliers or customers. When all five components

are considered, the firm’s competitive force, and thus, its profitability are valued. The

following table summarizes the degree of competition for each competitive force.

Competitive Force Degree of Competition

Rivalry Among Existing Firms High

Threat of New Entrants Moderate

Threat of Substitute Products Low

Bargaining Power of Customers Low

Bargaining Power of Suppliers High

Rivalry Among Existing Firms

When evaluating a business within an industry of rivals, it is vital to consider the

degree of competition within that industry. In an industry that is highly competitive,

pricing is the differentiating force that sets apart its competitors. In other industries,

 

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companies compete through other product features such as innovation or brand-image.

In order to determine the aspect that will set apart the firms image, consideration

should be given to industry growth, concentration of competitors, differentiation,

switching costs, economies of scale, fixed-variable costs, excess capacity and exit

barriers.

Industry Growth Rate

The growth rate in an industry is important to comprehend because of the

nature of an expanding firm. If the industry is growing at an increasing rate,

businesses do not need to compete on market share. But in some industries, as in the

energy shipping industry, the primary ways a firm can expand is by attempting to take

market share away from the competition or acquire (buy out) competitors. One way to

analyze market growth is to look at the sales figures of an industry.

Industry Sales (in thousands) Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding

$297,283 $454,120 $810,835 $1,000,303 $1,047,403 $1,129,305

Frontline Ltd. $551,595 $1,161,383 $1,855,666 $1,495,975 $1,558,369 $1,299,927

Teekay Corp. $783,327 $1,576,095 $2,219,238 $1,954,618 $2,013,306 $2,406,622

Tsakos Ltd. $130,004 $241,365 $318,278 $295,623 $427,624 $500,617

Total $1,764,211 $3,432,963 $5,204,017 $4,746,519 $5,046,702 $5,336,471

 

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Percentage Change in Sales Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding -36.66% 52.76% 78.55% 23.37% 4.71% 7.82%Frontline Ltd. -23.01% 110.55% 59.78% -19.38% 4.17% -16.58%Teekay Corp. -24.61% 101.21% 40.81% -11.92% 3.00% 19.54%Tsakos Ltd. 3.98% 85.66% 31.87% -7.12% 44.65% 17.07%

Total -24.92% 94.59% 51.59% -8.79% 6.32% 5.74%

$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

2002 2003 2004 2005 2006 2007

Industry Sales

Industry

Measured In Thousands of Dollars

‐40.00%

‐20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

2002 2003 2004 2005 2006 2007

Industry Sales Growth

Series1

 

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The above graph indicates that the industry experienced high growth in the early

2000’s, but has since experienced a decreasing growth trend. In the 2007 fiscal year,

the industry only experienced a 6.24% increase in sales compared to the 2003 fiscal

year when it experienced a 79.26% increase. Sales in the industry have stayed at a

steady growth, but significant increases in sales between 2002 and 2004 surpass these

newer growth patterns in comparison. Because of the relative decrease in the market

sales in the past two fiscal years, pricing wars might become more common in the

future.

Concentration of Competitors

According to Palepu and Healy’s Business Analysis and Valuation, “the number of

firms in an industry and their relative sizes determine the degree of competition in an

industry.” If the firms have relatively equal market share, then they will try to follow

pricing patterns of the other companies in the industry. Also, if the industry is

fragmented, then price competition will become rigorous due to multiple companies

competing for better share of the market. If the industry has one dominant firm, then

that business sets prices for the whole market and the rest tend to follow.

Market Share Percentage of Total Industry Sales Company 2003 2004 2005 2006 2007 Overseas

Shipholding 13% 16% 21% 21% 21%

Frontline Ltd. 34% 36% 32% 31% 24% Teekay Corp. 46% 43% 41% 40% 45% Tsakos Ltd. 7% 6% 6% 8% 9%

Total $3,432,963 $5,204,017 $4,746,519 $5,046,702 $5,336,471

 

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According to the 2007 market share graph, Teekay Corporation is the dominant

firm in this industry. These findings give evidence that there is unequal dominance in

this industry. The energy shipping industry has been around since the early 19th

century which hinders the introduction of large public firms to the industry, but does

not render it impossible. Furthermore the Herfindahl-Hirschman Index, which is a

commonly accepted measure of market concentration on a scale of zero to 10,000, only

measures to 534.14. This indicates a low concentration of firms for an industry of this

size on a global scale. This provides further evidence that, upon entry into the industry,

it is unlikely the new firm would obtain a large share of the market.

Level of Differentiation Differentiation is the company’s ability to enhance or change a product or service

to set itself apart from the competition. If the product or service offered by the

competing firms is similar, there exists a low degree of differentiation. Thus, the

customer chooses the firm on the basis of competitive pricing. The level of

differentiation among competing firms could be determined by several factors. One

such factor in the energy shipping industry could be shipping locations. It would stand

to reason that a potential customer would more readily utilize the services of a

particular company if that company had shipping locations close to the customer. In

21%

24%45%

10%

2007 Market ShareOverseas Shipholding Frontline Ltd. Teekay Corp. Tsakos Ltd.

 

Page | 22   

this industry, most firms participate in a global market minimizing the importance of

differentiation among shipping locations. Another differentiation factor is the use of

commercial pools (i.e. partnerships between firms) to network equipment use across

global locations. However, because many firms in this industry participate in

commercial pools, this aspect would not be a significant determinant of differentiation

among competing firms. Because of a similar service product line, the energy shipping

industry is mainly competitive through its pricing strategy.

Switching Costs

Switching costs determine a firm’s commitment to specialization within an

industry. Low switching costs indicate that a firm can use its production capital or

services for another business activity. Alternatively, high switching costs demonstrate

that companies use customized assets that could not be used in an industry with

differing business activities. Because the energy shipping industry has highly

customized production assets (tankers), they have high switching costs. Energy

shipping tankers are highly customized because they must meet certain regulations,

such as double thick hulls. The only low switching cost conversion would be to use the

tankers as offshore floating storage. Shipping companies presently engage in this

activity when low demand drives petroleum shipping rates up, “the decline in demand

already has pushed millions of barrels of oil into storage terminals and onto tankers

offshore” (WSJ-Oil Price Falls, Inventories Rise). These companies already understand

the risks involved with floating storage. When floating storage is only used during

times of low demand, profits are lost to the high rates and low activity of ships. “Tanker

rates have skyrocketed in the past couple of months, making oil storage more

expensive and wiping out some of the potential profits to be made with floating

storage” (WSJ-Oil Prices). Since these profits are lost during times of low demand,

firms would only engage in storage of oil products when high demand stimulates rates

low enough to realize a profit. This provides evidence that this industry has high

switching costs, but only at times of high demand for their services.

 

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Economies of Scale

The chart below highlights the total assets of the major shipping firms. The

information was provided by the 10-k’s of each company.

Total Assets (in thousands) Company 2002 2003 2004 2005 2006 2007

OSG $2,034,842 $2,000,686 $2,680,798 $3,348,680 $4,230,669 $4,158,917Frontline $3,034,743 $4,463,535 $4,338,760 $4,454,817 $4,589,937 $3,762,091Teekay $2,723,506 $3,588,044 $5,503,740 $5,294,100 $7,733,476 $10,060,153 Tsakos $694,545 $825,507 $937,938 $1,089,174 $1,969,875 $2,362,776Total $8,487,636 $10,877,772 $13,461,236 $14,186,771 $18,523,957 $20,343,973

According to Palepu and Healey, size is “an important factor for firms in the

industry.” Logistics, relationships with customers, and fleet size are where the

economies of scale lie within the shipping industry. The shipping industry’s market

concentration is high. A select number of companies dominate the market, operating

with large fleets and using commercial pools to gain more market share which make it

harder for the smaller firms to compete on that level.

Fixed-Variable Costs

“If the ratio of fixed to variable costs is high, firms have the incentive to reduce

prices to utilize installed capacity” (Palepu & Healy). Most firms will try to increase

demand to reduce fixed costs. In the shipping industry, the fixed costs of the firm are

high because of things like maintenance, dry-docking fees, and operating leases. The

variable costs of the shipping industry include voyage expenses and tariffs. These

variable costs are not very high, especially when compared to the extremely high fixed

costs. Although the ratio of fixed costs to variable costs is high, the fixed costs can be

managed through charters and commercial pools.

 

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Excess Capacity

Palepu and Healey state: “If capacity in an industry is larger than customer

demand, there is a strong incentive for firms to cut prices to fill capacity.”

Percentage Change in Sales

Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding -36.66% 52.76% 78.55% 23.37% 4.71% 7.82%

Frontline Ltd. -23.01% 110.55% 59.78% -19.38% 4.17% -16.58%

Teekay Corp. -24.61% 101.21% 40.81% -11.92% 3.00% 19.54%

Tsakos Ltd. 3.98% 85.66% 31.87% -7.12% 44.65% 17.07%

Standard Deviation 17.55 25.36 20.76 18.77 20.35 16.48

 

The chart above indicates that the industry experiences volatility in sales because

it is dependent on demand of petroleum products which influences spot and charter

rates. The shipping industry has high potential for meeting excess capacity because of

the potential to have too many tankers and not enough oil to ship if demand for oil

decreases. OSG is the only company that discloses any form of excess capacity. This is

measured by revenues compared to owned boats, and revenues compared to chartered

boats. The excess capacity is seen through the total amount of boats (with newbuilds)

compared to total shipping revenues. This excess capacity is displayed in the table

below.

 

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Relation of Vessels to Revenue Days

Excess Capacity Number of Boats Revenue Days Revenue Days Per

Boat

2002 55 15,199 276.35

2003 53 15,284 288.38

2004 62 17,579 283.53

2005 107 30,645 286.40

2006 137 29,757 217.20

2007 156 35,619 228.33

2008 154 39,709 257.85

As seen in the graph above, the percent of revenue days per boat increases from

2007 to 2008. This is due to the fact that OSG decreases its number of operating

vessels from 2007 to 2008. This percentage can determine the excess capacity for

276 288 284 286

217 228258

0

50

100

150

200

250

300

350

2002 2003 2004 2005 2006 2007 2008

Revenue Days per Boat

Revenue Days per Boat

 

Page | 26   

OSG, this is because the excess capacity of revenue days shifts from 156 vessels to only

154 vessels. This does not seem significant in the grand scheme, but this does

considerably increase revenue days per boat. The energy shipping industry will cut the

cost of shipping if there is an excess capacity of tankers. When excess capacity is high,

consumers enjoy a reduction in shipping rates and when excess capacity is low,

consumers experience increases in shipping rates. Excess capacity in the shipping

industry is volatile, as is the demand for the oil that it carries.

Exit Barriers

In the energy shipping industry, exit barriers are not high. These company’s

assets are fixed in their tankers, which are in high demand within the market. A

company could easily exit the industry just by selling its fleet. These used tankers are

also selling for the same price as new ones. There is not any strict regulation on exiting

the shipping industry.

Conclusion

Rivalry among existing firms is a critical component of evaluating an industry’s

level of competition. The energy shipping industry has a competitive environment

because the industry experiences entry barriers, but they are not completely prohibitive.

Furthermore, firms experience difficulty differentiating. Because the concentration of

competitors, economies of scale, and fixed to variable costs are all high and industry

growth, differentiation, switching costs, exit barriers and excess capacity are low, the

energy shipping industry can be considered price competitive when considering the

rivalry amongst existing shipping firms.

Threat of New Entrants

In a particular industry, firms should not only focus on rivalry from existing firms

but also from new businesses. High levels of profitability within an industry will attract

new entrants. New entrants will ultimately increase the level of competition and affect

 

Page | 27   

future profitability for the existing firms. Firms already in an industry benefit if barriers

make is difficult for outside businesses to come in and take part of the market share.

This threat depends on four factors: first mover advantage, distribution access and

relationships, economies of scale, and legal barriers.

First Mover Advantage

In certain industries, existing firms have an advantage over possible new

entrants due to the first mover advantage. First movers are able to set trends in an

industry and move ahead of the competition while everyone else tries to catch up. This

advantage usually takes place in industries where customers that change companies

incur high switching costs. In the energy shipping industry, there is not a significant

first mover advantage because it is easy for customers to switch to a different company

for their shipping needs. Customers mostly look at price and the specific type of vessels

they need when shipping crude oil, oil products, and liquefied natural gas. Existing firms

have gained a reputation with certain customers, but these firms would not have much

of an advantage if a new firm entered the industry with much lower shipping rates or

new bigger vessels. Overall, the relatively low effects of the first mover advantage

increase the threat of new entrants in this industry.

Access to Channels of Distribution and Relationships

Channels of distribution are an important part of every firm’s process to get the

final product out to the customers. Firms currently in the industry have the advantage

of having access to channels of distribution and forming relationships with not only

customers but also with each other. Certain firms have commercial pool agreements

with each other to operate more efficiently and be more cost effective. “Under a pooling

arrangement, different vessel owners pool their vessels, which are managed by a pool

manager, to improve utilization and reduce expenses (TK 10-K). These commercial

pools also allow businesses to provide better service to their customers. Although not all

firms operate under commercial pools, they allow existing firms to be more productive

and utilize the benefits from their relationships. These factors make it more difficult for

 

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new entrants to enter this industry and have an immediate effect. There are no specific

barriers to prevent new entrants to start commercial pools but forming relationships

within this industry takes time. While access to channels of distribution and forming

industry relationships puts new firms at a slight disadvantage, they do not significantly

lower the threat of new entrants.

Economies of Scale

Operational efficiency improves if there are large economics of scale. This is

another factor that new firms look at to see what they need to do to become

competitive. In the energy shipping industry, there are large economies of scale with

firms that have large total assets. Specifically, firms invest in vessels by buying, leasing,

or building them. In this industry, it is also common for larger firms to acquire smaller

businesses. When a business is acquired, so are all of the vessels and other assets that

were owned by that business. This is one reason it would be difficult for a new entrant

to compete in this industry.

Another reason that new entrants would have a difficult time in this industry

would be because the most successful firms are diversifying the types of vessels they

have to protect themselves from spot markets. Historically, spot markets have been

known to have higher rates of return than other more stable business sectors. Spot

markets have varying rates that can be very risky for firms in the industry that solely

rely on them. Existing firms go into different sectors of the industry to minimize this

risk. For a new entrant to fully compete with an existing firm, they would need to

strongly invest in fixed capital. A new entrant can easily enter this industry and focus on

one sector, but for long term success and the ability to compete with industry leaders,

diversity is very important. For this reason, economics of scale are one of the factors

that decrease the treat of new entrants in the energy shipping industry.

 

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Legal Barriers

It is important for new firms to understand the legal barriers that exist when

entering an existing industry. The energy shipping industry has laws and regulations

that are getting tougher and constantly changing. New firms have to abide by the laws

in areas in which their vessels operate. This would include local, state, national, and

international regulations. Vessels are also subject to scheduled and unscheduled

inspections by government and private organizations that make sure safety and

environmental standards are being followed (OSG 10-K). Also, the areas in which a new

company’s vessels will operate will determine the required licenses and permits that will

need to be acquired. Firms that fail to meet certain requirements in this industry risk

the possibility of severe fines. Although there are several legal requirements that new

firms need to follow, there are also regulations that every firm in this industry, new or

existing, must comply with. For this reason, legal barriers are not a major factor in the

threat of new entrants.

Conclusion

In the energy shipping industry, the threat of new entrants is moderate. The

biggest barrier that new firms have when entering this industry is obtaining the high

levels of capital that are required to remain competitive with industry leaders. A

company would have to invest in property, plant, and equipment, specifically shipping

vessels because of the large economies of scale. Although new entrants would start off

in this industry at a disadvantage because of the first mover advantage and access to

distribution channels, these are major factors that new entrant would be able to

overcome. Also the laws and regulations that new entrants would need to follow are the

same as existing firms, so there is not an advantage for either side on the legal barrier

issue. Overall, if a new entrant can enter the industry with a large diverse fleet of

vessels and start forming relationship with potential customers by offering lower

shipping rates, they could become a threat to existing firms.

 

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Threat of Substitute Products

The function that a company performs is the primary factor to consider when

evaluating the threat of substitute products. Since not all companies produce the same

product, it is important to analyze the function that each company or product performs

in order to determine whether or not they can be considered a substitute of one

another. When you consider the shipping of crude oil and petroleum products overseas,

there will not be much variation between companies in the functions they provide.

Therefore, there are a few other key factors to consider when determining substitute

products. “The threat of substitutes depends on the relative price and performance of

the competing products or services and on customers’ willingness to substitute” (Palepu

& Haley).

Relative Price and Performance

Two products can be considered substitutes if they perform the same function

for a very similar price. When two different products perform the same function for the

same price, it makes the customers focus more on the price then the product itself.

This makes a competitive price scheme very important to industries with low product

differentiation.

The energy shipping industry would fall into the low product differentiation

category, so it is important for their prices to stay competitive. Companies that ship

crude oil and other types of energy products provide similar functions. When a potential

buyer is looking for energy shippers, they simply need a vessel that can store and

transport their shipment to its final destination. Since most companies in the energy

shipping industry can satisfy the needs of potential customers, the price is the

differentiating factor. In order for companies to gain a competitive price advantage, to

gain increased revenue, internal costs must be kept at a minimum. If the shipping

company maintains low production costs, it will be able to, in turn, charge a lower fee

to the customer and eventually gain more business.

 

Page | 31   

It is pivotal for the success of companies in an industry such as this to perform

at a level that is satisfying to their customers. The performance of a company in an

industry with low service differentiation is what could potentially set them apart from

the rest of their competitors. If specific companies continually satisfy their customers

with their performance they could keep those customers for an extended amount of

time, even if their prices vary.

Customers’ Willingness to Switch

When firms are competing in an industry with low product or service

differentiation, buyers are attracted to firms that offer lower prices. This holds true for

the energy shipping industry, for which customer’s switching costs are low. With the

possibility of a high customer switching rate, an energy shipping company must

differentiate itself from the competition in ways other than pricing. Gaining customer

loyalty by providing shipping benefits or rebates are a few ways to earn a competitive

edge.

Conclusion

In order for a company to stay competitive in an industry with low product or

service differentiation, focus must be given on competitive pricing and improving

internal and external performance. If pricing and performance are favorable,

customer’s willingness to switch may not be a threat. Firms must keep internal costs

low so that they can afford to give their customers a lower price. It is also important

for a company to continually provide its customers with satisfying performance to gain

a loyal customer base. Since the threat of substitute products in this type of industry is

low, a company must find alternatives to pricing in order to set itself apart from the

competition.

Bargaining Power of Customers

Petroleum is shipped all over the world on a daily basis creating a large demand

for oil tankers to transport the petroleum from one country to another. In a commodity

 

Page | 32   

industry like energy shipping, it is important for companies to try and differentiate their

service as much as possible. Companies strive to keep shipping costs at a minimum,

creating price competition within the industry. This price competition gives the

customer control over the industry, allowing them to shop around for the best company

based primarily on price.

Switching Costs

Services in the industry are very similar which cause switching costs in the

industry to be low. There are many competitors in the industry, which creates price

competitions. The customer has the opportunity to compare the prices of each company

and choose the company that has the best price. However, because in the industry

customers ship such large amounts of petroleum, some customers might consider

paying slightly more for a more reliable or familiar company.

Differentiation

In any industry, it is important to differentiate products or services as much as

possible. Services in this industry are very similar, but many companies try to

distinguish their slight differentiations from other companies that they believe make

them a better choice. Some companies advertise the young age of their fleet and

others might advertise the size of their ships. In this industry differentiation can help to

win over a customer and gain their business for many years.

Importance of Product for Costs and Quality

In petroleum shipping price competition is highly important. The industry works

hard to compete on prices because the shipping industry is very homogeneous and

prices are elastic. Many customers are drawn to the lowest possible price because they

are shipping a large amount of petroleum. It is important for companies to keep their

prices in the same range because any company with a price too high will lose business.

When prices are comparable, companies will remain with the same company. Other

 

Page | 33   

customers will switch according to the lowest price. Product cost is an important

component in competing for customers.

Number of Buyers

The energy shipping industry services a high volume of customers. Most of

these customers are made up of major oil and gas companies, as well as, refiners and

traders (osg.com). Customers include large companies such as, BP, ExxonMobil,

ChevronTexaco, Valero, and ConocoPhillips (osg.com). Although there are many large

clients, a substantial amount of small firms play a part in the entire industry. Since

there are a large number of patrons that ship oil and petroleum products, the shipping

firms retain the bargaining power over the customers.

Volume Per Buyer

Within the energy shipping industry, the amount customers need to ship varies.

Since the shipping volumes vary, the industry incorporates many different kinds of

vessels to meet specific customer needs. These vessels’ volumes range from 500,000

to three million barrels of oil. When demand drops and rates are up, customers decide

to ship less. This causes companies to employ the use of their smaller capacity vessels

such as their 500,000 barrel Suezmax carriers. Volume per buyer in the shipping

industry is volatile since firms can meet the varying needs of the customers. This keeps

the bargaining power of customers low in the energy shipping industry.

Conclusion

In the energy shipping industry, low switching costs allow customers to move

with ease from one shipping firm to another. Such movement is determined by the

shipping firm’s differentiation, which is essentially age of the fleet and sizes of the

ships. The competition generated by such differentiation renders the service cost and

product quality important. Additionally, numerous buyers give bargaining power to the

shipping firm. This balance of competition and demand makes the energy shipping

industry a catalyst to low bargaining power of customers.

 

Page | 34   

Bargaining Power of Suppliers

The profitability of the sea transportation industry depends on a myriad of

factors like spot rates, charter rates and new ship build costs. In order to understand

the power suppliers have in this relationship, we will need to understand who provides

the inputs in which we add value. The relative power of these suppliers will affect the

profit margins of our business and theirs. When our industry is experiencing rapid sales

growth, as it did in 2006, suppliers want to increase their margins as well. Alternatively,

when our industry is contracting, as it did in 2001, neither suppliers nor users want to

reduce their operating margins. Both parties relative success in this dynamic

relationship will be the topic of the following discussion.

The sea transportation industry has few suppliers. Primarily, the suppliers are

shipbuilders, diesel used to propel the voyage, as well as the crew members on the ship

itself. Understandably, the most significant supplier in this relationship is the shipbuilder

because of their large contribution to our overall costs. For this analysis, we will ignore

the costs of diesel and personnel, because of their miniscule contribution to our costs

structure.

Switching Costs

In the context of supplier relationships, switching costs refer to the propensity

for the company to switch suppliers. If a supplier makes a critical component used in

the company’s product, and a limited number of alternative suppliers exist, the supplier

has significant power through the companies’ unwillingness to switch suppliers.

The sea transportation industry’s primary suppliers are the ship builders. Ship

builders are large, numerous and primarily Asian domiciled companies. Shipping

companies have very little customer loyalty as to who builds their tankers because of

the build-to-order and lengthy build time nature of the industry. Therefore, many

shipping companies have a number of ships made from multiple shipyards. The

 

Page | 35   

following chart reflects the diversity in shipyards supplying the vessels for the frontline

fleet.

Differentiation

Suppliers have more power over their customers if their products are of a

differentiated nature. The degree to which the inputs for the company are a commodity

or homogeneous nature influences the suppliers bargaining power over the company.

Alternatively, if the product the supplier sells is highly unique and proprietary, the

supplier has more power to dictate pricing over the company because of the lack of

relative substitutes. The following section will discuss the degree in which shipbuilders

build differentiated products and the price premiums warranted for these specialized

tankers. In particular, we will examine the recent trends in ship design and how the

industry is responding to these new products.

Sea transport companies differentiate themselves by how modern and

technologically advanced their fleet is as well as their age. It is imperative to

understand the advantages these modern fleets bring to the shipping company in order

to measure the recoverability and longevity of their assets. Additionally, as ship builders

can be more selective in the ships they build, it is important to determine if these high

10

13

86

6

4

7

Frontline Vessels by Shipyard

Hitachi

Hyundai

Samsung

Daewoo

Jinhaiwan

SWS

Other

 

Page | 36   

value added tankers really warrant the premium charged and the advantages are truly

unique to that shipbuilder.

Ship builders tend to make standardized products with few differences in the way

their products operate. For instance, liquid national gas carriers are seen in the industry

as being a higher-value added product, and thus warrant a price-premium. Similarly,

floating, production, storage and offloading vessels have emerged in recent years as an

“all-in-one” tanker with natural gas liquefaction and refining capabilities onboard.

However, these are unique examples in respect to the industry as a whole. The vast

majorities of tankers are highly similar and are differentiated on dead weight tons

alone. An example of this is the emergence of ULCCs (ultra large crude carriers) which

are tankers over 400,000 DWTs, and V-pluses, which are 50% larger than traditional

VLCCs (200,000+DWT). Due to the industries primary focus on cost, innovation in

tanker technology slants toward making larger ships that can take advantage of

economies of scale.

Daewoo Shipbuilding and Marine Engineering claims their proprietary pre-swirl

stator, which better directs water to the propeller, decreases fuel consumption by

5~6%. Similarly, their Computational Fluid Dynamics hull designs reduce the effect of

waves on the stability of the tankers, thus decreasing fuel consumption and increasing

operating efficiency. Hyundai heavy industries pride itself on its engine technology that

is expected to lower maintenance costs over the life of the tanker. Overall, the

significant differences in tankers are their capacity, with Daewoo Shipbuilding leading

the shift to ULCCs.

Importance for Cost and Quality

In any industry, the nature of the input for cost and quality determines how

powerful a supplier can be to the company as a whole. If it is not important for the

input to be of relatively high quality, cost competition is sure to occur and the

bargaining power of the supplier is diminished. Alternatively, if the input is needed to be

of relatively high quality, a supplier can leverage more power in the relationship. This

 

Page | 37   

section will analyze how important the ships are for cost and quality, and thus, how

much power the suppliers have in this situation.

The fixed assets of vessels represent a significant portion of the cost structure to

the shipping company. Depreciation and vessel expenses are the primary expense to a

shipping company and understanding the importance of vessel price and quality is

essential to creating a perspective of shipping companies and the relationship they have

with their suppliers.

Vessel cost and quality are critical in the consideration of expense management

and used ship sales revenue. Ship costs have much less to do with the costs of their

inputs, like labor and steel, than they do with expected future freight rates. Considering

how singular the supply chain is to a shipping company, it is very important for a

shipping company to understand the market for ships and freight rates, and therefore

manage their fleet through time-charters and sale and lease backs.

In order to examine the relative importance of ships to the overall cost structure,

we will look at how ship costs affect the income statements of Frontline, Overseas

Shipping and Teekay. For this analysis, we will use vessel expenses, which include all

maintenance and dry-docking expenses, to measure ship quality. Additionally, we will

look at depreciation, amortization and time-charter expenses to measure initial ship

purchase price relative to total expenses.

 

Page | 38   

As the figure indicates, depreciation and charter expenses represent a significant

portion of the cost structure, ranging from 30-48% of total expenses. This represents

the amortization of the purchase price of the vessels along with “rent” on vessels

owned by another independent operator, or sale-and-leaseback transactions. Vessel

expenses are included to show maintenance, repair and subsequent dry-docking fees

associated with the vessels themselves. In aggregate, these expenses represent 52-

78% of total expenses, placing high importance on ship quality and cost in the

industry’s key success factors.

Number and Volume of Suppliers

The number of suppliers in an industry affects the availability of inputs used for

value creation. For whatever reason, if a limited number of suppliers exist, firms must

manage relationships in order to guarantee continuous supply of raw materials, in this

case, shipping vessels. Similarly, the volume per supplier influences the relative power

of suppliers over buyers in the industry. If the market share of the various suppliers is

highly fragmented, purchasers are more dependent on a handful of suppliers and must

manage these relationships with sustainability in mind. Alternatively, if the market is

flush with firms willing to supply an input and market share is reasonably distributed,

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

OSG Teekay  Frontline 

Remaining Expenses

Vessel Expenses

Charter Expenses

Depreciation

 

Page | 39   

purchasers have much more bargaining power by being able to auction their upstream

needs.

The shipbuilding industry has numerous suppliers, but market share is highly

fragmented as well. The largest shipbuilders have the luxury of discerning what

business they would like to accept, that is, the high value added, high margin vessels.

Samsung Heavy Industries’ shipbuilding slogan is emblematic of this approach:

“Generating high profits by selectively receiving orders for high technology and high

value added ships.” Backlog for new builds is between 2-3 years across the industry and

build-time is around one year. This constant flow of business allows the suppliers to

manage their capacity and be selective as to which vessels they would like to build.

Although a comprehensive list of shipbuilders would be too elaborate to include

here(over 150), the fragmentation of the industry can be conveyed by showing the

market share of the tanker industry of the main shipyards.

Korean shipbuilders have emerged as the pre-eminent force in the industry with

Hyundai Heavy Industries accounting for 15% of the market, followed by Samsung with

11% and Daewoo with 13%. These shipbuilders have become so influential that they

demand payment in Korean won, instead of the U.S. Dollar, which was common

practice until recently.

Conclusion

A crucial element in valuing the sea transportation industry is determining the

relative bargaining power of the suppliers in the industry. We have discussed how

Korean shipbuilders are commanding more market share and more influence,

concentrating the supply of new vessels. Additionally, we have showed how important

initial purchase price of a vessel is to any shipping company, representing 30-48% of

total expenses, adding in vessel upkeep, and total vessel expenses range from 52-78%

of total expenses. It has been shown that product differentiation is focused primarily on

the size of the ship and its operating efficiency, but by no means, the prevailing

 

Page | 40   

characteristic of the needs of purchasers. Switching costs remain very low with very

little customer loyalty, as represented by the diversity of shipyards supplying shipping

company’s vessels. In this environment, we can expect increases in shipping rates to

directly correlate with purchase price of new and used crude carriers, necessitating

intelligent and strategic procurement of the more important fixed asset a shipping

company has, the vessel.

Conclusion

The energy shipping industry has been analyzed quantitatively by using Porter’s

Five Forces Model. This analysis revealed high level of rivalry among existing firms

within the industry. Analysis also revealed a moderate threat of first-time entrants to

the industry. The threat of substitute products, (or services as in this specific

industry) is determined to be low. Bargaining power of customers is low, where the

bargaining power of suppliers is high. By analyzing the rivalry among existing firms,

threat of new entrants and threat of substitute products, the measure of competition

can be obtained. The last two components of the five forces determine the industries

bargaining power of either suppliers or customers. When all five components are

considered, the industry as a whole has the potential of fostering highly profitable firms.

Key Success Factors

Within an industry, firms must decide on one of two strategies that create value.

The two most common competitive strategies include cost leadership and

differentiation. Successful companies choose one of these strategies to gain an

advantage against industry competitors. Essentially, firms that focus on cost leadership

“supply same product or service at a lower cost” and the ones that focus on

differentiation “supply a unique product or service at a cost lower than the price

premium customers will pay” (Palepu & Healy Figure 2-2). The key success factors that

 

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create value within the energy shipping industry include the economies of scale and

scope, efficient production, lower input costs, and superior product quality and variety.

Cost Leadership

Economies of Scale and Scope

Economies of scale and scope refer to the ability of a firm to reduce their

variable (per-unit) costs through heavy investments in capital, often leading to a higher

portion of fixed costs in their expense structure. The energy shipping industry is

emblematic of this approach in that larger, more flexible vessels are necessary for a

firm in the industry to be successful. Most crude oil is transported in very large crude

carriers (VLCCs) that weigh over 200,000 DWT. Such vessels can transport two million

barrels of oil in their hulls and usually have depreciable lives of 25 years.

In addition to large investments in physical assets, successful energy shipping

companies have multiple types of vessels enabling increased flexibility, utilizing

economies of scope. These vessels can travel the Panama Canal, as well as the Suez

Canal. These ships are referred to as Panamax and Suezmax tankers, respectively.

These high investments in physical assets and low industry differentiation lead to

the problems of excess capacity, putting downward pressure on spot rates. This volatile

business environment places heightened importance on energy shipping companies to

diversify their fleet to effectively hedge against these volatile rates.

Efficient Production

Efficient production occurs when a firm uses its available assets to produce the

maximum number of goods and services. In the energy shipping industry, percent

utilization can be used to measure this efficiency. Firms obtain a competitive advantage

if they can utilize their current fleet of vessels more efficiently than their rivals. “Ninety

percent utilization of the world's tanker fleet is considered full use by the industry”

 

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(Houston Chronicle: World's tanker fleet is 'close to 100 percent utilization). When firms

operate at ninety percent utilization, they can offer optimum shipping rates for their

customers. The remaining percentage accounts for vessel maintenance. Above 90

percent utilization, the shipping rates drastically increase for the customers.

Lower Input Costs

“Input costs are cost of direct material, direct labor, and other overhead items

devoted to the production of a good or service” (allbusiness.com). Reducing input costs

is a key success factor in any industry. The energy shipping industry is highly

competitive and firms that achieve lower input costs can have a strong competitive

advantage. Voyage expenses such as fuel, canal tolls, port charges, and tariffs are

major input costs that the overseas shipping industry strives to reduce. Additionally,

the costs of the vessels significantly impact a firm’s cost structure. The energy shipping

industry is service-based and thus firms cannot reduce input costs through vertical

integration by producing their own inputs (vessels, bunker fuel, etc.). Firms must think

of more creative ways to lower their input costs. Most companies manage these costs

by participating in commercial pools and charters that increase asset utilization through

coordination of resources.

Little Research and Development

Research and Development, or R&D, is the “investigative activities that a

business chooses to conduct with the intention of making a discovery that can either

lead to the development of new products or procedures, or to improvement of existing

products or procedures” (Investopedia.com). The energy shipping industry is a service

industry in which firms do not typically invest in research and development. Therefore,

this is not a cost incurred by an energy shipping firm. It would be very costly for a firm

to start building their own vessels, and it is common industry practice to buy or lease

the vessels they use for shipping. R&D would be much more likely to be seen in the

companies that build the vessels and then sell to firms in this industry.

 

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Differentiation

Superior Product Quality

In the energy shipping industry, superior product quality is essential to

maintaining a competitive edge. Many of the companies in the industry supply different

characteristics dealing with their products quality. Some companies base their superior

quality on the fact that their ships are new and state-of-the-art. “Others rely on their

innovations, such as, safe tank venting, inert gas systems, crude oil washing,

sophisticated engine room control systems and satellite navigation. The most

significant innovation in recent years has been the double hull design, which became

mandatory from the early 1990’s” (osg.com). Many major companies offer at least one

of these features in order to create a competitive advantage, in terms of quality, over

other companies in the industry.

Superior Product Variety

Companies within this industry must search for ways to provide their customers

with superior product variety in order to stay competitive. Since the basic functions of

each company do not significantly differ from one another, it is essential for companies

to offer a variety of products that set them apart from their competitors. For example,

since a large portion of the industry has begun to participate in the shipping of crude oil

internationally, some companies have started offering their customers other services

such as the shipment of liquefied natural gas. This allows a small portion of the

industry to gain a competitive advantage through an area in which other companies are

not participating. Providing superior product variety in the energy shipping industry will

allow a company to stay competitive and successful.

Conclusion

In the energy shipping industry, firms focus on various strategies that create

value and allow themselves to be competitive with rivals. Cost leadership is the main

strategy that these firms use to have competitive prices for customers. Companies that

 

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have lower input costs, utilize tight cost control systems, and refrain to focus

predominantly on research and development have been able to succeed. Industry

leaders apply differentiation strategies to stay ahead of a changing industry with an

increased focus on superior product quality and variety. With cost being very similar,

firms that are able to also differentiate have an edge over those that do not.

Competitive Advantage Analysis

Companies within the energy shipping industry compete against one another

using mostly cost leadership strategies. Since there is a relatively low amount of

product differentiation in this industry, companies try and distinguish themselves from

one another based on supplying their service at a lower price. Although cost leadership

is the strategy used to gain a competitive advantage in the energy shipping industry,

some companies use a few differentiation strategies to further set themselves apart.

Overseas Shipholding Group is one company within the industry that operates using

both the cost leadership and some differentiation strategies. OSG applies economies of

scale and scope, lower input costs, and tight cost control systems as cost leadership

strategies, and the use superior product quality and superior product variety as

differentiation strategies to gain a competitive advantage in their industry.

Economies of Scale and Scope

Overseas Ship holding Company excels in maintaining a diversified fleet of

vessels that take advantage of the dynamics of global trade. In particular, their

Aframax, Panamax and Suezmax vessels enable Overseas Shipping Company to ship

through the Panama Canal and the Suez Canal. In addition to allowing passageway

through various canals, the large size of the company’s Very Large Crude Carriers

(VLCC), enable overseas shipping to participate in the spot and charter markets moving

oil from the Middle East, North Sea and North Africa to North America, Western Europe

and Asian industrialized economies. Overseas Shipping also operates two of the four V-

 

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Plus VLCCs in existence. These ships can transport 3.2 million barrels of oil, opposed to

2 million barrels for a standard size VLCC, and achieve much greater economies of scale

through their reduced bunker (fuel) costs, decreased labor usage per barrel, and

decreased toll and port fees per barrel transported.

 

  As the above graph indicates, Overseas Shipping achieves increased asset

utilization through the flexibility of their fleet. This enables the company to dry dock or

time charter vessels that aren’t being used at full capacity and to combine their large

fleet with others in the industry through commercial pools. Through the aforementioned

strategies, Overseas Shipping is able hedge against the volatile spot market for energy

transportation by diversifying their fleet in order to take advantage of economies of

scale and scope.

Lower Input Costs

The energy shipping industry is service-based, therefore; firms cannot simply use

vertical integration or outsourcing to lower their input costs. They must be more

creative. According to Overseas Shipholding Group’s 10-k, financial flexibility is a big

part of their business strategy. “The Company believes its strong balance sheet, high

credit rating and high level of unencumbered assets give it access to both the

unsecured bank markets and the public debt markets, allowing it to borrow primarily on

an unsecured basis. This, in turn, reduces its financing costs and cash flow breakeven

Aframax

Suezmax

Panamax

VLCC

Handysize

Other

 

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levels. This financial flexibility permits the Company to pursue attractive business

opportunities” (OSG 10-k). Because OSG excels financially with a high credit rating, it is

able to lower input costs by financing business at a lower interest rate. Low financing

rates save the company money which results in lower cost to the customer. According

to Wikinvest.com, OSG’s cash to market cap ratio was 28% at the end of the third

quarter in 2007. OSG’s “growth and diversification has led to big gains in revenue over

the past four years” (wikinvest.com) Overseas Shipholding Group sometimes pays with

their large amounts of cash-on-hand to avoid interest expenses that could drastically

increase their input costs. In a serviced-based industry such as energy shipping, OSG

has found creative ways to reduce their input costs through efficient financing.

Superior Product Quality

Overseas Shipholding Group holds a competitive advantage over other

companies when it comes to its vessels’ ages and their double hulls. The company’s

VLCC (which includes its two V-Plus vessels) has an average age of seven years. The

Aframax vessel has an average age of 9.2 years and the average age of the world fleet

is 8.9 years. The Panamax has an average age of 4.3 years, while the world fleet

average is 9.1 years. The handysize product carriers have an average age of 6.2 years,

and the average world fleet is 9.4 years. Besides the Aframax every other type of

vessel is considerably younger and more up to date then the average age of the world

fleet. When customers consider the quality of the vessels that will be used to ship their

energy, they want to be assured that the vessels are reliable and up to date (OSG 10-

k).

Another factor that gives OSG a competitive advantage over other companies in

the energy shipping industry is the double hull enclosed in each of their vessels. The

newer ships that contain double hulls have a large advantage over older fleets that

have only single hulls. “A double hull is a ship hull design and construction method

where the bottom and sides of the ship have two complete layers of watertight hull

surface: one outer layer forming the normal hull of the ship, and a second inner hull

 

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which is somewhat further into the ship, perhaps a few feet, which forms a redundant

barrier to seawater in case the outer hull is damaged and leaks” (Wikipedia.com). It

would stand to reason companies would enjoy having this perk in their shipping vessels

because of the added protection it allows for their valuable energy shipment.

Superior Product Variety

Overseas Shipholding Group is on the leading edge of superior product variety

within the energy shipping industry. Since the energy shipping industry has a low

product differentiation, OSG has reached out and obtained one of the most diversified

fleets in the industry to allow them to compete in several different ways. In order to

distinguish themselves from the industry as a whole, they have developed four distinct

products to offer their customers. By offering their customers significantly more

products than their competitors, it helps them to gain a competitive advantage.

Although OSG’s main form of revenue is still crude oil shipment, their continually

diversifying their sources of revenue more efficiently than their competitors. Much

more diversified than many of their top competitors.

 

 

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The most noteworthy aspect of OSG’s company that allows them to gain a

competitive advantage in their industry is their participation in U.S. based shipping.

Although it is a small portion of their overall revenue, in the specific U.S. based market,

they hold an extremely high percentage of the market share. Two of their top

competitors, Frontline Ltd. and Tsakos Energy Navigation, do not even offer this

product to their customers. As you can see from the graph, where OSG is growing the

most is in their revenues from their international product fleet. Even though three of

OSG’s top four competitors also offer this service to their customers, OSG is expanding

their share of that market more than other firms. The last aspect of OSG’s product

variety is the shipment of liquefied natural gas. This makes up the smallest portion of

their overall revenue but, again, OSG is one of the top suppliers of this service relative

to the industry as a whole. One of OSG’s top competitors does not offer this service

while another top competitor has only one ship to supply this service.

Conclusion

In conclusion, Overseas Shipping primarily adheres to a cost leadership strategy

but finds ways to differentiate itself through several elements of the differentiation

strategy. Overseas Shipping positions itself in the market as a diverse shipper and

broker through its extensive product variety. The flexibility of their specialized fleet to

traverse various canals and waterways, as well as their economies of scale in

brokerage, logistics and sheer vessel size, enable Overseas Shipping to reap abnormal

returns relative to the industry.

It is through the aforementioned strategies that Overseas Shipping is able to

manage the “shipping cycle” through time charter arrangements, diverse shipping

destinations, scale/scope of their vessels and diversity of the customers they service.

The higher predictability (smoothing) of the company’s earnings infers a lower than

average cost of capital which further enhances their abilities to manage downturns(rate

backwardation) as well as expand in up markets(rate contagion).

 

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Accounting Analysis

“The purpose of accounting analysis is to evaluate the degree to which a firm’s

accounting captures its underlying business reality” (Palepu & Healy). Many companies

use accounting to portray an inaccurate view of the financial state of their business.

Therefore, a thorough accounting analysis is key to any financial evaluation. The six

steps required to perform a successful accounting analysis are:

1. Identifying the key accounting policies that directly relate to the firm’s key

success factors. By focusing on these related accounting policies, financial analysts have

a basis to measure the company’s critical components as well as its risks.

2. Assessing flexibility in choosing accounting policies and estimates. The policy

choices managers use have a sizeable impact on the reported performance of a

company and are, therefore, important to assess.

3. Evaluating the strategy managers use to maximize the benefits of the

flexibility in accounting policies. Managers who have accounting flexibility have the

ability to hide poor performance so analysts must pay attention to this.

4. Evaluating a firm’s choice in disclosure of accounting information and whether

the company used the disclosure to its benefit. Analysts must ask whether the

company’s choice of disclosure is helping or hurting the perception of the company.

5. Identifying potential red flags that highlight questionable accounting. Analysts

examine problematic items within the financial statements and gather more information

about them.

6. Undoing accounting distortions that are misleading. To prevent people from

mistakenly valuing the company based on misleading strategies and accounting policies,

analysts must undo misleading distortions.

 

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Key Accounting Policies

“In accounting analysis…the analyst should identify and evaluate the policies and

the estimates the firm uses to measure its critical factors and risks” (Palepu & Healy).

As previously discussed, the key success factors in an industry play a major role in

determining what a company should do to be successful. Economies of scale and scope,

efficient production, and lower input costs are all type 1 key success factors pertaining

to Overseas Shipholding Group. Accounting policies also contribute to a company’s

success. Overseas Shipholding Group’s type 2 key success factors were cost leadership

and differentiation. The cost leadership success factors included economies of scale and

scope, and lower input costs. Also, the differentiation success factors were a mixture of

superior product quality and variety. When OSG executes its key success factors well, it

is likely to be successful and profitable, but skewed accounting can lead to an

inaccurate valuation. Managers who are willing to distort accounting numbers will most

likely distort important policies to significantly improve their company’s financial

outlook. The smallest distortion in OSG’s accounting could potentially mislead their

customers. The job of an analyst, then, is to review a company’s accounting policies,

which tell whether or not a company is achieving their key success factors.

Operating Leases

In acquiring long-term fixed assets, firms have choices in the structure of their

payments and how these cash flows are reflected on the financial statements. A firm

can purchase the asset outright with cash generated from retained earnings or from

external financing sources. Alternatively, the firm can effectively “rent” the asset

through operating leases, or “rent-to-own” the asset through a capital lease. In the

event the company chooses to lease the asset, the type of lease (operating/capital)

determines whether or not future lease payments are incorporated in the liabilities

section of the balance sheet as well as the subsequent asset of the owned portion of

the asset, less accumulated depreciation. Additionally, the firm will have to recognize

 

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the interest expense associated with carrying value of the liability in the event a capital

lease is chosen.

Although capital and operating leases are close substitutes, each contractual

arrangement reflects different business realities and the appropriate lease type should

be chosen to reflect the operating life as well as the duration of future lease payments.

Operating leases are appropriate when the usage of a capital is short term, relative to

the life of the asset, and there exists no ownership rights to the asset. The usage of an

operating lease implies the lessee has no stake in capital gains, or losses, of the asset

because the firm lacks ownership rights to take advantage of such gains (or suffer the

associated losses). Operating leases reflect a short-term relationship of future lease

obligations and suggest to the investor that the firm could effectively “back-out” of their

usage of that asset and cease lease payments.

Capital leases are recorded on the balance sheet as a liability (present value of

all future lease payments) as well as the accompanying leased asset (fair value of the

asset or the equivalent present value of future payments, less accumulated

depreciation) at lease signing. This is the significant distinction between the two types

of leases in that future lease payments are recognized as a liability and ownership

rights of asset are effectively transferred to the end-user under a capital lease. The

usage of a capital lease communicates to the user of financial statements that the

duration of future payments better mirrors the useful life of the asset as well as

ownership of that asset and its capital gains or losses. Principally, a capital lease is

appropriate when the firm owns the asset at-risk and will continue to use the asset for

the majority of its useful life.

In the energy shipping industry, managing fixed assets, namely vessels, and

their potential for excess capacity (high fixed to variable costs) is a key success factor

of the industry. Accounting for these fixed assets is important in understanding the

future profitability of the company and its ability to earn abnormal returns on assets.

Accurately reflecting fixed future payments for vessels is important for several reasons.

 

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First, vessel prices are highly correlated with vessel spot rates and fluctuate greatly.

Reflecting the ownership component of the vessel is very important in communicating

the economic consequences of business activities because the firm will eventually have

to record a gain or loss on the sale of that asset (or adjust its depreciation methods to

write the asset off over time). Secondly, reflecting the binding aspect of future lease

payments, often lasting for longer than 15 years, is useful in determining the potential

for future excess capacity and the accompanying price-competitive environment.

Simply, how will the firm “weather the storm” of prolonged backwardation in spot rates

when they have to pay fixed operating expenses

Goodwill

Goodwill is an intangible asset that arises when a firm pays an excess price for a

certain acquisition. Goodwill gaps the difference between the market value and the

book value of an acquired asset. In the energy shipping industry, this premium a

company pays is due to external selling factors such as long-term customer

relationships or charter-in contracts acquired. This makes goodwill difficult to account

for and even harder to measure in terms of business activities. Though it is difficult to

account for, goodwill can be used to give a firm a more favorable standing with regard

to its financial statements. Goodwill can also be used to determine why the firm

overpaid for a certain asset. According to SFAS 142, “goodwill has to be written down

immediately upon being deemed overvalued.” This means that goodwill cannot be

amortized. Furthermore, SFAS 142 states that goodwill needs to be assessed for

impairment annually. OSG states that it impairs goodwill on a yearly basis as required

by SFAS 142. Yearly impairment is used unless an extreme situation requires the need

to impair it more frequently. Impairment to market value is necessary when the

carrying value is greater than fair value. Companies may leave goodwill on their

balance sheet indefinitely only as long as the goodwill remains valuable. If goodwill is

 

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left on the balance sheet and not impaired, then total assets will continue to be

overstated.

Assets = Liabilities + Equity Revenues - Expenses = Net Income

O N O N U O

N=No Effect O=Overstated U=Understated

As evidenced by the above table, managers can change the financial position of the

firm by overstating goodwill, not presenting it as impaired, when it should be.

Within the energy shipping industry, firms will acquire other shipping companies

in order to expand their own. Goodwill is recorded as an asset when firms buy these

new subsidiaries. The goodwill of Overseas Shipholding Group and its close competitors

is reported in the table below.

Goodwill (in thousands)

Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding 0 0 0 0 64,293 72,463

Frontline Ltd. 0 0 0 0 0 0

Teekay Corp. 89,189 130,754 169,590 170,897 266,718 434,590

Tsakos Ltd. 0 0 0 0 0 0

OSG and Teekay Corporation are the only two companies that have reported any

goodwill over the past six years. As seen above, goodwill has drastically increased over

the last few years. Though goodwill has increased over the past two years, it is only a

small portion of OSG’s total assets. OSG’s Property, Plant and Equipment for 2007

amount to $4,158,917,000, therefore, goodwill is only 1.74% of total PP&E for this

year.

 

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Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding 0 0 0 0 2.54% 2.46%

Teekay Corporation 4.62% 5.39% 5.17% 5.26% 5.02% 6.35%

The above table discloses the comparison of goodwill to plant, property, and

equipment. According to the table, goodwill is only a small portion of PP&E for both

Teekay and OSG. Over the last two years, OSG’s goodwill only represents an average

2.5% of PP&E. However, Teekay’s goodwill represents an average 5.3% of its PP&E

over the past six years. These numbers provide evidence that the premium paid on

acquired subsidiaries only represent a small portion of their PP&E.

Goodwill as Percent of Operating Income

Company 2002 2003 2004 2005 2006 2007

Overseas Shipholding 0 0 0 0 16.98% 34.91%

Teekay Corporation 74.73% 44.63% 26.84% 27.05% 63.23% 109.21%

For these close competitors, goodwill represents a large portion of operating

income as evidenced by the table above. Though OSG’s goodwill is a large portion of

its operating income, it is not as significant as Teekay’s reported goodwill. We believe

that OSG needs to impair more goodwill in order to accurately depict the portion of

operating income. To determine if goodwill compared to operating income is accurate

and significant, an amortization of goodwill compared to operating income must be

calculated. The following table depicts an amortization of 2007 goodwill over a five-

year period at twenty percent per year.

Goodwill as Percent of Plant, Property and Equipment

 

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Once this forecast is determined, the assumed amortized goodwill percentage of

operating income per year must be derived. The following table depicts these

percentages.

Amortized Goodwill as a Percent of Operating Income

Company 2003 2004 2005 2006 2007

Overseas Shipholding 6.44% 2.85% 3.05% 3.81% 6.69%

Teekay Corporation 29.67% 10.58% 13.76% 20.6% 21.84%

If OSG were to amortize its goodwill over a period of five years at twenty percent, it

would significantly decrease the goodwill portion of operating income. Teekay’s

goodwill portion of operating income would still be at a high level. This leads us to

reason that OSG is impairing its own goodwill at appropriate times. This method of

amortizing goodwill, as shown above, could drastically change the financial position of a

firm in this industry. Managers of the firm could use this or other described methods to

hide the true value of goodwill. This leads to the assessment of determining the

flexibility of goodwill relative to the accounting structure.

Goodwill Amortized at 20% (in thousands)

Company 2003 2004 2005 2006 2007

Overseas Shipholding 14,492 14,492 14,493 14,493 14,493

Teekay Corporation 86,918 86,918 86,918 86,918 86,918

 

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Hedging Activities

In industries that rely heavily on cost control procedures, as in the energy

shipping industry, certain differentiation activities may be used to reduce company

costs. Within the energy shipping industry, there are several factors that could lead to

an unstable market. Fluctuations in interest rates, foreign currency exchange rates,

and energy costs are some major factors that, if not handled properly by a firm, could

lead to unstable costs. In order to minimize and help control future costs in the energy

shipping industry, most companies choose to participate in an activity known as

hedging. “Hedging is a strategy designed to minimize exposure to such business risks

as a sharp contraction in demand for one's inventory, while still allowing the business to

profit from producing and maintaining that inventory” (wikipedia.com). The main

purpose of hedging is to reduce risk in an unstable market.

The energy shipping industry can be greatly affected by fluctuations in shipping

rates. A high majority of revenues earned by firms within the energy shipping industry

are from contracts in the spot market. “The spot market or cash market is a

commodities or securities market in which goods are sold for cash and delivered

immediately. Contracts bought and sold on these markets are immediately effective”

(wikipedia.com). Since such a high proportion of revenues come from the spot market

in the energy shipping industry (as evidenced by the graphs below) it is important for

firms within the industry to attempt as much control of the market rates as possible.

 

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As Percent of Total Revenue

One way that firms attempt to maintain a stable rate within the industry is by

entering into Forward Freight Agreements. These agreements are an “economic

instrument that reduces a firm’s exposure to changes in the spot market rates earned

by some of its vessels in the normal course of its shipping business” (OSG 10-K).

Firms within the energy shipping industry are also at risk to changing interest

rates. OSG and its top competitors implement a hedging activity known as interest rate

swaps to aid in minimizing this risk. Since the interest rates are constantly fluctuating

within this industry, firms employ interest rate swaps to ensure that a currently floating

rate will remain fixed when implemented. This is an important cost control feature for

firms because it allows them to maintain a steady rate in the future and remain

unaffected by changing interest rates other firms in the industry may be forced to use.

Since a large majority of business is conducted overseas within the energy

shipping industry, the foreign currency exchange rate is a major component that, if not

controlled, could have a damaging effect on a firm. Since some major firms in this

industry are paid in foreign currency, it is important they seek to keep these rates in

check. In order to do this, some firms will enter into forwards contracts that promise a

rate to be paid in the future even if it has fluctuated since the signing of the contract.

29%

71%

FrontlineTime Charter Spot Market

38%62%

Overseas Shipholding Group

Time Charter Spot Market

 

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Benefits and Pension Plan

Defined benefit pension plans and medical benefits are a firm’s future financial

obligations promised to workers. These obligations are recorded at present value as

liabilities of the future installments owed. The future installments are calculated by

using discount rates created by the firm’s management and outside actuaries. Too high

of a determined rate would understate liabilities, whereas too low of a rate would

overstate the liabilities. Since these numbers are primarily created by the firm, with

outside guidance, they can be subject to human error. These long-term liabilities could

greatly affect the financial position of a company through its financial statements. The

substantiality and validity of these pension plans can be derived from the company’s

10-K or equivalent annual report.

In comparison to Teekay Corp., Frontline Ltd. and Tsakos Ltd., Overseas

Shipholding is the only company that discloses information about discount rates, growth

rates for estimating future benefit costs, estimated asset growth used to pay for benefit

obligation liabilities, and the proportion of benefit plans relative to long-term debt. This

determines that OSG highly discloses information regarding benefit plans relative to

their competitors in the energy shipping industry. OSG’s 10-K indicates that it sponsors

a noncontributory defined benefit pension plan covering substantially all of their

domestic shore-based employees hired prior to January of 2005. The 10-K also

discloses that retirement benefits were based on years of service and compensation

earned during the last years of employment. OSG also provides certain postretirement

health care and life insurance benefits to qualifying domestic retirees and their eligible

dependents. Qualifying employees, according to OSG’s 10-K, are ones hired before

2005, who retire and have met minimum age and service requirements under a formula

related to total years of service (not disclosed). The postretirement health care plan is

contributory, whereas the life insurance plan is noncontributory.

The substantiality of these benefits on OSG’s balance sheet is miniscule

compared to total long-term debts. In 2007, OSG reported total long-term debt as

 

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1.506 billion when they only reported total benefit obligations (postretirement pensions

and other postretirement benefits) at 48.216 million (OSG 10-K). This proves that,

compared to the rest of their long-term debt, their long-term obligations to employees

only comprise a small amount of liabilities. Further disclosure is provided by OSG

because they report the rates at which to discount the future obligations in order to

determine their present values. OSG’s discount rates from 2002 to 2007 are shown in

the table below:

Defined Benefit Pension Plan Discount Rates

OSG 2003 2004 2005 2006 2007 2008

Discount

Rate 7.4% 6.7% 6.2% 5.75% 5.25% 5.20%

According to the U.S. Department of Labor, the average inflation in 2007 was

2.85%. This inflation rate has been at a decrease over the past few years. Since the

discount rate used by OSG from 2002 to 2007 decreased, these are seen as reasonable

rates compared to the inflation. OSG discounts their post retirement plans at a higher

rate than inflation because any return on an investment would receive this much

interest at a minimum without risk premium. OSG also uses a slightly declining

discount rate for other medical and post retirement benefits. These rates from 2002 to

2007 are shown in the table below:

Other Medical and Post Retirement Benefits

OSG 2003 2004 2005 2006 2007 2008

Discount Rate 7.4% 6.7% 6.2% 6.4% 6.4% 6.2%

 

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These rates are considered reasonable since they decrease with a relative

decreasing inflation rate. The obligation discount rates are disclosed, but the method

by which they are determined is not.

Assets are needed to pay for future, long-term obligations, such as pensions and

medical benefits. To determine how much a company needs in order to pay off these

liabilities, a formula is used to grow assets at a rate that is expected to be received in

the future. OSG defines the method for calculating these rates in its 10-K by saying

“the expected long-term rate of return on plan assets is based on the current and

expected asset allocations. Additionally, the long-term rate of return is based on

historical returns, investment strategy, inflation expectations and other economic

factors. The expected long-term rate of return is then applied to the market value of

plan assets.” Since many factors determine these rates, they are not an exact measure

of what the company will receive in the future. From 2003 to 2008 the expected return

on the plan assets that were used to pay pensions were set at rates shown in the table

below:

Rate of Return on Assets used to pay Pensions

OSG 2003 2004 2005 2006 2007 2008

Discount

Rate 8.75% 8.75% 8.75% 6.75% 6.75% 6.75%

These rates also follow the decreasing trend in inflation rates over the past

several years. In 2007 OSG determined that they needed 44.476 million to cover

pension benefits and 3.74 million to cover other postretirement benefits. The fair value

of the pension assets at the end of 2007 was 31.314 million, which left 12.762 million

unfunded plans at the end of that year. Furthermore, OSG had other unfunded benefits

of 3.74 million at the end of 2007. But, again, since these pension and other

 

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postretirement benefits are such a small portion of long-term debt, the amount left

unfunded is almost an inconsequential amount.

Assess Degree of Potential Accounting Flexibility

“Not all firms have equal flexibility in choosing their accounting policies and

estimates. Some firms’ accounting choice is severely constrained by accounting

standards and conventions” (Palepu & Healy). The strictness of accounting policies

varies from industry to industry. Some businesses’ accounting policies are highly

government-regulated while others are only partially regulated depending on their

nature. In certain more regulated industries, activities that are considered important are

sometimes required to be expensed while other industries can freely decide how to

report their business activities. When managers have constrained amounts of flexibility

in choosing accounting policies and estimates concerning their key success factors,

accounting data will not be helpful in trying to understand the firm’s financial status.

However, if managers have substantial amounts of flexibility when considering

accounting policies and estimates; their accounting numbers could potentially be

informative and reliable, as long as the managers have not used this flexibility to

manipulate data. When managers have a lot of flexibility in choosing accounting

policies, they should be monitored closely to determine whether or not they are

presenting inflated profitability or anything else that would mislead their customers. It is

important to determine, not only the level of flexibility but also the significance

associated with the business activity in order to make educated decisions based on the

company’s accounting figures. Analysts must interpret flexible accounting policies

differently than regulated ones. Because all firms have some flexibility regarding policies

such as depreciation, inventory accounting, and pensions, most of the analysts’ focus

should be placed on the flexibility of accounting numbers.

 

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Operating Leases

There exist several criterion mandated by the Financial Accounting Standards

Board that differentiate the appropriate use of operating and capital leases. Although

the intent of such standards is to accurately characterize the lease, it is often the case

that leases are structured with a designation in mind. We will examine the potential

flexibility a firm has in classifying a lease as operating or capital and the subsequent

effects this flexibility has on the firm’s financial statements.

Operating leases can be more advantageous to a public firm because they

reduce the firms liabilities, the accompanying asset, interest expense and depreciation

recorded on the balance and income statement. In addition, the conversion of an

operating lease to a capital lease tends to push earnings further back in the current

term and in future years through the higher discounting of cash flows in the short term.

This discounting effect occurs because interest expense is higher toward the beginning

of a loan amortization, while depreciation remains constant (strait-line) or is higher in

the near term (accelerated method). Therefore, there exist criterion that mandate the

use of capital leases as opposed to the use of operating leases. The criterion are as

follows:

1. If the leased life exceeds 75% of the life of the asset.

2. If there is a transfer of ownership at the end of the lease term.

3. If there is an option to buy the asset at a “bargain price” at the end of the lease

term.

4. If the present value of future lease payments, discounted at the appropriate discount

rate, exceeds 90% of the fair market value of the asset.

The constraints dictated above give users of financial statements a framework to

examine managers’ decisions to characterize the lease as operating or capital as well as

to shed light on further contractual covenants. The use of qualitative designations in the

 

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criterion allows significant flexibility in the structuring of leases. Additionally,

shareholders, debt-holders and the SEC are the only users with legal standing and

enforcement powers to challenge this designation.

Goodwill

When analyzing accounting strategies, it is necessary to take into account the

degree of flexibility that firms have on measuring and changing goodwill. GAAP changed

from allowing companies to amortize their assets to ultimately having them impair it, or

write it off, to the fair market value of the asset. This change occurred to keep assets

from being inflated. Goodwill is difficult to measure when trying to find the fair market

value, adding to the potential flexibility.

In the energy shipping industry, it is not common to have any goodwill stated on

financial statements. Therefore, companies that report goodwill, such as Overseas

Shipholding Group, have more flexibility than companies that do not. The reason

goodwill has appeared on OSG’s books in recent years is because of various

acquisitions, such as, the 2007 acquisition of Hiedmar Lightering. Increased flexibility

allows firms to manipulate its accounting and makes it more difficult to value.

Hedging Activities

Flexibility regarding how a firm can account for hedging activities could create

drastic changes in accounting numbers depending on the degree of flexibility allowed.

With regards to hedging activities, there are specific codes set up to provide firms with

detailed instructions on how to account for the exact activities that they have

participated in. The guidelines given by the FASB to account for hedging activities are

located in FAS 133. “FAS 133 states that all derivatives and hedging activities must be

recorded at fair value as an asset or liability” (fincad.com).

 

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The firm’s rational in applying the hedge accounting method must be clearly

identified in order to decide how to account for the activity. There are two primary

types of hedging activity relationships that affect how the specific activity will be

accounted for by the firm. The first is a fair-value hedge. A fair-value hedge is used

primarily by a firm in order to reduce the future risk that they may encounter. This

type of hedge is related to changes in the fair value of the recognized or unrecognized

asset or liability to which the hedge is linked. In order to account for a fair-value

hedge, the firm must report any gains or losses from the hedged item in the current

period net income. Since the amount of increase or decrease in the fair value of the

hedged asset is based on judgment rather than fact, there is a chance for bias.

The second hedging activity relationship is a cash-flow hedge. “A cash-flow

hedge is a hedge of the exposure to variability in cash flows of a recognized asset or

liability or a highly probable forecasted transaction, attributable to a specified risk”

(camagazine.com). The gains or losses reported from this type of hedge are

recognized on the income statement under other comprehensive income. There is

minimal room for bias in this area since the numbers are calculated by actual gains and

losses.

The FASB standards for reporting hedge activities make it clear that there is a

very low degree of flexibility in this area. The slight degree of flexibility comes from the

biases that could arise in the calculations of fair market values. Since there is such a

low degree of flexibility, it would be difficult for firms to influence their books to

promote healthier hedging activities than what actually is accounted.

Benefits and Pension Plan

Since pension and other postretirement plans are affected by arbitrary discount

and growth rates, they can be subject to human error. The flexibility of these rates,

can allow the firm to use larger than appropriate numbers in order to make the

 

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liabilities look smaller. Since these rates are flexible, a firm may use them to affect its

financial stability and standings in a manner that make them look more favorable to

potential investors.

OSG discloses most of the information used for these rates, whereas its

competitors do not disclose any. OSG does not, however, provide the expected rates to

determine return on plan assets used to cover other postretirement benefits. OSG does

mention in its 10-K that “the assumed health care cost trend rate for measuring the

benefit obligation included in other postretirement benefits is an increase of 10% for

2008, with the rate of increase declining steadily thereafter by 1% per annum to an

ultimate trend rate of 5% per annum in 2012.” This specifies that these rates are

estimated by the company’s management with opinions from outside actuaries. Since

these rates are estimated, issues of flexibility would arise for a firm. For OSG though,

the 1% increase/decrease effect on total of service and interest cost components in

2007 is only a difference of $62,000. Also, the 1% increase/decrease effect on

postretirement benefit obligation at the end of 2007 is a difference of $583,000. The

increase/decrease of rates determined by the firm are, again, insignificant compared to

the entire long-term debt. Because of this, it may be assessed that there is a high

allowance of flexibility on discount and growth rates.

Even though OSG has a lenient amount of flexibility in determining rates,

management could still allow growth rates that are lower than needed. This would

make the firm’s estimates of future liabilities appear lower. Because these future

liabilities would be lower, the firm’s expenses would be understated and therefore make

the company appear more profitable. The following over/under analysis depicts such

an environment.

Assets = Liabilities + Equity Revenues - Expenses = Net Income

N U O N U O

N=No Effect O=Overstated U=Understated

 

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This analysis shows the effect of rates on the accounting statements, and how it can

allow the company to appear more valuable. These subjective discount and growth

rates render flexibility on the accounting cycle at the discretion of the company.

Evaluate Actual Accounting Strategy

“When managers have accounting flexibility, they can use it either to

communicate their firm’s economic situation or to hide true performance” (Palepu &

Healy). Flexibility plays a major role in a firm’s accounting strategy. In order to

determine a company’s accounting strategy, an analyst must compare its accounting

policies and the level and quality of disclosure to those of others within the industry. It

can be difficult to recognize the different ways in which companies distort their

accounting numbers, but evaluating trends over time is a common way to detect any

skewed numbers. Exceptional increases or decreases in sales, income, or revenues

without corresponding economic or management changes are a good indicator of

accounting distortion. Analysts must also decide whether a company uses conservative

or aggressive accounting policies by considering market and book value. Understated

market values can lead to big gains for customers in the future while overstated book

values, which can overestimate the value of a company, could prompt less trading.

Operating Leases

A comprehensive equity analysis involves looking beyond the presented

information in annual reports and supplementary data. In order to ascertain the validity

of the information, it is necessary to determine the accounting strategy implemented by

the firms reporting units. Specifically, evaluating estimates, determining degrees of

aggressiveness or conservatism in discretionary items and assessing the relative level of

disaggregation in business segments are some of the processes this analysis will utilize

to gain a more informed perspective of business operations.

 

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Regarding the accounting strategy for leases (capital and operating), Overseas

Shipholding Group would be considered moderately aggressive in their reporting. The

extensive use of operating leases for vessels, which have operating lives similar to the

lease periods, is a strong signal of aggressive accounting policies. Additionally, OSG

does not provide a discount rate for their capital leases for the purposes of capitalizing

existing operating leases on restated financials. Due to the high similarity in vessels

being leased, a discount rate for capital leases would be highly useful in capitalizing the

existing operating leases. To better convey the relative mix of operating and capital

leases, the following graph shows the proportion of operating and capital leases

payments in future lease obligations.

Although more conservatism in the designation of leases as either operating or

capital would be beneficial, the voluntary disclosures detailing operating days, revenue

days and assets the lease encompasses are provided. Revenue and operating days are

useful in computing a depreciation rate associated with capitalizing the existing

operating leases as well as determining how the operating lease payments are

segmented into office space or vessel expenses. Relative to the industry as a whole,

OSG is very transparent in the performance of their various subsidiaries. Present in the

annual reports are details of revenue, operating vessels, expenses and business

97% 97% 97% 98% 100%

3% 3% 3% 2% 0%

0%10%20%30%40%50%60%70%80%90%100%

2008 2009 2010 2011 2012

Future Lease Obligations

Capital Leases

Operating Leases

 

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descriptions of the various entities under the OSG parent company. This information is

useful in determining future cash flows, liabilities and service diversification which aid

hedging efforts across all shipping needs and routes.

Goodwill

The amount of goodwill that Overseas Shipholding Group impairs will cause a

change in total assets which, in turn, will affect their expenses. Overseas Shipholding

and Teekay are the only competitors in the energy shipping industry that record

goodwill on their balance sheets. Although OSG’s goodwill only represents 1.74% of its

total assets, reporting it would still overstate the company’s earnings because their

expenses will decrease. The amount of goodwill that OSG is disclosing each year seems

accurate, considering the nature of the energy shipping industry. The company is

maintaining goodwill at less than two percent of total assets, which means OSG is

considered conservative when reporting net income.

Hedging Activities

Overseas Shipholding Group participates in hedging activities in order to reduce

future risks that the firm may encounter. In order to account for these activities, they

are required to follow strict guidelines stated in FAS 133. This statement instructs firms

that take part in hedging activities to calculate the fair value of its assets or liabilities

and record them on the balance sheet. Changes in the fair value of the assets or

liabilities are then computed and recorded in either net income or other comprehensive

income, as discussed in the previous section of hedging activities. Since OSG and its

competitors use market prices to determine fair value and all firms are required to

follow the restrictions given in FAS 133, the items reported on their financial statements

will resemble one another in the hedging area. It is difficult for a firm to implement

 

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conservative or aggressive accounting strategies in this area since estimates are

relatively similar and guidelines are strictly followed.

Benefits and Pension Plan

Disclosure of information about pension and retirement benefits can be used to

determine the value of a firm. OSG is the only company out of its close competitors

that actually discloses information related to its pension and postretirement benefit

plans. This high level of disclosure affords OSG a higher value over its competitors.

Since OSG discloses almost all information related to discount rates, growth rates,

assets used to pay future retirement liabilities and actual cost of future retirement

debts, this effectively gives more value to its financial statements. This value is

assessed through disclosure because it allows outside investors and entities to

determine the validity of the liabilities reported. Even though these liabilities are a

small portion of overall debt, disclosing information related to postretirement benefits

sanctions this analysis.

Furthermore, with regard to evaluating the accounting strategy, managers, with

well-informed opinions of outside actuaries, are allowed to determine if the discount

and growth rates used will be on a conservative or aggressive basis. Since OSG is the

only firm to disclose this information, we conclude that they use a conservative

approach for determining this information. The conservatism is portrayed through the

decline in growth and discount rates over the last six years. This is relative to the fact

that interest rates have decreased over the past several years as well. These rates can

also be determined as conservative since they do not effect the financial statements

substantially. Lastly, these rates can be determined as conservative on a national basis

since the “S&P 500 companies had a combined pension deficit of $376 billion at the end

of 2008, according to Bank of America. Many companies with defined-benefit plans had

more than half their assets in equities at the end of 2007. If all that was in the U.S.,

 

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they still lost 40% last year” (WSJ – Pension Deficit Disorder). This provides that actual

rates were falling nation-wide, not just within a particular industry.

Quality of Disclosure: Qualitative Analysis

“While accounting rules require a certain amount of minimum disclosure,

managers have considerable choice in the matter” (Palepu & Healy). Analysts must

evaluate everything from the letter to shareholders to the footnotes in order to decide

whether a company is using such seemingly insignificant things to make their company

look better. Evaluating quality of disclosure is less about looking at accounting policies

and more about reviewing the other ways managers can misrepresent information

concerning their companies. Analysts consider the Management Discussion and Analysis

section of the report, footnotes, letter to shareholders, and the manner in which

management deals with adverse situations. These elements offer subtle clues to the

approach a company takes when considering the subject of disclosure.

Type 1 Key Accounting Policies

It is essential to consider how the quality of supplementary disclosure reflects

upon the key success factors identified in an industry. For the energy shipping industry,

we identified economies of scale and scope, efficient production, and lower input as our

key success factors. In the following subsection we will examine how the quality of

disclosure of operating and capital leases reflects upon the aforementioned key success

factors.

Economies of Scale and Scope

Overseas Shipping Group discloses, quite extensively, the relative ownership of

their leased vessels as well as the expiry of such leases. Additionally, OSG discloses

 

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such items like revenue days, operating days, average TCE rates in an effort to allow

the investor to examine their operating efficiency and profitability. Many firms in the

industry do not go as far as OSG does in disclosing the nature of the operating leases.

Specifically, what types of boats are leased, the expiry date, and the remaining revenue

days associated with the leased vessels overtime (aggregate contractual obligations).

These items are inherently related to economies of scale and scope as well as lower

input costs.

Users of OSG’s financial statements can compare the type of vessels acquired,

their future lease obligations and the date of expiry to current lease payments found on

the current year’s income statement. This would enable the investor to determine how

much OSG is paying to lease vessels and increase total revenue days. Although OSG

voluntarily discloses more information about their leased vessels than do, for example

Teekay, a less convoluted structure to the way they compute revenue days as well as

further explanation of the computation would be beneficial in determining the ability to

achieve lower input costs. Revenue days are weighted by ownership, but not by vessel

type. For example, a revenue day for an Aframax carries the same weight as does a

revenue day for a VLCC. This presents distortions in calculating how efficiently OSG is

obtaining its vessels.

Efficient Production

The key success factor of efficient production can be best related to the energy

shipping industry in terms of vessels operating in commercial pools. Commercial pools

aggregate vessels of similar size and use and coordinate the logistics to ensure efficient

use of all the vessels as a whole. Independent operators commit their vessels to these

pools and pay management/administrative fees in return for a higher return on their

operating fleet. Although OSG details which vessels are operating in commercial pools,

they leave the majority of the disclosure up to the commercial pools themselves. The

pools don’t report how much they charge for management fees, nor does OSG present

 

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what kind of revenue these ships can generate if they were employed independently.

Additionally, OSG doesn’t discuss how many revenue days are derived from commercial

pools. This disclosure would aid the calculation of revenue per revenue day. As

discussed earlier, revenue days are calculated indiscriminate to the type of vessel being

operated. Discussion of relative revenue days and the management/administrative fees

would aid investors in determining the competitive advantage afforded through

participation in commercial pools.

Lower Input Costs

Obtaining lower input costs is a key success factor in an industry characterized

by cost leadership. In the context of the energy shipping industry, lower input costs

best relates to the acquisition of the operating fleet. As discussed earlier, OSG employs

operating leases for 53(fy2008) of its vessels, necessitating the calculation of the costs

of these operating leases relative to the vessels obtained. OSG doesn’t disclose the

price per year of an operating lease on a single vessel, but instead, chooses to only

disclose the total amount paid for operating leases in that year. Additionally, OSG

discloses the revenue days and expiry of all vessels allowing the investor to determine

this is information in a dubious manner. As presented, there is no method to determine

if the current years’ lease expenses are related to future vessels, additional current

vessels or a sale-and-leaseback transaction. Therefore, it is very difficult to forecast

future lease obligations beyond the minimum lease payments provided, but more so, it

is difficult to determine if OSG is benefiting from the use of operating leases. Additional

detail is needed to determine if the choice of operating leases opposed to capital leases

or outright purchases is beneficial in participating in the spot market while rates are

high and limiting their capacity when rates are low. Their disclosure of expiry dates

relates to the latter, but actual costs of operating lease contracts related to the specific

vessels employed and their participation in spot and charter out markets would be very

relevant and useful.

 

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Type 2 Key Accounting Policies

Operating Leases

Previously we evaluated the degree of conservatism or aggressiveness in

reporting financial statements. In regard to operating and capital leases, significant

amount details are needed to calculate the restated depreciation expenses for the life of

the asset, interest expense and discount rates. For this analysis, examining the quality

of disclosure relating to operating and capital leases clarifies the nature of future

contractual obligations.

Overseas shipping group employs a significant amount of operating leases

relative to their capital leases. Since 2003, the company has increased their number of

chartered in vessels from 7.1 (ownership weighted) to 53 in 2007. The company

provides revenue days as well as operating days relative to the future operating lease

obligations. Operating days simply reflect the sum of the future calendar days the ship

is expected to be operational. Revenue days represent operating days minus time in dry

docking, repair and layup, weighted to reflect ownership. In addition, OSG discloses the

expiry dates of operating leases (charter-ins) on every vessel they operate, as well as

percentage ownership of the vessels under capital leases. Opposed to their competitors,

OSG discloses information related to their new build program, their subsidiaries’ fleet

and the date certain vessels will be banned for the lack of double hull construction or

special coating for environmental purposes.

Although we applaud OSG for their levels of supplementary disclosure, there are

several items in which we would like more clarification. First, operating lease obligations

rise year over year (since 2003), however their minimum net lease obligations don’t

reflect the future expansion of their fleet. Additionally, the degree to which the

company is expected to charter-out future vessels impacts their exposure to

overcapacity if shipping rates decline to unprofitable levels. Most significantly, the lack

of disclosure relating to the nature of the sale-and-leaseback transactions is of high

concern. Commonly, operating leases on vessels involve provisions to extend the life of

 

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the contract at a specified rate, or simply an option to purchase the vessel outright.

This limitation inhibits the transparency of the available information like operating days

and expiry dates of operating lease contracts to determine the intent of the company.

Simply, the current payments and supplementary disclosures may conceal the

company’s strategy to extend, cancel or charter out future vessels under operating

leases.

In conclusion, OSGs quality of disclosure could be considered mixed, moderate

or slightly better than the majority of energy shipping terms. The firm goes beyond

what similar companies disclose, however, their voluntary disclosure raises new

concerns on the details of contractual obligations.

Goodwill

On an absolute basis, the quality of disclosing goodwill in Overseas Shipholding’s

financial statements is fair. Furthermore, OSG’s disclosure of goodwill is above average

when compared to its close competitors. Teekay is OSG’s only competitor that

acknowledges goodwill. This determines that OSG and Teekay are the only firms that

acquire subsidiaries at a premium cost. The information provided by OSG is considered

to add transparency to the financial statements. This transparency is derived from the

company’s reporting of goodwill, which effectively aids in the analysis of the company.

Compared to the rest of the industry, an investor would look highly on reported rather

than unreported goodwill. The investor would see that the company is making an

attempt to expand by acquiring new subsidiaries within the past two years. This

evidence supports our determination that OSG is fair with regard to disclosure of

goodwill.

Hedging Activities

As stated in Hedging Activities section under the Key Accounting Policies, firms

within the energy shipping industry can be greatly affected by fluctuating rates. The

 

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firms engage in extended contracts that could be affected by changing rates and

therefore cause a firm to lose money. They also engage in shipping overseas which can

cause transactions to be heavily influenced by foreign exchange rates. The hedging

activities executed by firms reduce risk and give an advantage in a cost leadership

industry.

The information disclosed in Overseas Shipholding Group’s 10-K regarding its

hedging activities is adequate. OSG discloses exactly what types of items are hedged

and the reasons why it is thought to be necessary to do so. Under their “Risk

Management” section, the company provides a clear answer to what activities require

hedging. Initially the firm indicates its engagement in interest rate swaps which are an

“agreement to exchange various combinations of fixed and variable interest rates based

on agreed upon notional amounts”. After they discuss interest rate swaps, they

disclose information on implementation of Forward Freight Agreements. OSG states

that by using these agreements, it “manages the financial risk associated with

fluctuating market conditions.” OSG declared that in 2007 their FFA agreements had a

fair value of nearly $6,500,000. OSG recorded this amount as a liability. The last

hedging activity disclosed in OSG’s 10-K is related to foreign exchange rates. In order

to avoid any fluctuations in these rates, OSG uses a functional currency of U.S. dollars

and says that its revenues and costs are accounted for in this currency.

Overseas Shipholding Goup has all of its hedging activities accounted for in its

10-K. Although some of the fair values determined for assets and liabilities can be

affected by biases as discussed earlier, OSG does not leave much in question. The

description and rationale of activities performed is clearly outlined. When comparing

OSG’s 10-K to that of top competitors, it becomes clear that this is the standard amount

of disclosure for firms in the energy shipping industry.

Benefits and Pension Plan

The qualitative disclosure on postretirement benefits for OSG is high relative to

other companies in the energy shipping industry. Close competitors to OSG do not

 

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disclose any information about postretirement benefits or pension plans. OSG discloses

almost every facet regarding the determination of postretirement costs to the firm. The

transparency of these accounting numbers is better than OSG’s close competitors and

is, therefore, considered fairly transparent. Since OSG does not provide the equation

for determining growth rates of postretirement benefits, its analysis of future costs for

medical plans and other benefits is somewhat indeterminate. Overall the transparency

of the financial statements with regard to postretirement benefits is reasonable.

Quality of Disclosure: Quantitative Analysis

Quantitative analysis is imperative when evaluating and understanding a

company’s financial statements. Analysts use many different ratios to obtain “real

world” numbers from a company’s accounting statements. These ratios are used to

analyze accounting quality and disclosure within the industry. Ratios are useful in

exposing possible distortions and, thus, lead to a more accurate view of the company.

These ratios by themselves, however, are not the final answer in analyzing the

valuation of a company. When used in conjunction with one another, ratios can depict

certain trends not previously apparent.

Sales Manipulation Diagnostics

The sales manipulation diagnostics are used to analyze the financial data of a

firm and to determine if there are any abnormalities that might be caused by distortions

in the way firms report revenue related accounting numbers. Firms may want to

manipulate its sales numbers to either understate or overstate its net income for a

given year. Essentially, we will be assessing the credibility of the sales reported. Data

from the last seven years will be used to calculate ratios for Overseas Shipholding

Group and three other competitors in the energy shipping industry. In the end, we will

determine if there are any potential red flags that show up from possible manipulation

 

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of financial information or improper discloser. Since there is no unearned revenue,

inventory, or warranty liability in this industry, we will look closer at revenues and how

it compares to cash from sales and accounts receivable. The tables that were used to

create the following graphs can be found in Appendix A.

Net Sales/Cash from Sales

The net sales over cash from sales ratio is used to view the revenues that a firm

is earning and the amount the company is currently making from transactions as

opposed to receiving payment at a later date. The net sales to cash from sales ratio

essentially reveals if a firm’s sales are supported by the amount of cash collected. This

ratio should be close to 1:1 and stay consistent over time. A firm with an increase in

sales should experience an increase in the cash collected from total sales. There could

be a potential red flag if a there is high variability in this ratio because it might mean

that a firm is recognizing too much or not enough sale during a given period.

 

0.85

0.90

0.95

1.00

1.05

1.10

1.15

2003 2004 2005 2006 2007 2008

Net Sales/Cash from Sales (raw)

OSG

Frontline

Teekay

Tsakos

‐15.00

‐10.00

‐5.00

0.00

5.00

2003 2004 2005 2006 2007 2008

Net Sales/ Cash from Sales (change)

OSG

Frontline

Teekay

Tsakos

 

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Since 2005, OSG has had consistent net sales to cash from sales ratio close to

1:1. This suggests that the revenues that OSG reports in its 10-K are supported by the

cash collected. The firms in this industry increase and decrease together from year to

year which means there is structural movement in the energy shipping industry. The

change graph also does not suggest any red flags or manipulation of sales. OSG has

maintained a consistent positive change from year to year. There is no concern when

the value of a change graph is greater than zero.

Net Sales/Accounts Receivable

The net sales over accounts receivable ratio is used to access if the revenues

that a firm is earning support the amounts that a firm reports that it expects to receive

at a later date from those sales. There should be a positive correlation in these graphs.

If the revenues of a firm increase, it is expected that the accounts receivable would also

increase. A firm that has abnormal net sales to accounts receivable ratio for a given

year would raise a concern that they may be overstating sales for the purpose of

overstating net income. Cases such as this would result in a potential red flag.

 

0.00

5.00

10.00

15.00

20.00

2002 2003 2004 2005 2006 2007 2008

Net Sales/ Accounts Recievable (Raw)

OSG

Frontline

Teekay

Tsakos

 

Page | 79   

 

  According to the raw and change form graphs above, OSGs sales are supported

by the account receivable. Although lower than the rest of the energy shipping industry,

the ratio has remained stable over the last seven year. After analyzing the change form

graph, the same is true except for a positive increase between 2007 and 2008. A

positive value is a good sign and is expected, so OSG does not raise any red flags for

this section of the diagnostic test.

Conclusion

Overall, no potential red flags were found when assessing the credibility of the

revenues that OSG reports. These diagnostics do not raise concerns that OSG

manipulates its sales for the purpose of increasing or decreasing net income during a

given year.

(80.00)

(60.00)

(40.00)

(20.00)

‐

20.00 

40.00 

2003 2004 2005 2006 2007 2008

Net Sales/ Accounts Receivable (change)

OSG

Frontline

Teekay

 

Page | 80   

Sales Manipulation Diagnostics   

OSG  2002  2003  2004  2005  2006  2007  2008 

Sales/Cash from Sales (raw)  ‐‐‐‐ 1.02 1.14 1.02  1.03  1.05 1.01

Sales/Cash from Sales (change)  ‐‐‐ 0.35 1.33 0.72  1.14  1.55 0.94

Sales/Account Receivables (raw)  5.77 7.62 5.16 5.57  5.04  4.26 6.00

Sales/Account Receivables (change)  ‐‐‐‐ 19.38 3.66 8.43  1.67  1.43 29.91

Sales/Inventory  N/A N/A N/A N/A  N/A  N/A N/A

Sales/Unearned Revenue  N/A N/A N/A N/A  N/A  N/A N/A

  

Frontline  2002  2003  2004  2005  2006  2007  2008 

Sales/Cash from Sales (raw)  ‐‐‐‐ 1.017 1.05 0.96  1.004  1.00 N/A

Sales/Cash from Sales (change)  ‐‐‐ 0.54 1.11 1.76  ‐10.58  1.01 N/A

Sales/Account Receivables (raw)  11.33 17.15 11.18 16.13  15.78  12.63 N/A

Sales/Account Receivables (change)  ‐‐‐‐ 31.36 7.81 5.57  10.44  ‐62.35 N/A

Sales/Inventory  N/A N/A N/A N/A  N/A  N/A N/A

Sales/Unearned Revenue  N/A N/A N/A N/A  N/A  N/A N/A

  

Teekay  2002  2003  2004  2005  2006  2007  2008 

Sales/Cash from Sales (raw)  ‐‐‐‐ 1.05 1.029 0.971  1.02  1.03 N/A

Sales/Cash from Sales (change)  ‐‐‐ 0.53 0.98 1.85  ‐1.47  1.08 N/A

Sales/Account Receivables (raw)  11.05 10.76 10.56 12.88  10.49  9.17 N/A

Sales/Account Receivables (change)  ‐‐‐‐ 10.48 10.12 4.53  1.46  5.58 N/A

Sales/Inventory  N/A N/A N/A N/A  N/A  N/A N/A

Sales/Unearned Revenue  N/A N/A N/A N/A  N/A  N/A N/A

  

Tsakos  2002  2003  2004  2005  2006  2007  2008 

Sales/Cash from Sales (raw)  ‐‐‐‐ 1.00 1.02 0.98  1.00  1.04 N/A

Sales/Cash from Sales (change)  ‐‐‐ 0.46 1.05 2.26  1.06  1.38 N/A

Sales/Account Receivables (raw)  5.3 9.44 10.44 12.99  18.78  11.68 N/A

Sales/Account Receivables (change)  ‐‐‐‐ 105.86 15.64 2.93  110002  3.63 N/A

Sales/Inventory  N/A N/A N/A N/A  N/A  N/A N/A

Sales/Unearned Revenue  N/A N/A N/A N/A  N/A  N/A N/A

 

Page | 81   

Expense Manipulation Diagnostics

The expense manipulation diagnostics are used to see if there are any distortions

in the accounting information provided that companies might have manipulated to

either seem more profitable now or in the future. For example, a firm could understate

interest expenses for the purpose of overstating net income during a given year. The

purpose of this would be to seem more profitable in the following year or to decrease

the current tax burden. Information will be used from Overseas Shipholding Group’s

past seven financial statements to see how their ratios compare with other firms in the

energy shipping industry. If any irregularities are found, we will determine if they are

potential red flags. The tables that were used to create the following graphs can be

found in Appendix A.

Asset Turnover

Asset turnover is defined as sales of the current year divided by the assets of the

previous year. This measure is useful in identifying outlying years when an abnormal

amount of sales are generated by a given amount of assets, or vice versa. Additionally,

the metric helps identify a firm’s capital requirements to support future growth in sales.

Simply put, a certain amount of capital must be “put at risk” to generate the next year’s

sales.

0.00

0.10

0.20

0.30

0.40

0.50

2002 2003 2004 2005 2006 2007 2008

Asset Turnover

OSG

Frontline

Teekay

Tsakos

 

Page | 82   

Business firms that have inconsistent revenues, or variable pricing, tend to have

very inconsistent asset turnovers. Conversely, firms that have stable pricing tend to

have much more stable asset turnover ratios because there is a direct relationship

between increasing capacity and increasing sales. For the energy shipping industry,

asset turnovers are highly variable because rates for energy shipping services are highly

variable to say the least. It’s not uncommon to have a five-fold increase or decrease in

shipping rates in a single year. Therefore, examining asset turnover without

consideration to shipping rates is misleading in understanding the relationship to adding

capacity, and receiving proportional higher total revenues.

In order to negate the industry wide effects of changing rates, it is relevant to

examine the yearly change in asset turnover across an industry. If a firm is

experiencing the opposite change as their peers, several things may be occurring. First,

the firm may be operating in a fundamentally different environment and thus subject to

different shipping rates (product vs. oil/U.S. Flag vs. International). Secondly, a firm

may be recording assets that are not yet cash flow-producing, like taking delivery of a

ship that hasn’t been deployed yet. Thirdly, a firm may be changing their fundamental

business model and engaging in a non-related industry. Finally, the firm may be

inaccurately characterizing their expenses and recording higher or lower sales with the

same amount of assets.

(8.00)

(6.00)

(4.00)

(2.00)

‐

2.00 

2003 2004 2005 2006 2007 2008

Asset Turnover (change)

OSG

Frontline

Teekay

Tsakos

 

Page | 83   

CFFO/OI

The CFFO/OI ratio is another ratio used to test for potential expense

manipulation by analyzing if the cash flows from operations are supported by the

operating income. There is no concern if a firm’s ratio remains consistent over a long

period of time, in this case seven years.

The raw graph above, which includes OSG and its competitors, illustrates that

there has not been very much variation in CFFO/OI in this industry. Since there are no

major changes over the years, it can be concluded that OSG’s cash flows from

operations support the operating income that is stated on its income statements. In the

change form of the expense diagnostics, a value that is less than zero would be a

reason for concern. OSG remained positive for the entire seven years after looking at

the change form graph.

0.00

0.50

1.00

1.50

2.00

2.50

2002 2003 2004 2005 2006 2007 2008

CFFO/OI (raw)

OSG

Frontline

Teekay

Tsakos

‐5.00

0.00

5.00

10.00

15.00

2003 2004 2005 2006 2007 2008

CFFO/OI (change)

OSG

Frontline

Teekay

Tsakos

 

Page | 84   

CFFO/NOA

The CFFO/NOA ratio is another ratio used to test for potential expense

manipulation by analyzing if the cash flows from operations are supported by the net

operating assets. Net operating assets include property, plant, and equipment minus

the accumulated depreciation. In the energy shipping industry, net operating assets

would mostly account for all the vessels that the firms use for transportation.

The raw form graph indicates that are significant structural movements in this

industry. In most cases, if a firm has considerable increases in this ratio followed by

decreases it would indicate a potential red flag and possible manipulation of expenses.

Since every company in this industry follows this trend, there are no reasons for

concern when analyzing OSG. There is a potential for a red flag when looking at the

0.000.050.100.150.200.250.300.35

2002 2003 2004 2005 2006 2007 2008

CFFO/NOA (raw)

OSG

Frontline

Teekay

Tsakos

‐10.00

‐5.00

0.00

5.00

10.00

2003 2004 2005 2006 2007 2008

CFFO/NOA (change)

OSG

Frontline

Teekay

Tsakos

 

Page | 85   

change form graph. Since 2006, the change form CFFO/NOA falls below zero and into

the negatives which suggests that there is a concern that expense manipulation could

have occurred.

Total accruals/change in sales

The total accruals to change in sales ratio is the final diagnostic ratio used find

the purpose of finding any expense manipulations on the financial statements. Basically,

this ratio is used to see if a firm’s total accruals are supported by the change in sales.

Accruals can be simply calculated by taking cash flows from operations of a given year

and subtracting the operating income of the same year. There are significant structural

movements when analyzing this ratio for the industry as a whole. The variation in this

ratio between 2005 and 2007 would in most cases signal a potential red flag but since

the competitors of OSG also follow this trend no manipulation will be assumed.

Conclusion

When assessing the credibility of the expenses that OSG reports, a few potential

red flags were found from analyzing the graphs and information. The change form

graphs for asset turnover and CFFO/NOA fell below zero which raised concern for

potential manipulation of its expenses. This could have occurred for the purpose of

increasing or decreasing net income during a given year. Overall, there was more

concern that OSG possibility manipulated its expenses when compared to its revenue.

(1.00)

(0.50)

‐

0.50 

1.00 

1.50 

2.00 

2003 2004 2005 2006 2007 2008

Total Accurals/Δsales

OSG

Frontline

Teekay

Tsakos

 

Page | 86   

Expense Manipulation Diagnostics OSG  2002  2003  2004  2005  2006  2007  2008 

Asset Turnover  0.15 0.23 0.30 0.30 0.25  0.27 0.44Asset Turnover (change)  ‐‐‐‐ ‐4.59 0.52 0.28 0.05  ‐1.14 ‐2.14

CFFO/OI (Raw)  0.23 0.99 0.73 0.84 1.11  0.77 1.03CFFO/OI (Change)  ‐‐‐‐ 1.24 0.52 6.73 ‐0.09  1.51 1.41CFFO/NOA (Raw)  0.01 0.16 0.25 0.19 0.18  0.06 0.14

CFFO/NOA (Change)  ‐‐‐‐ ‐4.04 1.50 0.07 0.05  ‐1.52 ‐6.39Total Accruals/ Sales  ‐‐‐‐ ‐0.01 ‐0.38 ‐0.44 0.95  ‐0.60 0.02

  Frontline  2002  2003  2004  2005  2006  2007  2008 

Asset Turnover  0.18 0.27 0.44 0.34 0.34  0.35 N/AAsset Turnover (change)  ‐‐‐‐ 0.48 ‐6.32 ‐1.42 0.46  0.31 N/A

CFFO/OI (Raw)  1.56 1.11 0.81 1.14 1.04  1.05 N/ACFFO/OI (Change)  ‐‐‐‐ 1.01 0.58 ‐0.26 2.71  1.01 N/ACFFO/NOA (Raw)  0.05 0.02 0.31 0.30 0.27  0.22 N/A

CFFO/NOA (Change)  ‐‐‐‐ 0.01 ‐0.01 0.25 0.80  0.53 N/ATotal Accruals/ Sales  ‐‐‐‐ 0.09 ‐0.32 ‐0.35 0.45  ‐0.10 N/A

  Teekay  2002  2003  2004  2005  2006  2007  2008 

Asset Turnover  0.29 0.44 0.40 0.37 0.26  0.24 N/AAsset Turnover (change)  ‐‐‐‐ 0.92 0.34 1.26 0.02  0.17 N/A

CFFO/OI (Raw)  1.50 1.56 0.99 0.96 1.23  0.64 N/ACFFO/OI (Change)  ‐‐‐‐ 1.59 0.68 1.09 0.42  11.10 N/ACFFO/NOA (Raw)  0.09 0.19 0.25 0.19 0.11  0.04 N/A

CFFO/NOA (Change)  ‐‐‐‐ 0.56 0.42 6.72 ‐0.05  ‐0.27 N/ATotal Accruals/ Sales  ‐‐‐‐ 0.21 ‐0.01 0.09 1.69  ‐0.36 N/A

  Tsakos  2002 2003 2004 2005 2006  2007 2008

Asset Turnover  0.19 0.29 0.34 0.27 0.22  0.21 N/AAsset Turnover (change)  ‐‐‐‐ 0.85 0.68 ‐0.15 0.15  0.19 N/A

CFFO/OI (Raw)  2.28 1.19 1.06 0.95 1.05  0.76 N/ACFFO/OI (Change)  ‐‐‐‐ 0.91 0.93 ‐0.72 1.35  ‐0.55 N/ACFFO/NOA (Raw)  0.06 0.13 0.24 0.21 0.15  0.10 N/A

CFFO/NOA (Change)  ‐‐‐‐ 0.51 ‐3.78 ‐0.09 0.09  ‐0.06 N/ATotal Accruals/ Sales  ‐‐‐‐ 0.12 0.11 0.35 0.07  ‐0.81 N/A

 

Page | 87   

Potential “Red Flags”

“’Red Flags’ suggest that the analyst should examine certain items more closely

or gather more information on them” (Palepu & Healy). When reviewing a company’s

accounting quality, analysts should consider some common “red flags” such as

unexplained changes in accounting that could be used to inaccurately portray a

company’s financial success, and an increasing gap between reported income and cash

flow from operating activities, which would normally have a steady relationship.

Although these “red flags” are a great guideline for an initial evaluation, they each have

many interpretations and should not be used as an end point.

Operating leases are considered a red flag for Overseas Shipholding Group.

Operating leases are like renting ships, with an average life of 20 years and make the

company seem less capital-intense. Therefore, implementing operating leases allows

the company to conceal the actual amount of liabilities reported. Because the present

value of operating leases grossly exceeded 10% of the long term debt, the income

statement and balance sheet over the previous six years had to be entirely restated.

Undo Accounting Distortions

“If the accounting analysis suggests that the firm’s reported numbers are

misleading, analysts should attempt to restate the reported numbers to reduce

distortion” (Palepu & Healy). Because analysts must rely on outside information, they

will never be able to fully undo every distortion. The cash flow statement and financial

statement footnotes, however, provide important information such as performance

based on accrual and cash accounting that can assist in accurately re-valuing a

company. The following tables represent OSG’s Statement of Income from Operations

and Balance Sheet respectively (OSG 10-K).

 

Page | 88   

OSG Income Statement (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 RevenuesVoyage charter revenues 53,429 83,797 126,029 267,574 431,777 Time and bareboat charter revenues 116,957 309,471 282,409 361,431 366,629 Pool Revenues 640,449 607,035 638,965 500,300 906,291

Total Revenues 810,835 1,000,303 1,047,403 1,129,305 1,704,697

Voyage Expenses (COGS) (21,254) (38,641) (54,586) (90,094) (159,312)

Gross Profit 789,581 961,662 992,817 1,039,211 1,545,385

Ship Operating Expenses:Vessel expenses 108,170 177,349 209,998 267,947 314,553 Time and bareboat charter hire expenses 65,550 120,301 174,817 258,116 429,808 Depreciation and Amortization 100,088 152,311 141,940 185,499 189,163 General and Administrative 51,993 79,667 99,525 127,211 144,063 Goodwill Impairment Charges 62,874 Loss/(Gain) on Sale of Vessels (39,007) (7,134) 59,738

Total Ship Operating Expenses 325,801 529,628 587,273 831,639 1,200,199

Income from Vessel Operations 463,780 432,034 378,544 207,572 345,186 Equity in Income of Joint Ventures 45,599 43,807 22,474 8,876 12,292

Operating Income 509,379 475,841 401,018 216,448 357,478 Other Income/(Expense) 45,781 77,367 52,107 75,434 (28,847)

Net Earnings Before Interest and Taxes 555,160 553,208 453,125 291,882 328,631

Interest Expense 74,146 89,489 (68,652) (74,696) (57,449)

Change in Accounting Principle and Minority Interest 384,473 217,186 271,182 Provision/(Credit) for Federal Income Taxes 79,778 (1,110) 8,187 (4,827) 34,004

Minority Interest (1,049) 12,479

Net Income 401,236 464,829 392,660 211,310 317,665 Cash Dividends Paid (27,532) (27,615) (36,576) (38,038) (44,856)

Addition to Retained Earnings 373,704 437,214 356,084 173,272 272,809

 

Page | 89   

OSG Income Statement (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 RevenuesVoyage charter revenues 53,429 83,797 126,029 267,574 431,777 Time and bareboat charter revenues 116,957 309,471 282,409 361,431 366,629 Pool Revenues 640,449 607,035 638,965 500,300 906,291

Total Revenues 810,835 1,000,303 1,047,403 1,129,305 1,704,697

Voyage Expenses (COGS) (21,254) (38,641) (54,586) (90,094) (159,312)

Gross Profit 789,581 961,662 992,817 1,039,211 1,545,385

Ship Operating Expenses:Vessel expenses 108,170 177,349 209,998 267,947 314,553 Operating leases payments newly capitalized 24,537 48,624 213,692 280,483 313,914 Depreciation and Amortization 100,088 152,311 141,940 185,499 189,163 General and Administrative 51,993 79,667 99,525 127,211 144,063 Goodwill Impairment Charges 62,874 Loss/(Gain) on Sale of Vessels (39,007) (7,134) 59,738

Total Ship Operating Expenses 284,788 457,951 626,148 854,006 1,084,305

Income from Vessel Operations 504,793 503,711 366,669 185,205 461,080 Equity in Income of Joint Ventures 45,599 43,807 22,474 8,876 12,292

Operating Income 550,392 547,518 389,143 194,081 473,372 Other Income/(Expense) 45,781 77,367 52,107 75,434 (28,847)

Net Earnings Before Interest and Taxes 596,173 624,885 441,250 269,515 444,525

Interest Expense 74,146 89,489 68,652 74,696 57,449

Change in Accounting Principle and Minority Interest 522,027 535,396 372,598 194,819 387,076 Provision/(Credit) for Federal Income Taxes 79,778 (1,110) (8,187) 4,827 (34,004)

Minority Interest (1,049) 12,479

Net Income 442,249 536,506 380,785 188,943 433,559 Cash Dividends paid (27,532) (27,615) (36,576) (38,038) (44,856)

Addition to Retained Earnings 414,717 508,891 344,209 150,905 388,703

 

Page | 90   

OSG Balance Sheet (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008

AssetsCash and cash equivalents 479,181 188,588 606,758 502,420 343,609 Voyage receivables 144,237 157,334 136,043 180,406 219,500 Other receivables 12,815 22,202 71,723 84,627 64,773 Inventories 1,132 1,855 7,002 9,195 6,627 Prepaid expenses 8,252 14,908 23,995 28,105 43,780 Total Current Assets 645,617 384,887 845,521 804,753 678,289

Capital Construction Fund 268,414 296,126 315,913 151,174 48,681 Vessels (At Cost) 1,422,239 2,288,481 2,501,846 2,691,005 2,683,147 Vessels under Capital Leases 24,382 36,267 30,750 24,399 1,101 Deferred Drydock expenditures 19,805 50,774 81,619 79,837 Vessel Held for Sale 9,744 53,975 Investments in Joint Ventures 227,701 269,257 275,199 131,905 98,620 Other Assets 82,701 53,457 53,762 87,522 130,237 Goodwill 64,293 72,463 9,589 Intangible Assets 92,611 114,077 106,585 Total Non-Current Assets 2,035,181 2,963,793 3,385,148 3,354,164 3,211,772

Total Assets 2,680,798 3,348,680 4,230,669 4,158,917 3,890,061

LiabilitiesAccounts payable 3,960 105,173 192,500 178,837 167,615 Sundry liabilities and accrued expenses 76,087 Federal income taxes 90,943 Short-term debt and current installments of long-term debt 25,024 20,066 27,426 26,058 26,231 Current obligations under capital leases 4,729 6,968 7,650 8,406 1,092 Total Current Liabilities 200,743 132,207 227,576 213,301 194,938

Long-term Debt 863,466 923,612 1,273,053 1,506,396 1,396,135 Obligations under Capital Leases 42,717 42,043 33,894 24,938 Deferred Federal Income Taxes 141,334 270,076 281,711 Deferred Credits and Other Liabilities 147,500 233,456 218,759 182,076 474,355 Minority Interest 132,470 101,766 Total Non-Currrent Liabilities 1,053,683 1,340,445 1,795,782 2,127,591 1,972,256

Total Liabilities 1,254,426 1,472,652 2,023,358 2,340,892 2,167,194

Common stock 40,791 40,791 40,791 40,791 40,791 Paid-in additional capital 199,054 199,570 202,712 208,817 224,522 Retained earnings 1,203,528 1,640,742 1,996,826 2,170,098 2,442,907

Stockholders' Equity 1,442,013 1,881,103 2,240,329 2,419,706 2,708,220 Cost of Treasury Stock (17,579) (17,019) (34,522) (583,708) (838,994) Accumulated other comprehensive income/(loss) 1,938 11,944 1,504 (17,973) (146,359)

Total Shareholders' Equity 1,426,372 1,876,028 2,207,311 1,818,025 1,722,867

Total Liabilities and Shareholders' Equity 2,680,798 3,348,680 4,230,669 4,158,917 3,890,061

 

Page | 91   

OSG Balance Sheet (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008

AssetsCash and cash equivalents 479,181 188,588 606,758 502,420 343,609 Voyage receivables 144,237 157,334 136,043 180,406 219,500 Other receivables 12,815 22,202 71,723 84,627 64,773 Inventories 1,132 1,855 7,002 9,195 6,627 Prepaid expenses 8,252 14,908 23,995 28,105 43,780 Total Current Assets 645,617 384,887 845,521 804,753 678,289

Capital Construction Fund 268,414 296,126 315,913 151,174 48,681 Vessels (At Cost) 1,422,239 2,288,481 2,501,846 2,691,005 2,683,147 Vessels Under Capital Leases 24,382 36,267 30,750 24,399 1,101 Vessels Under Operating Leases, Newly Capitalized 222,364 1,207,297 1,584,651 1,924,540 2,032,783 Deferred Drydock Expenditures 19,805 50,774 81,619 79,837 Vessel Held for Sale 9,744 53,975 Investments in Joint Ventures 227,701 269,257 275,199 131,905 98,620 Other Assets 82,701 53,457 53,762 87,522 130,237 Goodwill 64,293 72,463 9,589 Intangible Assets 92,611 114,077 106,585 Total Non-Current Assets 2,257,545 4,170,690 4,969,799 5,278,704 5,244,555

Total Assets 2,903,162 4,555,577 5,815,320 6,083,457 5,922,844

LiabilitiesAccounts payable 3,960 105,173 192,500 178,837 167,615 Sundry liabilities and accrued expenses 76,087 Federal income taxes 90,943 Short-term debt and current installments of long-term debt 25,024 20,066 27,426 26,058 26,231 Current obligations under capital leases 4,729 6,968 7,650 8,406 1,092 Total Current Liabilities 200,743 132,207 227,576 213,301 194,938

Long-term Debt 863,466 923,612 1,273,053 1,506,396 1,396,135 Obligations under Capital Leases 42,717 42,043 33,894 24,938 Obligations under Operating Leases 222,364 1,207,297 1,584,651 1,924,540 2,032,783 Deferred Federal Income Taxes 141,334 270,076 281,711 Deferred Credits and Other Liabilities 147,500 233,456 218,759 182,076 474,355 Minority Interest 132,470 101,766 Plug for Liabilities 161,910 31,784 172,801 339,273 (190,802) Total Non-Current Liabilities 1,237,215 2,438,192 3,283,158 3,977,223 3,814,236

Total Liabilities 1,437,958 2,570,399 3,510,734 4,190,524 4,009,174

Common stock 40,791 40,791 40,791 40,791 40,791 Paid-in additional capital 199,054 199,570 202,712 208,817 224,522 Retained earnings 1,241,001 1,749,892 2,094,101 2,245,006 2,633,709

Stockholders' Equity 1,480,846 1,990,253 2,337,604 2,494,614 2,899,022 Cost of treasury stock (17,579) (17,019) (34,522) (583,708) (838,994) Accumulated other comprehensive income/(loss) 1,938 11,944 1,504 (17,973) (146,359)

Total Shareholders' Equity 1,465,205 1,985,178 2,304,586 1,892,933 1,913,669

Total Liabilities and Shareholders' Equity 2,903,162 4,555,577 5,815,320 6,083,457 5,922,844

 

Page | 92   

OSG Cash Flow (Raw)

2004 2005 2006 2007 2008Net Income 401,236 464,829 392,660 211,310 317,665 Sales 810,835 1,000,303 1,047,403 1,129,305 1,704,697 Operating Income 509,379 475,841 401,018 216,448 357,478

CFFO/Sales 0.49 0.45 0.43 0.15 0.22CFFO/Net Income 0.99 0.97 1.14 0.79 1.15CFFO/Operating Income 0.78 0.95 1.11 0.77 1.03

CFFO 396,825 452,046 445,975 167,624 366,677 CFFI (191,175) 45,259 (256,702) (34,895) (77,022) CFFF 199,528 (787,898) 228,897 (237,067) (448,466)

OSG Cash Flow (Restated)

2004 2005 2006 2007 2008Net Income 442,249 536,506 380,785 188,943 433,559 Sales 810,835 1,000,303 1,047,403 1,129,305 1,704,697 Operating Income 550,392 547,518 389,143 194,081 473,372

CFFO/Sales 0.54 0.52 0.41 0.13 0.28CFFO/Net Income 0.99 0.98 1.14 0.77 1.11CFFO/Operating Income 0.80 0.96 1.12 0.75 1.02

CFFO 437,838 523,723 434,100 145,257 482,571 CFFI 268,289 (37,181) 8,202,194 (6,730,002) (1,710,510) CFFF 199528 (787898) 228897 (237067) (448466)

 

Page | 93   

Restating Distortions in Financial Statements

The purpose of capitalizing the operating lease payments is to accurately reflect

the right to use a vessel for an extended length of time. Similarly, the obligation to pay

future operating lease payments must be accurately reflected in the liabilities section of

the restated balance sheet. The method we employed involves the amortization future

minimum lease obligations using a 5.2% discount rate (see appendix B) and recording

the carrying value as an equally as an asset and a liability. Additionally, we substituted

the operating lease payments on the income statement (starting in 2002) and replaced

them with interest expense (carrying value X 5.2%) and depreciation expense [carrying

value / (Total remaining revenue days/ average yearly revenue days)]. This process is

essentially revenue neutral and reschedules expenses to reflect the nature of the long-

term liability and asset. The net effect is a larger asset and liability account as well as

higher net income in the short-run and lower net income in later years.

 

Page | 94   

Financial Analysis, Forecast Financials, and Cost of Capital

Estimation

In order to fairly evaluate a company, an analyst must analyze ratios, forecast

financial statements, and determine the cost of capital of the entire company.

Calculating ratios is one of the most efficient ways to compare the company to other

companies within the industry. These ratios also play a big role in forecasting Overseas

Shipholding Group’s financial statements. We will be using 6 years of past data from

OSG’s financial statements to forecast financials for the next 10 years. Lastly, we will

calculate the cost of capital using standard formulas to further our evaluation of OSG.

Financial Analysis

Investors, analysts and creditors rely on financial statements when comparing a

company with competitors in their industry. Financial ratios are most commonly used to

produce smaller and more easily comparable numbers across the industry. These ratios

assist in evaluating a firm along with its competitors and the industry as a whole.

Financial ratios measure the profitability, liquidity, and capital structure of firms. The

numbers computed by using these ratios can assist analysts in forecasting and

comparing data over a large span of time. These ratios provide a straightforward way

to compare Overseas Shipholding Group’s overall financial worth to its competitors and

industry.

Liquidity Ratio Analysis

Liquidity is the ability to convert an asset to cash in a short amount of time with

either no difference or a slight difference in the value of the asset. It is important for a

firm to possess enough liquid assets so that they will be able to account for any short-

term obligations that may arise. Investors use liquidity ratios when evaluating

 

Page | 95   

companies to help determine whether or not they will have the ability to pay off

their short-term debt obligations. If analysts discover that a company has high values

for their liquidity ratios, it illustrates that the company has a large margin of safety

when accounting for their short-term debts. The liquidity ratios we will discuss include

the current ratio, the quick asset ratio, accounts receivable turnover ratio, days sales

outstanding ratio, and the working capital turnover ratio. Many industries also include

the inventory turnover ratio and the days supply inventory ratio, but in the energy

shipping industry no inventory is held.

Current Ratio

The current ratio is a measure of a firm’s ability to pay back its short-term

liabilities with its short-term assets. It is calculated by dividing a firm’s current assets by

its current liabilities. In order to indicate that a firm has enough current assets to cover

its short-term obligations, this ratio should be higher than 1. A ratio less than 1

illustrates that at the point in time when the ratio was calculated, the firm would not be

capable of paying off its obligations. Having a ratio under 1 shows the poor financial

health of a firm, but does not necessarily mean that the firm will go bankrupt because

there are many other ways to access financing. (Investopedia)

 

   

0

0.5

1

1.5

2

2.5

3

3.5

4

2003 2004 2005 2006 2007 2008

Current Ratio

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 96   

2003 2004 2005 2006 2007 2008

OSG 1.44 3.22 2.91 3.72 3.77 3.48

OSG restated 1.44 3.22 2.91 3.72 3.77 3.48

Frontline 3.73 3.38 2.54 2.51 1.8 n/a

Teekay 1.75 2.22 1.36 0.97 1.1 n/a

Tsakos 1.4 1.93 2.1 2.2 1.73 n/a

Industry Avg. 2.08 2.69 2.23 2.35 2.1 n/a

As illustrated in the graph and table above, from 2005 to 2006, OSG reached a

high value of over 3.5 and was able to maintain it over the last three years. This value

is notably larger than its top competitors on this scale. Although OSG does maintain a

significantly larger current ratio than its competitors, all have been able to sustain a

ratio higher than 1. Due to the fact that Teekay was the only energy shipping firm that

fell to a ratio below 1 in 2006, and because it was by such a small margin, we can

conclude that this energy shipping industry posses the ability to cover their short-term

obligations. However, because OSG has produced a current ratio above the industry

average since 2004 they would be able to cover nearly twice as much short-term debt

as their top competitors. These facts make OSG the safest investment based on current

ratios.

Quick Asset Ratio

The quick asset ratio is very similar to the current ratio. The only difference in

the quick asset ratio is that only the most liquid assets are included in the value of the

current assets. To calculate this ratio add cash, cash equivalents, marketable securities,

accounts receivable, and then divide that amount by the firm’s current liabilities. Since

some current assets can be more difficult to liquidate, and may even be worth a

different amount then the books represent, the quick asset ratio is a good indicator of

 

Page | 97   

the most liquid assets being able to cover the firm’s short-term liabilities. The value for

this ratio should be 1 or higher, similar to the current ratio. If it is greater than 1 then

the firm will be able to cover their short-term debt with their most liquid assets, while a

ratio less than 1 implies they cannot.

 

 

2003 2004 2005 2006 2007 2008

OSG 1.28 3.11 2.62 3.26 3.2 2.89

OSG restated 1.28 3.11 2.62 3.26 3.2 2.89

Frontline 0.54 0.94 0.7 0.58 0.41 n/a

Teekay 1.6 1.54 0.84 0.69 0.76 n/a

Tsakos 1.2 1.7 1.79 1.87 1.29 n/a

Industry Avg. 1.16 1.82 1.49 1.6 1.42 n/a

 

The graph and table for the quick asset ratio reiterates the good standing of

OSG’s liquidity. Their quick asset ratio is significantly higher than any of their top

competitors, which is a great advantage for their industry. This shows that OSG would

be much more capable of covering their short-term debts by using only their most liquid

assets. When compared to Frontline’s ratio, which has been below 1 for the last 6

0

0.5

1

1.5

2

2.5

3

3.5

2003 2004 2005 2006 2007 2008

Quick Asset Ratio

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 98   

years, and Teekay’s ratio, which has fallen beneath 1 over the last 3 years, OSG has

outstanding financial health in this area. When considering the quick asset ratio, OSG

would be considered the soundest investment.

Accounts Receivable Turnover

A common way for a firm to obtain revenue is to perform a service for their

customer based on the customer’s promise of a future payment. After the agreement is

made and the service is rendered to the customer, the revenue earned by the firm is

known as accounts receivable. The accounts receivable turnover is a calculation that

measures how efficiently a company is extending credit to its customers as well as

collecting its customer’s debts. A high accounts receivable turnover implies that a firm is

able to recover its outstanding receivables in a timely manner. A low rate indicates that

it takes the firm a prolonged amount of time to collect its customer’s debt, which shows

that the firm is remaining in debt for an extended period of time. This ratio is calculated

by dividing the firm’s total net sales by its accounts receivable.

0

5

10

15

20

2003 2004 2005 2006 2007 2008

Accounts Receivable Turnover

OSG

OSG restated

Teekay

Frontline

Tsakos

Industry Avg.

 

Page | 99   

2003 2004 2005 2006 2007 2008

OSG 7.62 5.16 5.57 5.04 4.26 5.99

OSG restated 7.62 5.16 5.57 5.04 4.26 5.99

Teekay 10.76 10.56 12.88 10.49 9.17 n/a

Frontline 17.15 11.88 16.13 15.78 12.63 n/a

Tsakos 9.44 10.44 12.99 18.78 11.68 n/a

Industry Avg. 11.24 9.51 11.89 12.52 9.44 n/a

As seen in the graph and table above, OSG has a much consistently lower

accounts receivable turnover than the rest of the industry. This proves that it takes OSG

a greater amount of time to collect on their customer’s outstanding receivables than

their top competitors. However, because the turnover rate has stayed relatively

consistent for OSG over the last 6 years there should be no major concern. The steady

rate indicates that OSG will still collect on their outstanding receivables, even if it takes

a much longer period of time than the industry average. Though this fact remains, they

are still at a great disadvantage when compared to their competitors. Investors are

much more confident in firms who can quickly realize their accounts receivable.

Days Sales Outstanding

The days sales outstanding ratio is used to indicate the amount of time it takes a

firm to collect its outstanding accounts receivable. By dividing the number of days in a

year by a firm’s accounts receivable turnover, we are able come up with a more

accurate measure of exactly how many days it takes a firm to collect its customer’s

debt. The higher the ratio the longer it takes a firm to collect its short-term debt. It is

better for a firm to have a lower days sales outstanding ratio to prove they can quickly

collect accounts receivable and in turn possess more of their assets.

 

Page | 100   

 

 

2003 2004 2005 2006 2007 2008

OSG 47.9 70.74 65.53 72.42 85.68 60.93

OSG restated 47.9 70.74 65.53 72.42 85.68 60.93

Frontline 21.28 30.72 22.63 23.13 28.9 n/a

Teekay 33.92 34.56 28.34 34.8 39.8 n/a

Tsakos 38.67 34.96 28.1 19.44 31.25 n/a

Industry Avg. 35.44 42.75 36.15 37.45 46.41 n/a

 

As indicated by the graph and table above, OSG has a much higher days sales

outstanding ratio than the rest of their top competitors. Since this ratio is directly

related to the accounts receivable turnover ratio, the information depicted in this graph

falls in line with what was previously determined. When compared to the industry as a

whole, OSG takes a significantly longer amount of time to collect on their outstanding

accounts receivable. If OSG, who has averaged nearly 70 days to collect their

outstanding accounts receivables the last 6 years, were taken out of the industry, the

total average would drastically lower to 30 days sales outstanding. This means that

OSG has accounts receivable for specific customers for nearly 40 days longer than their

0102030405060708090

2003 2004 2005 2006 2007 2008

Days Sales Outstanding

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 101   

competitors do. Its takes over twice as much time for OSG to collect cash as the

industry average. This is a drastic difference in the amount of time it takes OSG to

obtain their accounts receivable. Since OSG takes so much more time to collect their

receivables, they have a significantly larger portion of assets held in the accounts

receivable section of their balance sheet. This is not a sign of financial strength for OSG

and could be a concern for potential investors.

Working Capital Turnover

The working capital turnover ratio is used to analyze the relationship between

the money used to fund operations and the sales generated from these operations.

(Investopedia) The working capital of a firm is found by subtracting the firm’s current

assets by their current liabilities. The amount found by performing this equation is

typically what the firm will use to fund operations and purchase inventory. In order to

find the working capital turnover ratio, a firm will divide its net sales by its working

capital. The higher the working capital turnover ratio, the better off a firm is because it

will be generating more revenue from sales then the amount of expenses they are

using to fund the sales.

 

   

0

2

4

6

8

10

12

2003 2004 2005 2006 2007 2008

Working Capital Turnover

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 102   

2003 2004 2005 2006 2007 2008

OSG 10.51 1.82 3.96 1.69 1.91 3.53

OSG restated 10.51 1.82 3.96 1.69 1.91 3.53

Frontline 1.32 2.24 2.13 2.33 2.75 n/a

Teekay 7.66 4.41 11.80 -147.85 25.29 n/a

Tsakos 7.22 4.26 2.95 3.53 4.29 n/a

Industry Avg. 6.35 2.77 3.01 2.52 2.98 n/a

 

In order to keep the graph relatively simple, we omitted Teekay’s working capital

turnover because they are inconsistent, with numbers much lower and higher than the

industry average. From 2004 to the present, one can see that OSG’s numbers, and the

numbers of the other two competitors, have remained relatively consistent by keeping

their working capital turnover between the 2:1 and 4:1. Although OSG possessed the

lowest working capital turnover in the industry in 2006 and 2007, we can see that it’s

climbing back up in 2008. Since we do not have any of their competitor’s numbers for

2008 this information is not much help. We can only conclude from the data that the

industry as a whole is relatively consistent and no one firm is at a great advantage in

this area.

Conclusion

Now that we have calculated all of the various liquidity ratios for OSG and its top

competitors in the energy shipping industry, we can accurately compare the level of

liquidity each firm possesses. We concluded from the current ratio that OSG is the most

capable of all the firms to cover its short-term debt obligations. The same information

was derived from the quick asset ratio for OSG. They are the most competent firm in

the industry when it comes to maintaining a high level of liquid assets on their balance

sheet. These two ratios show that OSG is significantly healthier financially when judging

 

Page | 103   

by the liquidity of current assets. This gives OSG a significant advantage over their

competition in the liquidity analysis as a whole.

When we analyzed the accounts receivable turnover ratio and days sales

outstanding ratio for the industry, we concluded that OSG has a much more difficult

time collecting its outstanding receivables compared to their competitors. This puts a

great deal of pressure on their liquidity analysis since it is such a substantial difference

from the industry as a whole. Finally, when we determined the working capital turnover

for the industry we found the OSG and its top competitors all maintain a relatively

similar ratio.

An additional fact that can be concluded from the overall liquidity analysis the

irrelevance of the cash to cash cycle. The cash to cash cycle is the summation of days

sales outstanding and days supply inventory. Since inventory is not relevant to OSG,

their days supply inventory in nonexistent. Since OSG does not possess a days supply

inventory ratio, their cash to cash cycle cannot be calculated since only one component

of the equation is employed.

Ratio Performance Trend

Current Ratio Outperforming Stable

Quick Asset Ratio Outperforming Stable

Accounts Receivable Turnover Underperforming Stable

Days Sales Outstanding Underperforming Decreasing

Working Capital Turnover Average Increasing

 

Page | 104   

Profitability Ratio Analysis

Profitability ratios allow us to analyze how effective a firm has been at

generating revenues to create profit during a given year. Investors use these ratios to

evaluate if a firm’s profits follow a positive and stable trend or if there are reasons to be

concerned. Investors view consistent profitability as a sign of financial health. The most

common ratios used for this analysis include gross profit margin, operating expense

ratio, operating profit margin, net profit margin, asset turnover, return on assets (ROA),

and return on equity (ROE). When comparing these ratios over a five year period and

with industry competitors it is important to note that a high ratio is desirable in most

situations.

Gross Profit Margin

Gross profit margin is calculated by dividing a firm’s gross profit during a given

year by the net sales for the same year. Gross profit is equal to revenues minus the

cost of goods sold. In the energy shipping industry, commission and voyage expenses

are subtracted from revenues to find the gross profit. A high margin indicates that a

firm is making a profit from performing a service and managing the cost related to that

service. Efficient firms consistently achieve high levels of gross profit margin.

0

0.2

0.4

0.6

0.8

1

1.2

2003 2004 2005 2006 2007 2008

Gross Profit Margin

OSG

OSG restated

Frontline

Teekay

Tsakos

industry average

 

Page | 105   

2003 2004 2005 2006 2007 2008

OSG 0.95 0.97 0.96 0.95 0.92 0.91

OSG-restated 0.95 0.97 0.96 0.95 0.92 0.91

Frontline 0.73 0.82 0.83 0.81 0.82 n/a

Teekay 0.75 0.81 0.79 0.74 0.78 n/a

Tsakos 0.75 0.83 0.84 0.80 0.82 n/a

industry average 0.80 0.86 0.85 0.82 0.84 n/a

Since the energy shipping industry is a service industry, the voyages that the

firms take part in will be considered their product. Voyage expenses include fuel, canal

tolls, and port charges. In highly competitive industries such as this one, keeping

product costs down is important to remain profitable and offer competitive rates.

Overseas Shipholding Group has consistently had a gross profit margin above the entire

industry over the past six years with an average of about 95%. OSG’s high margin can

be attributed to its ability to keep voyage expenses low relative to its competitors. The

rest of the industry has also been stable over the same time period with averages under

85%. OSG’s consistent high margin when compared to the industry is very desirable

when evaluating profitability.

Operating Expense Ratio

The operating expense ratio is found by taking operating expenses and dividing

by the net sales. In the energy shipping industry, operating expenses include vessels

expenses, time and bareboat charter hire expenses, and general and administrative

expenses. A low operating expense ratio is desirable because it indicates that a firm is

efficiently controlling cost related to business operations, and ultimately less is taken

away from gross profits.

 

Page | 106   

2003 2004 2005 2006 2007 2008

OSG 0.53 0.40 0.53 0.64 0.82 0.80

OSG-restated 0.54 0.35 0.46 0.60 0.76 0.64

Frontline 0.31 0.20 0.25 0.29 0.42 n/a

Teekay 0.56 0.44 0.46 0.53 0.62 n/a

Tsakos 0.46 0.37 0.32 0.32 0.32 n/a

industry average 0.47 0.35 0.39 0.45 0.54 n/a

According to the graph and table above, OSG’s operating expense ratio has been

above the industry average for each of the past six years. In 2007, OSG had an

operating expense ratio 30% higher than the industry average. One of the reasons for

this is that OSG has a greater amount of charter hire expense relative to its

competitors. Investors will look negatively on this ratio because it shows that OSG has

too many operating expenses when compared to the rest of the industry, and it will

decrease overall profitability. Although this is the case, the restated financial statements

slightly improve this ratio. The restated operating expense ratio is consistently lower

than the original and has a decreasing trend since 2007.

0.00

0.20

0.40

0.60

0.80

1.00

2003 2004 2005 2006 2007 2008

Operating Expense Ratio

OSG

OSG‐restated

Frontlilne

Teekay

Tsakos

industry average

 

Page | 107   

Operating Profit Margin

The operating profit margin is found by dividing operating income by net sales.

This is another measure of operating efficiency that is used to evaluate profitability. “A

healthy operating margin is required for a company to be able to pay for its fixed costs,

such as interest on debt” (Investopedia). It is desirable for a firm to achieve a high

sustainable operating profit margin.

2003 2004 2005 2006 2007 2008

OSG 0.50 0.63 0.52 0.38 0.19 0.21

OSG-restated 0.50 0.63 0.52 0.38 0.19 0.21

Frontline 0.41 0.61 0.57 0.52 0.40 n/a

Teekay 0.19 0.37 0.32 0.21 0.17 n/a

Tsakos 0.29 0.46 0.52 0.48 0.50 n/a

industry average 0.35 0.52 0.48 0.40 0.31 n/a

According to the graph, OSG has followed the industry trend over the last five

years. Although this is the case, since 2006 the operating profit margin has been below

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

2003 2004 2005 2006 2007 2008

Operating Profit Margin

OSG

OSG restated

Frontline

Teekay

Tsakos

industry average

 

Page | 108   

the industry average and has been moving in the negative direction. This is not a

positive sign when evaluating profitability. The significant decrease in the operating

margin for OSG is a result of the increase in all operating expenses, especially a 250%

increase in “time and bareboat charter hire expenses” between 2004 and 2008.

Controlling charter hire expenses in future years will be beneficial for OSG to improve

its operating expense ratio, operating profit margin, and ultimately increasing

profitability. Also, OSG’s restated financial statements do not impact operating profit

margin.

Net Profit Margin

The net profit margin is found by dividing the net income by the net sales in a

given year. This ratio measures the actual amount earned for every dollar of revenue.

The higher the net profit margin, the better the firm is viewed by investors. “A higher

profit margin indicates a more profitable company that has better control over its costs

compared to its competitors” (Investopedia).

0

0.1

0.2

0.3

0.4

0.5

0.6

2003 2004 2005 2006 2007 2008

Net Profit Margin

OSG

OSG restated

Frontline

Teekay

Tsakos

industry average

 

Page | 109   

2003 2004 2005 2006 2007 2008

OSG 0.27 0.49 0.46 0.37 0.19 0.19

OSG-restated 0.27 0.49 0.46 0.37 0.19 0.19

Frontline 0.35 0.56 0.41 0.33 0.44 n/a

Teekay 0.11 0.34 0.29 0.13 0.08 n/a

Tsakos 0.24 0.45 0.55 0.46 0.37 n/a

industry average 0.24 0.46 0.43 0.32 0.27 n/a

Overseas Shipholding Group has closely followed the industry trend over the past

six years. Overall, the average for the industry has varied from about 20% to 50%

during this time. This variation is due to the changes in net sales for every company in

the energy shipping industry from year to year. Since 2006, OSG’s margin has slipped

below the industry average and could be a slight concern for investors. There is no

affect on this ratio when considering restated financial statements.

Asset Turnover

Asset turnover, or asset productivity, is calculated by taking the sales of a given

year and dividing that by the total assets of the previous year. This lag is necessary

because the previous year’s assets are used to generate revenue in the current year. A

high ratio indicates that firms are efficiently using their assets to create income.

 

Page | 110   

2003 2004 2005 2006 2007 2008

OSG 0.22 0.41 0.37 0.31 0.27 0.41

OSG-restated 0.22 0.38 0.34 0.23 0.19 0.28

Frontline 0.38 0.43 0.36 0.35 0.28 n/a

Teekay 0.58 0.62 0.36 0.38 0.31 n/a

Tsakos 0.35 0.39 0.31 0.39 0.25 n/a

industry average 0.38 0.46 0.35 0.36 0.28 n/a

Since 2005, the energy shipping industry has been relatively stable when

compared to previous years with averages between 30% and 35%. OSG maintained an

asset turnover ratio slightly below the industry average until 2007. Although Overseas

Shipholding Group is the only company to report their 2008 numbers at this point, it is a

positive sign that it had a significant increase in productivity during that year. This

significant increase in asset turnover can be attributed to 50% increase in revenue

between 2007 and 2008.

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

2003 2004 2005 2006 2007 2008

Asset Turnover

OSG

OSG‐restated

Frontlilne

Teekay

Tsakos

industry average

 

Page | 111   

The asset turnover of OSG using its restated financial statements is lower than

the original turnover for OSG and the rest of the industry. This is due to the fact that

there were more assets added after restating operating leases. It is a positive sign

when analyzing profitability that there was an increase in this ratio since 2007.

Return on Assets

“ROA gives an idea as to how efficient management is at using its assets to

generate earnings” (Investopedia). It is calculated by dividing a firm’s net income in a

given year by the total assets of the previous year. Alternatively, ROA can be measured

by multiplying the firm’s profit margin by the asset turnover. The lag is necessary

because of the asset turnover portion of this equation. A high ROA is desirable for firms

that want to remain profitable.

0.00

0.05

0.10

0.15

0.20

0.25

2003 2004 2005 2006 2007 2008

Return on Assets

OSG

OSG‐restated

Frontlilne

Teekay

Tsakos

industry average

 

Page | 112   

2003 2004 2005 2006 2007 2008

OSG 0.06 0.20 0.17 0.12 0.05 0.08

OSG restated 0.06 0.19 0.16 0.09 0.04 0.05

Frontline 0.13 0.24 0.14 0.12 0.12 n/a

Teekay 0.07 0.21 0.10 0.05 0.02 n/a

Tsakos 0.09 0.17 0.17 0.18 0.09 n/a

Industry Avg. 0.09 0.21 0.15 0.12 0.07 n/a

In the energy shipping industry, the industry average ROA has fluctuated

between 5% and 20% over the past five years. OSG has remained consistent with a

return on assets that closely matches the industry average on a yearly basis. In 2008,

OSG experienced an increase in ROA which was caused by the increase in the asset

turnover during the same year. Since the energy shipping industry has revenues that

vary from year to year, ratios such as this one will be less stable when compared to

other industries. For this reason, it is important for firms to have a ROA that is not

consistently below the rest of the industry.

When taking into account the restated financial statements for OSG, the ROA is

consistently below the industry average and the original OSG ROA. This is caused by

the increase in the amount of assets that were added because of operating leases.

Return on Equity

Return on equity is calculated by taking the net income in a given year and

dividing that by the owner’s equity of the previous year. “ROE is a comprehensive

indicator of a firm’s performance because it provides an indication of how well

managers are employing the funds invested by the firm’s shareholders to generate

 

Page | 113   

returns” (Palepu & Healy). A high ROE ratio is desirable because it means that the firm

is efficiently using equity for profit.

2003 2004 2005 2006 2007 2008

OSG 0.15 0.44 0.33 0.21 0.10 0.17

OSG restated 0.15 0.44 0.33 0.21 0.10 0.17

Frontline 0.33 0.82 0.66 0.72 0.85 n/a

Teekay 0.12 0.46 0.26 0.12 0.07 n/a

Tsakos 0.22 0.46 0.31 0.32 0.24 n/a

Industry Avg. 0.17 0.45 0.30 0.22 0.14 n/a

In the energy shipping industry, ROE ratios vary over time because of the

changes in industry sales from year to year. Overseas Shipholding Group has

consistently stayed with the industry average over the past six years, if Frontline is

omitted from the average as an outlier. However, in 2008, OGS did experience an

increase in ROE due to the significant increases in revenue and net income during that

year. Currently, there are no concerns about ROE when analyzing profitability, but if

00.10.20.30.40.50.60.70.80.9

2003 2004 2005 2006 2007 2008

Return on Equity

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 114   

OSG continues to experience similar increases in the future it can positively affect its

position in the industry. Additional, there is no impact to ROE when considering the

restated financial statements.

Conclusion

After comparing OSG’s profitability ratios with its competitors in the energy

shipping industry it can be concluded that its profitability performance is mixed. OSG’s

ability to control cost such as voyage expenses has allowed it to be an industry leader

when measuring the gross profit margin. On the other hand, OSG is consistently below

the average in the areas of operating expenses ratio and operating profit margin

because of the high charter hire expenses that OSG takes on when compared to its

competitors. Recent information from 2008 indicates that OSG is headed in the right

direction in these areas which improve their overall position of profitability. Net profit

margin, asset turnover, ROA, and ROE have all been similar to the industry averages,

but also have an increasing trend since 2007 which is favorable.

Ratio Performance Trend

Gross Profit Margin Outperforming Stable

Operating Expense Ratio Underperforming Decreasing

Operating Profit Margin Underperforming Decreasing

Net Profit Margin Average Decreasing

Asset Turnover Average Increasing

Return on Assets Average Increasing

Return on Equity Average Increasing

 

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Firm Growth Rate Ratios

Understanding and evaluating the growth rates of a particular firm can generate

a good basis for assessing that firm’s potential to maintain its future growth without

having to depend on outside sources of financing. If a firm can rely on its own internal

funds when expanding into the future it will hold an advantage over other firms who

borrow money to expand. When comparing firms by their growth rates you can also get

a better understanding of how well the firm will be able to compete in the future. If a

firm has to rely on outside funds to maintain an increasing profit they will be much

more hesitant to expand and grow when compared to the firms who can finance their

own growth. The two growth rate ratios we will use to evaluate OSG and their top

competitors in the energy shipping industry are the internal growth rate and the

sustainable growth rate.

Internal Growth Rate

The internal growth rate, or IGR, is the maximum level of growth attainable for a

firm without acquiring outside sources of funding. If the IGR is applied to a firm then

the only possibility for a firm to continue to increase in size is by utilizing their cash

flows and retained earnings. The IGR can be calculated by multiplying the firm’s return

on assets, or ROA, by 1 minus the dividend payout ratio (dividends / net income). It is

advantageous for a firm to possess a high IGR to prove that by using only internal

funds they can continue to finance capital and assets.

 

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2003 2004 2005 2006 2007 2008

OSG 0.05 0.19 0.16 0.11 0.04 0.07

OSG restated 0.05 0.19 0.16 0.11 0.04 0.07

Frontline 0.02 0.00 -0.07 -0.03 -0.02 n/a

Teekay 0.05 0.20 0.09 0.04 0.01 n/a

Tsakos 0.07 0.15 0.13 0.14 0.06 n/a

Industry Avg. 0.05 0.13 0.08 0.06 0.02 n/a

As illustrated by the graph and table above, the energy shipping industry has a

relatively stable IGR as a whole. The decline in the industry’s average IGR is due to the

fact that each firm has been consistently paying out more cash dividends. When a firm

earns a profit throughout the year, they can choose to distribute a portion of that

money to their shareholders in the form of dividends. Although paying out dividends to

shareholders can show a firm’s financial health, it can significantly lower their IGR. The

funds used to pay dividends are no longer held by the firm and this reduces the firm’s

retained earnings.

‐0.1

‐0.05

0

0.05

0.1

0.15

0.2

0.25

2003 2004 2005 2006 2007 2008

Internal Growth Rate

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

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Only one of OSG’s top competitors, Frontline, has had a negative rate over the

past 5 years. This is due to the fact that they did not have enough net income to cover

the amount paid as dividends to their shareholders. If Frontline were taken out of the

industry average, the average would significantly increase and the remaining three

firms would be in much closer relation to it. Since these firms all possess positive rates

with only a slight degree of differentiation among them, no one firm in particular is at

an advantage when judged by their IGR. The majority of the firms used for comparison

here have the ability for potential growth based solely on internal funding.

Sustainable Growth Rate

The sustainable growth rate, or SGR, is a measure of how much growth a firm

can sustain without being forced to borrow money to supplement existing funds. This

growth rate is typically employed to give an idea of a steady maintainable rate for a

firm when they are growing at rapid rates that cannot be upheld. When a firm

surpasses their SGR, they are forced to rely on outside sources of financing to stimulate

their personal financing activities and future growth. The SGR for a firm can be

calculated by multiplying a firm’s IGR by 1 plus their debt over equity.

‐0.60

‐0.40

‐0.20

0.00

0.20

0.40

0.60

2003 2004 2005 2006 2007 2008

Sustainable Growth Rate

OSG

OSG‐restated

Frontline

Teekay

Tsakos

Industry Avg.

 

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2003 2004 2005 2006 2007 2008

OSG 0.11 0.35 0.29 0.20 0.09 0.15

OSG-restated 0.11 0.38 0.40 0.28 0.14 0.23

Frontline 0.08 -0.02 -0.45 -0.21 -0.16 n/a

Teekay 0.11 0.49 0.22 0.12 0.05 n/a

Tsakos 0.18 0.26 0.24 0.36 0.17 n/a

Industry Avg. 0.12 0.27 0.08 0.12 0.04 n/a

The information provided by the graph and table above shows how closely the

IGR and the SGR are related. It is once again made apparent that the industry, as a

whole, is moderately stable and has a positive sustainable growth rate. Over the past 5

years OSG has stayed close to the industry average, with only minor fluctuations above

and beneath it. When taking into account the restated financial statements, the overall

SGR improves due to the increase in the debt to equity ratio. Even though this is a good

sign for their personal financial health, their top competitors (with the exception of

Frontline) all possess relatively similar rates. It can be concluded once more that there

is no one firm in particular with an advantage from the rest of the industry based on

their SGR. The greater part of the industry holds stable, positive rates with no reason to

predict a change in the near future.

Conclusion

OSG has performed around the same level as the industry average for the last 5

years. Although this is a good sign since the majority of the industry has held steady

and positive growth rates, they are not drastically outperforming their top competition.

These ratios show that there is room for potential growth, but they do not give

potential investors a solid reason to believe OSG will grow at a greater rate than their

 

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competition in the upcoming years. Based on both the internal growth rate and

sustainable growth rate of OSG, they will continue to perform at the industry average

for several years to come.

Ratio Performance Trend

Internal Growth Rate Average Increasing

Sustainable Growth Rate Average Increasing

Capital Structure Ratios

The capital structure ratios are used to determine how a firm raises money to

fund its assets. Companies have to decide to either borrow from a bank and increase

liabilities or obtain money from the sale of company stock. The decisions that a

company makes can affect its credit rating and future interest rates and expenses. The

ratios that are used to analyze the capital structure of a particular company include

debt to equity ratio, times interest earned, and debt service margin.

Debt to Equity

The debt to equity ratio indicates the firm’s risk at financing its assets and is

found by taking total liabilities and dividing by stockholders equity. Finding the right

combination of liabilities and equity is important for a company to remain competitive in

its industry. Firms with a high ratio have the opportunity to earn more revenue than

firms that rely on internal financing. The downside: credit ratings for these firms will

decrease because too much debt is considered risky. The interest rates to borrow will

grow and it will become more difficult to raise future funds because they will be

considered more likely to default. A low debt to equity ratio is also not preferable. “Too

much equity financing can indicate that you are not making the most productive use of

 

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your capital; the capital is not being used advantageously as leverage for obtaining

cash” (US Chamber of Commerce).

2003 2004 2005 2006 2007 2008

OSG 1.18 0.88 0.78 0.92 1.29 1.26

OSG-Restated 1.33 1.04 1.43 1.63 2.35 2.44

Frontline 2.44 3.59 5.23 5.87 7.44 n/a

Teekay 1.17 1.46 1.37 2.06 2.74 n/a

Tsakos 1.62 0.81 0.79 1.61 1.76 n/a

Industry Avg. 1.60 1.68 2.04 2.61 3.31 n/a

In the energy shipping industry, having a good credit rating is important because

firms need to finance the shipping vessels that they purchase. Poor credit ratings will

drastically increase interest expenses and hinder a firm’s ability to remain profitable.

According to the graph above, OSG has a debt to equity that has been consistently

stable and at the bottom of the industry. OSG and Tsakos are the only two firms in this

industry to stay below a 2:1 ratio since 2003. The restated financial statements impact

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

2003 2004 2005 2006 2007 2008

Debt to Equity

OSG

OSG‐Restated

Frontline

Teekay

Tsakos

Industy Avg

 

Page | 121   

this ratio because of the increase of debt when taking into account the operating

leases. This increase is significant and will ultimately affect other areas such as the

sustainable growth rate.

This ratio can explain why one of OSG’s competitive advantages is its high credit

rating. In turn, the high credit rating allows OSG to reduce financing costs and remain

financially flexible when compared to the rest of the industry (OSG 10K). On the other

hand, Frontline has consistently increased over the last six years with a debt to equity

ratio of almost 8:1 in 2007. In a recession, Frontline will have a difficult time paying off

its debt and have high interest expenses and rates.

Times Interest Earned

The ability to obtain low interest rates in the energy shipping industry is very

important because of the amount of interest expense that firms in this industry face.

The times interest earned ratio indicates if a company has the income to cover the

interest expenses that need to be paid. It is measured by taking the net income before

interest and taxes (NIBIT) in a given year and dividing that number by the interest

expense of the same year.

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008

Times Interest Earned

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

Page | 122   

2003 2004 2005 2006 2007 2008

OSG 3.62 8.20 8.35 6.46 3.48 5.75

OSG restated 3.62 8.20 8.35 6.46 3.48 5.75

Frontline 6.48 15.17 11.57 10.83 7.00 n/a

Teekay 3.62 10.14 7.80 5.21 4.91 n/a

Tsakos 5.71 11.76 12.51 16.59 20.18 n/a

Industry Avg. 4.86 11.32 10.06 9.77 8.89 n/a

When analyzing the times interest earned there are no concerns in the capital

structure if a firm has a ratio over 4:1. If a company has a ratio of more than 7:1,

banks would be more willing to loan to a particular company because this ratio explains

the firm’s ability to pay off interest expenses. A high ratio is desirable to a point. “A high

ratio can indicate that a company has an undesirable lack of debt or is paying down too

much debt with earnings that could be used for other projects” (Investopedia).

Overseas Shipholding Group has an average ratio of 6:1 over the last six years which is

not a concern. This ratio means that OSG has $6.00 dollars for every $1.00 of interest

expense that needs to be paid. Also, there is no impact to this ratio when taking into

account OSGs restated financial statements.

Debt Service Margin

The debt service margin ratio measures if a firm has enough cash flows to cover

the current payments of long term debt. This ratio is found by dividing the current year

cash flows from operations by the current installment of long term debt for the year

before. The current installment of long term debt appears on most financial statements

under current liabilities as either notes payable current or current portion of long term

 

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debt. A high ratio is desirable when analyzing the capital structure because the firm has

more cash to cover current debt obligations.

2003 2004 2005 2006 2007 2008

OSG 15.63 26.05 30.46 31.22 11.74 25.67

OSG restated 15.63 26.05 30.46 31.22 11.74 25.67

Frontline 3.19 5.42 5.84 4.96 3.25 n/a

Teekay 5.45 9.74 7.28 6.23 3.05 n/a

Tsakos 2.79 5.08 4.86 7.12 6.31 n/a

Industry Avg. 6.76 11.58 12.11 12.38 6.09 n/a

OSG has a debt service margin that has remained significantly above the rest of

the energy shipping industry over the past six years. This is due to the fact that

Overseas Shipholding Group has less current long term liabilities than their competitors.

This ratio stays the same when taking into account OSG restated financial statements.

In 2007, OSG experienced a decrease in cash flows from operations of over 60% which

can explain the drop in debt service margin during this time.

0

5

10

15

20

25

30

35

2003 2004 2005 2006 2007 2008

Debt Service Margin

OSG

OSG restated

Frontline

Teekay

Tsakos

Industry Avg.

 

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Altman’s Z-Score

The Altman’s Z-Score is a formula with five financial components that measures

a public company’s likelihood to become bankrupt. “Real world application of the Z-

Score successfully predicted 72% of corporate bankruptcies two years prior to these

companies filing for Chapter 7” (Investopedia). A lower Z-Score results in a greater

probability that a firm is headed towards bankruptcy. If the Z-Score is less than 1.81 for

a company, the model predicts this to be an unhealthy company that is in high danger

of bankruptcy. If the Z-Score is between 1.81 and 2.67, the model predicts a company

in the grey area. Finally, if the Z-Score is more than 2.67, the model predicts a healthy

company that is unlikely to become bankrupt. The Altman’s Z-Score is calculated using

the formula below.

0.000.501.001.502.002.503.003.50

2003 2004 2005 2006 2007 2008

Altman's Z‐Score

OSG

OSG‐restated

Frontline

Teekay

Tsakos

Industry Avg.

 

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2003 2004 2005 2006 2007 2008

OSG 1.83 2.59 2.31 1.88 1.83 1.97

OSG-restated 1.68 2.32 1.54 1.26 1.16 1.24

Frontline 1.19 1.97 1.43 1.28 1.45 n/a

Teekay 2.57 1.98 1.81 1.16 0.99 n/a

Tsakos 1.48 3.12 2.95 1.76 1.46 n/a

Industry Avg. 1.77 2.42 2.12 1.52 1.43 n/a

The energy shipping industry as a whole is at a high risk of bankruptcy according

to the Altman’s Z-Score. The industry average has been below the 1.61 mark since

2006. The industry is in danger of high interest rates because they will have lower

credit ratings since they will be more likely to default. The ability to loan money and pay

off increasing interest expenses will be increasingly difficult if Z-Scores continue to drop

as they have since 2004. OSG is the only company in the industry to have a Z-Score

that is higher than 1.81 for each of last six years. OSG’s average of 2.07 puts them in

the grey area category. Although this is the case, OSG’s restated financial statements

do not tell the same story. The restated Z-Score is significantly lower with a score of

1.24 in 2008. This is mostly caused by the additional assets that were added in the

restatements due to operating leases. This score would put the company in the danger

zone when predicting bankruptcy for the company at its current state.

Conclusion

Capital structure ratios allow investors to have a better look at how the firm is

structured when it comes to financing. OSG states in its 10-K that its high credit rating

allows the company to be financially flexible and it was determined that this was one of

the company’s competitive advantages. The results of the capital structure analysis

 

Page | 126   

agree with this statement. OSG has a debt to equity ratio and debt service margin that

is consistently outperforming the rest of the energy shipping industry. The times

interest earned ratio of OSG is average for this industry, but there is no concern about

the capital structure because they have a ratio of over 4:1. A high credit rating will

reduce the future interest rates for OSG and minimize interest expenses relative to the

rest of the industry. A strong credit score will also be beneficial for OSG during this

tough economic climate.

The Altman’s Z-Score results also show that OSG is outperforming the industry

as the only company in the “grey” area with an average of 2.07. Although this is the

case, the restated financial statements bring the new Z-Score of OSG back to the

industry average. In this area, companies have a high risk of becoming bankrupt. The

restated numbers also negatively impacted the debt to equity ratio by going from

outperforming the industry to being average.

Ratios Performance Trend

Debt to Equity Outperforming Stable

Times Interest Earned Average Stable

Debt Service Margin Outperforming Increasing

Altman’s Z-Score Average Stable

 

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Forecasted Financial Statements

Financial statements reflect the consequences of business activities through the

language of accounting. The purpose of our analysis is to determine if Overseas

Shipping Group is overvalued, undervalued or fairly valued. The prices of equities reflect

future expectations of business activities relative to substitutable investments.

Therefore, it wouldn’t be accurate to simply continue past trends in forecasting what we

believe will happen in the market for energy shipping services. It will be in the context

of our previous industry, accounting and financial analysis that we examine the future

financial consequences of Overseas Shipping’s operations.

Income Statement

The income statement reflects how the company used sales dollars to pay for the

operations that support the cash-to-cash conversion cycle. That is, what does it cost the

company to develop inventory, market and sell the product, service debt obligations

and taxes and realize a profit (or loss). Our first step in this process involved forecasting

future sales.

Sales forecasting

Forecasting future sales is somewhat irregular and problematic for an industry of

this nature. The energy shipping industry derives its sales from a combination of

volume of oil and natural gas transported as well as the prevailing market rate for such

services. Therefore, it was necessary to forecast both volume and price movements to

capture changes in net sales. We utilized a revenue day, that is, days the ship is

operable minus time in dry dock (repairs) and idle time to proxy for the total amount of

operating capacity in terms of volume. Revenue days are measured by OSG and

reported on their 10k and are weighted to reflect ownership stakes in ships not wholly

 

Page | 128   

owned by OSG and its subsidiaries. In terms of total revenue days, there existed

categorical differences in reporting from 2000-2002. Therefore, we examined total

revenue days post 2002, and international pool revenue days to forecast future growth

in revenue days. The average growth rate of total revenue days was 17.1%, and 14.9%

for the international pool revenue days. As expected, revenue days increase when rates

are experiencing contagion and remain flat (or slightly decrease) in times of rate

backwardation. Assuming rates remain flat; these figures would reflect rapid future

growth of OSG’s total sales and be unrealistic in regard to the total number of large

crude carriers and the accessibility of shipping lanes. In light of OSGs previous rapid

expansion of their fleet, we forecasted a conservative increase in revenue days of 7% in

2009, 8.5% in 2010 and 10% thereafter.

The process of forecasting future rates involved taking a 3-year moving average

of the average time constant equivalent rate OSG had reported in prior years.

Examining total percent changes in rates over a 10 year period is largely an exercise in

reversion to mean. Shipping rates can vary significantly year-to-year and a three year

moving average captured these changes while allowing flexibility (deviation) in rates as

a whole. Inevitably, the rates showed little deviation toward the end of the forecasting

period. This uncertainty regarding future rates is a significant obstacle for the industry

as a whole and we feel the user of this analysis would be better served adjusting their

personal cost-of-equity to reflect a model price more conducive to their risk-tolerances

and expectations for energy shipping rates.

The final part of our sales forecast simply involved adding the year to year

percent changes in rates and revenue days to reflect changes in total sales. Since we

knew what the total amount of sales was for 2008, we could simply apply these

changes and come to a total sales forecast for the following years.

%∆ %∆   %∆  

 

Page | 129   

Expense Structure

In order to forecast future net income, we need to forecast future sales

and expenses. This process involved creating a common-size income statement defined

as every line item as a percentage of total sales. As discussed earlier, changes in sales

may reflect changes in rates alone, not requiring increases in expenses from year to

year. To accommodate this inconsistency, we grew total operating expenses by the

amount of the increase in revenue days. For example, depreciation and amortization

increase 7% in 2009, 8.5% in 2010 and 10% thereafter reflecting the additional

expenses associated with growing OSGs fleet.

Income Statement Restated

The process of restating operating leases had no effect on sales for Overseas

Shipping Group, but had a material effect on the firm’s cost structure. Specifically, the

payments for chartering in vessels was capitalized as an asset as well as the related

liability, with the respective depreciation and interest expense being used as the total

operating lease expense. Essentially, this restatement reallocated the operating lease

payments from an expense to an asset, recognizing depreciation and interest as the

appropriate yearly expense. This perspective is more accurate to the characteristics of

the payments, in that OSG has a long-term liability as well as a long-term asset at their

disposal, and that obligation is reflected in the restatement.

Balance Sheet

The method we used in forecasting the future balance sheets for OSG involved

utilizing a revenue day turnover opposed to an asset turnover. Asset turnover is defined

as sales over asset and is useful in forecasting future total assets as a ratio of total

sales. A stable asset turnover ratio assumes that it requires a certain amount of assets

to support a given amount of sales. As stated earlier, sales in the energy shipping

 

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industry are a function of volume and price. Therefore, we can’t simply use a constant

asset turnover to reflect the assets necessary to support a given amount of sales.

However, revenue days and shipping rates are independent from one-another on a

micro level and it would be reasonable to assume it takes a certain amount of assets to

support a given amount of revenue days (volume). Disregarding outliers such as years

with large cash positions distorting total assets used for shipping activities, we were

able to estimate a constant revenue day turnover with little deviation. That is, what

dollar amount of assets is necessary to support a single revenue day? This approach

isolated volume in relation to assets and allowed our total dollar amount of sales to be

independent of total assets for the purposes of creating pro-forma statements.

We calculated that for every $1 million dollars in total assets, OSG can support

5.025(4.254 for restated) revenue days, or days the ship is operating minus days in dry

dock for maintenance and repairs. As discussed in the preceding paragraphs, we

forecasted a conservative 7% increase for 2009, 8.5% increase for 2010 and 10%

thereafter (average since 2002: 14.9%).

Balance Sheet Restated

The effect of capitalizing operating lease payments was an increase in assets and

liabilities. As OSG had increased its operating lease obligations over the years, the

carrying value (discounted at 5.1%) of the future lease obligations was capitalized to

reflect the respective obligation and the right to use these cash flow producing assets in

the future. Additionally, the restated total equity was larger in 2008(before forecasting)

because of the larger net income in previous years. The cause of this larger net income

is explained in further detail under the income statement section. The increased liability

reflects OSGs contractual obligation to make payments on its vessels under operating

leases.

 

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Statement of Cash Flows

The statement of cash flows reflects the consequences of business activities to

the firm’s cash position. In estimating future cash flows, we examined three different

ratios and their consistency over time to accurately reflect cash position. These ratios

are CFFO/Net Income, CFFO/Operating Income and CFFO/Net Sales. CFFO/Operating

Income proved to be the most consistent over time and was used in the estimation of

CFFO in the forecasting periods.

Cash flows from investing activities were measured by taking the yearly change

in vessels at cost, minus accumulated depreciation. The long-term asset of vessels was

increased as a percentage of total assets from 43% to 53.6% to reflect the changes in

the way vessels are acquired or utilized. Overseas Shipping Group employs operating

leases to obtain vessels usually for a 5 year term. This method involves capitalizing

these future lease obligations under restated financial statements. Aggregating the

procurement of vessels to outright purchases simplified the measurement of cash flow

from investing activities and allowed us to accurately estimate OSGs investment in their

fleet as well as the expected expansion of revenue days, cited earlier.

Cash flows from financing activities were simplified to reflect only the cash

dividends paid to stockholders. This assumption was necessary because it is beyond of

our ability as users of financial statements to predict future stock buybacks, issuances

and private placements (like issuances). Therefore, we maintained the stair-step

approach to dividends OSG has employed in the past and paid the same dividend for

two years in a row, increasing it relative to the increase in net income in two year

intervals.

 

 

OSG Income Statement (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 RevenuesVoyage charter revenues 53,429 83,797 126,029 267,574 431,777 Time and bareboat charter revenues 116,957 309,471 282,409 361,431 366,629 Pool Revenues 640,449 607,035 638,965 500,300 906,291

Sales Growth -18.52% 12.14% 18.68% 3.60% 11.72% 11.12% 8.71% 10.50% 10.10% 9.77%Total Revenues 810,835 1,000,303 1,047,403 1,129,305 1,704,697 1,388,918 1,557,566 1,848,502 1,915,015 2,139,374 2,377,206 2,584,202 2,855,541 3,144,027 3,451,072

Voyage Expenses (COGS) (21,254) (38,641) (54,586) (90,094) (159,312) (109,684) (123,002) (145,977) (151,230) (168,948) (187,729) (204,076) (225,504) (248,286) (272,533)

Gross Profit 789,581 961,662 992,817 1,039,211 1,545,385 1,279,234 1,434,564 1,702,525 1,763,785 1,970,426 2,189,476 2,380,126 2,630,037 2,895,741 3,178,539

Ship Operating Expenses:Vessel expenses 108,170 177,349 209,998 267,947 314,553 Time and bareboat charter hire expenses 65,550 120,301 174,817 258,116 429,808 Depreciation and Amortization 100,088 152,311 141,940 185,499 189,163 General and Administrative 51,993 79,667 99,525 127,211 144,063 Goodwill Impairment Charges 62,874 Loss/(Gain) on Sale of Vessels (39,007) (7,134) 59,738

Total Ship Operating Expenses 325,801 529,628 587,273 831,639 1,200,199 1,064,753 1,169,916 1,326,077 1,424,395 1,576,355 1,740,914 1,906,103 2,100,457 2,311,352 2,540,355

Income from Vessel Operations 463,780 432,034 378,544 207,572 345,186 Equity in Income of Joint Ventures 45,599 43,807 22,474 8,876 12,292

Operating Income 509,379 475,841 401,018 216,448 357,478 265,411 321,761 444,229 409,610 472,518 535,730 568,781 634,288 699,675 764,728 Other Income/(Expense) 45,781 77,367 52,107 75,434 (28,847)

Net Earnings Before Interest and Taxes 555,160 553,208 453,125 291,882 328,631

Interest Expense 74,146 89,489 (68,652) (74,696) (57,449) 73,877 82,847 98,322 101,860 113,794 126,444 137,454 151,887 167,232 183,563

Change in Accounting Principle and Minority Interest 384,473 217,186 271,182 Provision/(Credit) for Federal Income Taxes 79,778 (1,110) 8,187 (4,827) 34,004

Minority Interest (1,049) 12,479

Net Income 401,236 464,829 392,660 211,310 317,665 181,047 227,154 331,951 293,292 342,572 391,338 411,816 460,842 508,706 555,110 Cash Dividends Paid (27,532) (27,615) (36,576) (38,038) (44,856) (49,590) (49,590) (53,841) (53,841) (65,176) (65,176) (70,843) (70,843) (76,511) (76,511)

Addition to Retained Earnings 373,704 437,214 356,084 173,272 272,809 131,457 177,564 278,110 239,451 277,396 326,162 340,973 389,998 432,195 478,599

Forecasted FinancialsActual Financials

 

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OSG Income Statement (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 RevenuesVoyage charter revenues 53,429 83,797 126,029 267,574 431,777 Time and bareboat charter revenues 116,957 309,471 282,409 361,431 366,629 Pool Revenues 640,449 607,035 638,965 500,300 906,291

Sales Growth -18.52% 12.14% 18.68% 3.60% 11.72% 11.12% 8.71% 10.50% 10.10% 9.77%Total Revenues 810,835 1,000,303 1,047,403 1,129,305 1,704,697 1,388,918 1,557,566 1,848,502 1,915,015 2,139,374 2,377,206 2,584,202 2,855,541 3,144,027 3,451,072

Voyage Expenses (COGS) (21,254) (38,641) (54,586) (90,094) (159,312) (109,684) (123,002) (145,977) (151,230) (168,948) (187,729) (204,076) (225,504) (248,286) (272,533)

Gross Profit 789,581 961,662 992,817 1,039,211 1,545,385 1,279,234 1,434,564 1,702,525 1,763,785 1,970,426 2,189,476 2,380,126 2,630,037 2,895,741 3,178,539

Ship Operating Expenses:Vessel expenses 108,170 177,349 209,998 267,947 314,553 Operating leases payments newly capitalized 24,537 48,624 213,692 280,483 313,914 Depreciation and Amortization 100,088 152,311 141,940 185,499 189,163 General and Administrative 51,993 79,667 99,525 127,211 144,063 Goodwill Impairment Charges 62,874 Loss/(Gain) on Sale of Vessels (39,007) (7,134) 59,738

Total Ship Operating Expenses 284,788 457,951 626,148 854,006 1,084,305 889,168 984,147 1,134,400 1,202,461 1,335,307 1,478,000 1,614,018 1,780,374 1,959,536 2,152,668

Income from Vessel Operations 504,793 503,711 366,669 185,205 461,080 Equity in Income of Joint Ventures 45,599 43,807 22,474 8,876 12,292

Operating Income 550,392 547,518 389,143 194,081 473,372 361,333 430,429 576,032 543,853 623,167 703,612 750,664 835,531 921,309 1,007,857Other Income/(Expense) 45,781 77,367 52,107 75,434 (28,847)

Net Earnings Before Interest and Taxes 596,173 624,885 441,250 269,515 444,525

Interest Expense 74,146 89,489 68,652 74,696 57,449 131,947 147,969 175,608 181,926 203,241 225,835 245,499 271,276 298,683 327,852

Change in Accounting Principle and Minority Interest 522,027 535,396 372,598 194,819 387,076 Provision/(Credit) for Federal Income Taxes 79,778 (1,110) (8,187) 4,827 (34,004)

Minority Interest (1,049) 12,479

Net Income 442,249 536,506 380,785 188,943 433,559 230,775 284,017 402,273 363,842 422,066 480,155 507,749 567,110 625,770 683,457 Cash Dividends paid (27,532) (27,615) (36,576) (38,038) (44,856) (49,590) (49,590) (53,841) (53,841) (65,176) (65,176) (70,843) (70,843) (76,511) -76510.9611

Addition to Retained Earnings 414,717 508,891 344,209 150,905 388,703 181,184 234,427 348,432 310,001 356,890 414,979 436,905 496,267 549,259 606,946

Actual Financials Forecasted Financials

 

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OSG Balance Sheet (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

AssetsCash and cash equivalents 479,181 188,588 606,758 502,420 343,609 Voyage receivables 144,237 157,334 136,043 180,406 219,500 142,950 155,101 170,611 187,672 206,439 227,083 249,792 274,771 302,248 332,473 Other receivables 12,815 22,202 71,723 84,627 64,773 38,937 42,246 46,471 51,118 56,230 61,853 68,038 74,842 82,326 90,559 Inventories 1,132 1,855 7,002 9,195 6,627 5,364 5,820 6,402 7,042 7,747 8,521 9,373 10,311 11,342 12,476 Prepaid expenses 8,252 14,908 23,995 28,105 43,780 Total Current Assets 645,617 384,887 845,521 804,753 678,289 508,529 551,754 606,929 667,622 734,384 807,823 888,605 977,465 1,075,212 1,182,733

Capital Construction Fund 268,414 296,126 315,913 151,174 48,681 Vessels (At Cost) 1,422,239 2,288,481 2,501,846 2,691,005 2,683,147 2,865,948 3,119,428 3,442,989 3,798,905 4,190,413 4,621,072 5,094,796 5,615,893 6,189,100 6,819,627 Vessels under Capital Leases 24,382 36,267 30,750 24,399 1,101 Deferred Drydock expenditures 19,805 50,774 81,619 79,837 Vessel Held for Sale 9,744 53,975 Investments in Joint Ventures 227,701 269,257 275,199 131,905 98,620 Other Assets 82,701 53,457 53,762 87,522 130,237 Goodwill 64,293 72,463 9,589 Intangible Assets 92,611 114,077 106,585 Total Non-Current Assets 2,035,181 2,963,793 3,385,148 3,354,164 3,211,772 3,396,607 3,685,318 4,053,850 4,459,235 4,905,159 5,395,675 5,935,242 6,528,766 7,181,643 7,899,807

Total Assets 2,680,798 3,348,680 4,230,669 4,158,917 3,890,061 3,905,136 4,237,072 4,660,779 5,126,857 5,639,543 6,203,497 6,823,847 7,506,232 8,256,855 9,082,540

LiabilitiesAccounts payable 3,960 105,173 192,500 178,837 167,615 Sundry liabilities and accrued expenses 76,087 Federal income taxes 90,943 Short-term debt and current installments of long-term debt 25,024 20,066 27,426 26,058 26,231 Current obligations under capital leases 4,729 6,968 7,650 8,406 1,092 Total Current Liabilities 200,743 132,207 227,576 213,301 194,938 205,051 222,480 244,728 269,201 296,121 325,733 358,306 394,137 433,550 476,905

Long-term Debt 863,466 923,612 1,273,053 1,506,396 1,396,135 Obligations under Capital Leases 42,717 42,043 33,894 24,938 Deferred Federal Income Taxes 141,334 270,076 281,711 Deferred Credits and Other Liabilities 147,500 233,456 218,759 182,076 474,355 Minority Interest 132,470 101,766 Total Non-Currrent Liabilities 1,053,683 1,340,445 1,795,782 2,127,591 1,972,256 1,845,761 1,982,704 2,106,053 2,308,207 2,516,577 2,724,757 2,971,561 3,228,117 3,507,131 3,810,863

Total Liabilities 1,254,426 1,472,652 2,023,358 2,340,892 2,167,194 2,050,812 2,205,184 2,350,781 2,577,408 2,812,698 3,050,490 3,329,867 3,622,253 3,940,681 4,287,768

Common stock 40,791 40,791 40,791 40,791 40,791 Paid-in additional capital 199,054 199,570 202,712 208,817 224,522 Retained earnings 1,203,528 1,640,742 1,996,826 2,170,098 2,442,907 2,574,364 2,751,928 3,030,038 3,269,489 3,546,885 3,873,047 4,214,020 4,604,018 5,036,214 5,514,812

Stockholders' Equity 1,442,013 1,881,103 2,240,329 2,419,706 2,708,220 Cost of Treasury Stock (17,579) (17,019) (34,522) (583,708) (838,994) Accumulated other comprehensive income/(loss) 1,938 11,944 1,504 (17,973) (146,359)

Total Shareholders' Equity 1,426,372 1,876,028 2,207,311 1,818,025 1,722,867 1,854,324 2,031,888 2,309,998 2,549,449 2,826,845 3,153,007 3,493,980 3,883,978 4,316,174 4,794,772

Total Liabilities and Shareholders' Equity 2,680,798 3,348,680 4,230,669 4,158,917 3,890,061 3,905,136 4,237,072 4,660,779 5,126,857 5,639,543 6,203,497 6,823,847 7,506,232 8,256,855 9,082,540

Actual Financials Forecasted Financials

 

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OSG Balance Sheet (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

AssetsCash and cash equivalents 479,181 188,588 606,758 502,420 343,609 Voyage receivables 144,237 157,334 136,043 180,406 219,500 142,950 155,101 170,611 187,672 206,439 227,083 249,792 274,771 302,248 332,473 Other receivables 12,815 22,202 71,723 84,627 64,773 38,937 42,246 46,471 51,118 56,230 61,853 68,038 74,842 82,326 90,559 Inventories 1,132 1,855 7,002 9,195 6,627 5,364 5,820 6,402 7,042 7,747 8,521 9,373 10,311 11,342 12,476 Prepaid expenses 8,252 14,908 23,995 28,105 43,780 Total Current Assets 645,617 384,887 845,521 804,753 678,289 676,667 734,184 807,602 888,362 977,199 1,074,918 1,182,410 1,300,651 1,430,716 1,573,788

Capital Construction Fund 268,414 296,126 315,913 151,174 48,681 Vessels (At Cost) 1,422,239 2,288,481 2,501,846 2,691,005 2,683,147 3,230,753 3,943,609 4,783,132 5,643,354 6,524,320 7,432,426 8,413,659 9,463,888 10,538,425 11,687,535 Vessels Under Capital Leases 24,382 36,267 30,750 24,399 1,101 Vessels Under Operating Leases, Newly Capitalized 222,364 1,207,297 1,584,651 1,924,540 2,032,783 Deferred Drydock Expenditures 19,805 50,774 81,619 79,837 Vessel Held for Sale 9,744 53,975 Investments in Joint Ventures 227,701 269,257 275,199 131,905 98,620 Other Assets 82,701 53,457 53,762 87,522 130,237 Goodwill 64,293 72,463 9,589 Intangible Assets 92,611 114,077 106,585 Total Non-Current Assets 2,257,545 4,170,690 4,969,799 5,278,704 5,244,555 5,350,089 5,804,847 6,385,331 7,023,864 7,726,251 8,498,876 9,348,763 10,283,640 11,312,004 12,443,204

Total Assets 2,903,162 4,555,577 5,815,320 6,083,457 5,922,844 6,026,756 6,539,030 7,192,933 7,912,227 8,703,449 9,573,794 10,531,174 11,584,291 12,742,720 14,016,992

LiabilitiesAccounts payable 3,960 105,173 192,500 178,837 167,615 Sundry liabilities and accrued expenses 76,087 Federal income taxes 90,943 Short-term debt and current installments of long-term debt 25,024 20,066 27,426 26,058 26,231 Current obligations under capital leases 4,729 6,968 7,650 8,406 1,092 Total Current Liabilities 200,743 132,207 227,576 213,301 194,938 205,051 222,480 244,728 269,201 296,121 325,733 358,306 394,137 433,550 476,905

Long-term Debt 863,466 923,612 1,273,053 1,506,396 1,396,135 Obligations under Capital Leases 42,717 42,043 33,894 24,938 Obligations under Operating Leases 222,364 1,207,297 1,584,651 1,924,540 2,032,783 Deferred Federal Income Taxes 141,334 270,076 281,711 Deferred Credits and Other Liabilities 147,500 233,456 218,759 182,076 474,355 Minority Interest 132,470 101,766 Plug for Liabilities 161,910 31,784 172,801 339,273 (190,802) Total Non-Current Liabilities 1,237,215 2,438,192 3,283,158 3,977,223 3,814,236 3,726,852 3,987,270 4,270,493 4,655,313 5,062,726 5,488,479 5,976,380 6,497,400 7,067,157 7,691,128

Total Liabilities 1,437,958 2,570,399 3,510,734 4,190,524 4,009,174 3,931,903 4,209,750 4,515,221 4,924,514 5,358,846 5,814,212 6,334,687 6,891,537 7,500,707 8,168,034

Common stock 40,791 40,791 40,791 40,791 40,791 Paid-in additional capital 199,054 199,570 202,712 208,817 224,522 Retained earnings 1,241,001 1,749,892 2,094,101 2,245,006 2,633,709 2,814,893 3,049,320 3,397,752 3,707,753 4,064,643 4,479,622 4,916,527 5,412,794 5,962,053 6,568,999

Stockholders' Equity 1,480,846 1,990,253 2,337,604 2,494,614 2,899,022 Cost of treasury stock (17,579) (17,019) (34,522) (583,708) (838,994) Accumulated other comprehensive income/(loss) 1,938 11,944 1,504 (17,973) (146,359)

Total Shareholders' Equity 1,465,205 1,985,178 2,304,586 1,892,933 1,913,669 2,094,853 2,329,280 2,677,712 2,987,713 3,344,603 3,759,582 4,196,487 4,692,754 5,242,013 5,848,959

Total Liabilities and Shareholders' Equity 2,903,162 4,555,577 5,815,320 6,083,457 5,922,844 6,026,756 6,539,030 7,192,933 7,912,227 8,703,449 9,573,794 10,531,174 11,584,291 12,742,720 14,016,992

Forecasted FinancialsActual Financials

 

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OSG Cash Flow (Restated)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Net Income 442,249 536,506 380,785 188,943 433,559 264,224 349,663 484,369 526,840 632,667 741,984 836,521 957,604 1,085,159 1,217,026 Sales 810,835 1,000,303 1,047,403 1,129,305 1,704,697 Operating Income 550,392 547,518 389,143 194,081 473,372 394,782 496,074 658,128 706,851 833,768 965,441 1,079,436 1,226,025 1,380,697 1,541,426

AverageCFFO/Sales 0.54 0.52 0.41 0.13 0.28 0.38CFFO/Net Income 0.99 0.98 1.14 0.77 1.11 1.00CFFO/Operating Income 0.80 0.96 1.12 0.75 1.02 0.93

CFFO 437,838 523,723 434,100 145,257 482,571 513,217 644,896 855,567 918,907 1,083,899 1,255,073 1,403,267 1,593,832 1,794,906 2,003,854 CFFI 268,289 (37,181) 8,202,194 (6,730,002) (1,710,510) (547,606) (712,857) (839,523) (860,222) (880,966) (908,106) (981,233) (1,050,230) (1,074,537) (1,149,110) CFFF 199528 (787898) 228897 (237067) (448466) (49,590) (49,590) (53,841) (53,841) (65,176) (65,176) (70,843) (70,843) (76,511) (76,511)

OSG Cash Flow (Raw)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Net Income 401,236 464,829 392,660 211,310 317,665 431,550 483,950 574,347 595,013 664,724 738,620 802,936 887,243 976,879 1,072,281 Sales 810,835 1,000,303 1,047,403 1,129,305 1,704,697 Operating Income 509,379 475,841 401,018 216,448 357,478 515,913 578,557 686,625 711,332 794,669 883,012 959,901 1,060,689 1,167,847 1,281,899

AverageCFFO/Sales 0.49 0.45 0.43 0.15 0.22 0.35CFFO/Net Income 0.99 0.97 1.14 0.79 1.15 1.01CFFO/Operating Income 0.78 0.95 1.11 0.77 1.03 0.93

CFFO 396,825 452,046 445,975 167,624 366,677 670,344 751,739 892,156 924,258 1,032,541 1,147,328 1,247,232 1,378,190 1,517,424 1,665,616 CFFI (191,175) 45,259 (256,702) (34,895) (77,022) (182,801) (253,480) (323,560) (355,916) (391,508) (430,659) (473,725) (521,097) (573,207) (630,527) CFFF 199,528 (787,898) 228,897 (237,067) (448,466) (49,590) (49,590) (53,841) (53,841) (65,176) (65,176) (70,843) (70,843) (76,511) (76,511)

Actual Financials Forecasted Financials

Actual Financials Forecasted Financials

 

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OSG Income Statement (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 RevenuesVoyage charter revenues 7% 8% 12% 24% 25%Time and bareboat charter revenues 14% 31% 27% 32% 22%Pool Revenues 79% 61% 61% 44% 53%

Total Revenues 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Voyage Expenses (COGS) -3% -4% -5% -8% -9% -8% -8% -8% -8% -8% -8% -8% -8% -8% -8%

Gross Profit 97% 96% 95% 92% 91% 92% 92% 92% 92% 92% 92% 92% 92% 92% 92%

Ship Operating Expenses:Vessel expenses 13% 18% 20% 24% 18%Time and bareboat charter hire expenses 8% 12% 17% 23% 25%Depreciation and Amortization 12% 15% 14% 16% 11%General and Administrative 6% 8% 10% 11% 8%Goodwill Impairment Charges 4%Loss/(Gain) on Sale of Vessels -4% -1% 4%

Total Ship Operating Expenses 40% 53% 56% 74% 70% 77% 75% 72% 74% 74% 73% 74% 74% 74% 74%

Income from Vessel Operations 57% 43% 36% 18% 20%Equity in Income of Joint Ventures 6% 4% 2% 1% 1%

Operating Income 63% 48% 38% 19% 21% 19% 21% 24% 21% 22% 23% 22% 22% 22% 22%Other Income/(Expense) 6% 8% 5% 7% -2%

Net Earnings Before Interest and Taxes 68% 55% 43% 26% 19%

Interest Expense 9% 9% -7% -7% -3% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%

Change in Accounting Principle and Minority Interest 37% 19% 16%Provision/(Credit) for Federal Income Taxes 10% 0% 1% 0% 2%

Minority Interest 0% 1%

Net Income 49% 46% 37% 19% 19% 13% 15% 18% 15% 16% 16% 16% 16% 16% 16% Cash Dividends Paid -3% -3% -3% -3% -3% -4% -3% -3% -3% -3% -3% -3% -2% -2% -2%

Addition to Retained Earnings 46% 44% 34% 15% 16% 9% 11% 15% 13% 13% 14% 13% 14% 14% 14%

Actual Financials Forecasted Financials

 

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OSG Income Statement (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 RevenuesVoyage charter revenues 7% 8% 12% 24% 25%Time and bareboat charter revenues 14% 31% 27% 32% 22%Pool Revenues 79% 61% 61% 44% 53%

Total Revenues 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Voyage Expenses (COGS) -3% -4% -5% -8% -9% -8% -8% -8% -8% -8% -8% -8% -8% -8% -8%

Gross Profit 97% 96% 95% 92% 91% 92% 92% 92% 92% 92% 92% 92% 92% 92% 92%

Ship Operating Expenses:Vessel expenses 13% 18% 20% 24% 18%Operating leases payments newly capitalized 3% 5% 20% 25% 18%Depreciation and Amortization 12% 15% 14% 16% 11%General and Administrative 6% 8% 10% 11% 8%Goodwill Impairment Charges 0% 0% 0% 0% 4%Loss/(Gain) on Sale of Vessels 0% 0% -4% -1% 4%

Total Ship Operating Expenses 35% 46% 60% 76% 64% 64% 63% 61% 63% 62% 62% 62% 62% 62% 62%

Income from Vessel Operations 62% 50% 35% 16% 27%Equity in Income of Joint Ventures 6% 4% 2% 1% 1%

Operating Income 68% 55% 37% 17% 28% 26% 28% 31% 28% 29% 30% 29% 29% 29% 29%Other Income/(Expense) 6% 8% 5% 7% -2%

Net Earnings Before Interest and Taxes 74% 62% 42% 24% 26%

Interest Expense 9% 9% 7% 7% 3% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Change in Accounting Principle and Minority Interest 64% 54% 36% 17% 23%Provision/(Credit) for Federal Income Taxes 10% 0% -1% 0% -2%

Minority Interest 1%

Net Income 55% 54% 36% 17% 25% 17% 18% 22% 19% 20% 20% 20% 20% 20% 20% Cash Dividends paid -3% -3% -3% -3% -3% -4% -3% -3% -3% -3% -3% -3% -2% -2% -2%

Addition to Retained Earnings 51% 51% 33% 13% 23% 13% 15% 19% 16% 17% 17% 17% 17% 17% 18%

Actual Financials Forecasted Financials

 

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OSG Balance Sheet (Raw)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

AssetsCash and cash equivalents 18% 6% 14% 12% 9%Voyage receivables 5% 5% 3% 4% 6% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4%Other receivables 0% 1% 2% 2% 2% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%Inventories 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Prepaid expenses 0% 0% 1% 1% 1% Total Current Assets 24% 11% 20% 19% 17% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%

Capital Construction Fund 10% 9% 7% 4% 1%Vessels (At Cost) 53% 68% 59% 65% 69% 73% 74% 74% 74% 74% 74% 75% 75% 75% 75%Vessels under Capital Leases 1% 1% 1% 1% 0%Deferred Drydock expenditures 0% 1% 1% 2% 2%Vessel Held for Sale 0% 0% 0% 0% 1%Investments in Joint Ventures 8% 8% 7% 3% 3%Other Assets 3% 2% 1% 2% 3%Goodwill 0% 0% 2% 2% 0%Intangible Assets 0% 0% 2% 3% 3% Total Non-Current Assets 76% 89% 80% 81% 83% 87% 87% 87% 87% 87% 87% 87% 87% 87% 87%

Total Assets 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

LiabilitiesAccounts payable 0% 3% 5% 4% 4%Sundry liabilities and accrued expenses 3% 0% 0% 0% 0%Federal income taxes 3% 0% 0% 0% 0%Short-term debt and current installments of long-term debt 1% 1% 1% 1% 1%Current obligations under capital leases 0% 0% 0% 0% 0% Total Current Liabilities 7% 4% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%

Long-term Debt 32% 28% 30% 36% 36%Obligations under Capital Leases 2% 1% 1% 1% 0%Deferred Federal Income Taxes 0% 4% 6% 7% 0%Deferred Credits and Other Liabilities 6% 7% 5% 4% 12%Minority Interest 0% 0% 0% 3% 3% Total Non-Currrent Liabilities 39% 40% 42% 51% 51% 47% 47% 45% 45% 45% 44% 44% 43% 42% 42%

Total Liabilities 47% 44% 48% 56% 56% 53% 52% 50% 50% 50% 49% 49% 48% 48% 47%

Common stock 2% 1% 1% 1% 1%Paid-in additional capital 7% 6% 5% 5% 6%Retained earnings 45% 49% 47% 52% 63% 66% 65% 65% 64% 63% 62% 62% 61% 61% 61%

Stockholders' Equity 54% 56% 53% 58% 70%Cost of Treasury Stock -1% -1% -1% -14% -22%Accumulated other comprehensive income/(loss) 0% 0% 0% 0% -4%

Total Shareholders' Equity 53% 56% 52% 44% 44% 47% 48% 50% 50% 50% 51% 51% 52% 52% 53%

Total Liabilities and Shareholders' Equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Actual Financials Forecasted Financials

 

 

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OSG Balance Sheet (Restated)

Dollars in thousands at December 31 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

AssetsCash and cash equivalents 17% 4% 10% 8% 6%Voyage receivables 5% 3% 2% 3% 4% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%Other receivables 0% 0% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%Inventories 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Prepaid expenses 0% 0% 0% 0% 1% Total Current Assets 22% 8% 15% 13% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%

Capital Construction Fund 9% 7% 5% 2% 1%Vessels (At Cost) 49% 50% 43% 44% 45% 54% 60% 66% 71% 75% 78% 80% 82% 83% 83%Vessels Under Capital Leases 1% 1% 1% 0% 0%Vessels Under Operating Leases, Newly Capitalized 8% 27% 27% 32% 34%Deferred Drydock Expenditures 0% 0% 1% 1% 1%Vessel Held for Sale 0% 0% 0% 0% 1%Investments in Joint Ventures 8% 6% 5% 2% 2%Other Assets 3% 1% 1% 1% 2%Goodwill 0% 0% 1% 1% 0%Intangible Assets 0% 0% 2% 2% 2% Total Non-Current Assets 78% 92% 85% 87% 89% 89% 89% 89% 89% 89% 89% 89% 89% 89% 89%

Total Assets 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Liabilities 0% 0% 0% 0% 0%Accounts payable 0% 2% 3% 3% 3%Sundry liabilities and accrued expenses 3% 0% 0% 0% 0%Federal income taxes 3% 0% 0% 0% 0%Short-term debt and current installments of long-term debt 1% 0% 0% 0% 0%Current obligations under capital leases 0% 0% 0% 0% 0% Total Current Liabilities 7% 3% 4% 4% 3% 3% 3% 3% 3% 3% 3% 3% 3% 3% 3%

Long-term Debt 30% 20% 22% 25% 24%Obligations under Capital Leases 1% 1% 1% 0% 0%Obligations under Operating Leases 8% 27% 27% 32% 34%Deferred Federal Income Taxes 0% 3% 5% 5% 0% Deferred Credits and Other Liabilities 5% 5% 4% 3% 8%Minority Interest 0% 0% 0% 2% 2%Plug for Liabilities 6% 1% 3% 6% -3% Total Non-Current Liabilities 43% 54% 56% 65% 64% 62% 61% 59% 59% 58% 57% 57% 56% 55% 55%

Total Liabilities 50% 56% 60% 69% 68% 65% 64% 63% 62% 62% 61% 60% 59% 59% 58%

Common stock 1% 1% 1% 1% 1%Paid-in additional capital 7% 4% 3% 3% 4%Retained earnings 43% 38% 36% 37% 44% 47% 47% 47% 47% 47% 47% 47% 47% 47% 47%

Stockholders' Equity 51% 44% 40% 41% 49%Cost of treasury stock -1% 0% -1% -10% -14%Accumulated other comprehensive income/(loss) 0% 0% 0% 0% -2%

Total Shareholders' Equity 50% 44% 40% 31% 32% 35% 36% 37% 38% 38% 39% 40% 41% 41% 42%

Total Liabilities and Shareholders' Equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Actual Financials Forecasted Financials

 

 

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OSG Cash Flow (Restated)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Net Income 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%SalesOperating Income 124% 102% 102% 103% 109% 149% 142% 136% 134% 132% 130% 129% 128% 127% 127%

CFFO/SalesCFFO/Net IncomeCFFO/Operating Income

CFFO 99% 98% 114% 77% 111% 194% 184% 177% 174% 171% 169% 168% 166% 165% 165%CFFI 61% -7% 2154% -3562% -395% -207% -204% -173% -163% -139% -122% -117% -110% -99% -94%CFFF 45% -147% 60% -125% -103% -19% -14% -11% -10% -10% -9% -8% -7% -7% -6%

OSG Cash Flow (Raw)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Net Income 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%SalesOperating Income 127% 102% 102% 102% 113% 120% 120% 120% 120% 120% 120% 120% 120% 120% 120%

CFFO/SalesCFFO/Net IncomeCFFO/Operating Income

CFFO 99% 97% 114% 79% 115% 155% 155% 155% 155% 155% 155% 155% 155% 155% 155%CFFI -48% 10% -65% -17% -24% -42% -52% -56% -60% -59% -58% -59% -59% -59% -59%CFFF 50% -170% 58% -112% -141% -11% -10% -9% -9% -10% -9% -9% -8% -8% -7%

Actual Financials Forecasted Financials

Actual Financials Forecasted Financials

 

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Cost of Capital Estimation

A firm’s cost of capital is the opportunity cost of an investment and is also

necessary for valuing a firm. The weighted average cost of debt and cost of equity

make up cost of capital, which is equal to the average required return on the firm. The

weighted average is derived from the firm’s capital structure, or the percentage of

assets financed by debt and the percentage financed by equity. We will use the

information from Overseas Shipholding Group’s 10-K as well as our forecasts of future

performance to estimate OSG’s cost of capital.

Cost of Equity

The cost of equity is the minimum rate of return a firm must offer shareholders

to compensate for waiting for their returns, and for bearing some risk. Because it costs

more to finance equity, the cost of equity is typically higher than the cost of debt. The

Capital Asset Pricing Model (CAPM) is commonly used to calculate the cost of equity:

Cost of Equity = Beta of the Firm (Return of the Market–Risk Free Rate) + Risk Free

Rate

In order to determine the cost of equity for Overseas Shipholding group, we first

had to estimate its beta coefficient. Beta is the measure of systematic risk that can be

explained by the risk of the market. We used regression analysis to calculate the beta

coefficient. Because CAPM does not explain the appropriate riskless return, we had to

test whether the point on the yield curve matters. We used five points on the yield

curve to do this: 3 months, 1 year, 2 years, 5 years, and 10 years. We then performed

regressions using 72 months, 60 months, 48 months, 36 months, and 24 months of

returns for each of the five different points on the yield curve in order to test for beta

stability. These regressions can be seen in Appendix 1.

Next, we broke down the regression output and looked for the beta with the

highest adjusted r2. As a rule, the higher the adjusted r2, the higher the explanatory

 

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power of the estimated beta. Our highest adjusted r2 was 66.74% with a beta of 1.897

in the 24-month regression using the 3-month T-Bill. OSG’s beta is reasonably stable,

staying within the range of 1.65 to 1.9, and our calculated beta of 1.897 is close to

OSG’s published beta of 1.7.

 

Against 3 Mo. T‐Bill Yield beta  beta 

Slice  beta  adj r squared  lower 95%  upper 95%  mrp rf  est ke  low ke high ke72  1.783  0.456  1.326 2.241 6.8 2.87  14.997  11.886 18.10960  1.765  0.424  1.234 2.295 6.8 2.87  14.871  11.264 18.47948  1.696  0.503  1.206 2.186 6.8 2.87  14.404  11.074 17.73536  1.714  0.528  1.164 2.263 6.8 2.87  14.522  10.783 18.26124  1.897  0.667  1.324 2.469   6.8 2.87  15.767  11.872 19.662

Against 1 yr. T‐Bill Yield beta  beta 

Slice  beta  adj r squared  lower 95%  upper 95%  mrp rf  est ke  low ke high ke72  1.737  0.447  1.284 2.191 6.8 2.87  14.682  11.598 17.76660  1.702  0.415  1.182 2.222 6.8 2.87  14.444  10.907 17.98148  1.635  0.495  1.156 2.114 6.8 2.87  13.988  10.729 17.24736  1.662  0.524  1.125 2.199 6.8 2.87  14.170  10.520 17.82024  1.859  0.665  1.295 2.424   6.8 2.87  15.514  11.676 19.352

Against 2 yr. T‐Bill Yieldbeta beta

Slice  beta  adj r squared lower 95% upper 95% mrp rf est ke  low ke high ke72  1.780  0.454  1.322 2.239 6.8 2.87  14.976  11.858 18.09360  1.761  0.422  1.229 2.292 6.8 2.87  14.842  11.230 18.45448  1.694  0.504  1.206 2.183 6.8 2.87  14.391  11.068 17.71436  1.707  0.527  1.158 2.256 6.8 2.87  14.480  10.747 18.21324  1.892  0.667  1.320 2.463   6.8 2.87  15.735  11.849 19.620

 

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Against 5 yr. T‐Bill Yieldbeta  beta 

Slice  beta  adj r squared  lower 95%  upper 95%  mrp rf  est ke  low ke high ke 72  1.775  0.452  1.316 2.234 6.8 2.87  14.937  11.816 18.05960  1.750  0.420  1.220 2.280 6.8 2.87  14.772  11.167 18.37648  1.685  0.503  1.199 2.172 6.8 2.87  14.330  11.020 17.64136  1.699  0.526  1.152 2.246 6.8 2.87  14.423  10.706 18.14124  1.885  0.667  1.315 2.455   6.8 2.87  15.688  11.814 19.562

Against 10 yr. T‐Bill Yield beta  beta 

Slice  beta  adj r squared  lower 95%  upper 95%  mrp rf  est ke  low ke high ke 72  1.768  0.449  1.305 2.230 6.8 2.87  14.889  11.745 18.034

60  1.741  0.418  1.212 2.270 6.8 2.87  14.710  11.113 18.307

48  1.677  0.502  1.192 2.162 6.8 2.87  14.273  10.973 17.572

36  1.691  0.526  1.147 2.236 6.8 2.87  14.371  10.667 18.075

24  1.879  0.667  1.310 2.447   6.8 2.87  15.645  11.779 19.510

After deriving the beta coefficient, we multiplied the beta by the market risk

premium, which is calculated by subtracting the risk free rate from the return of the

market. We derived the risk free rate from the St. Louis Federal Reserve, which is

2.87%, and the return of the market from the S&P 500, which is 9.67%. The market

risk premium is, therefore, 6.8%. We used these numbers to calculate the cost of

equity, using the formula stated above. The cost of equity was determined to be

15.77%. We believe this number is accurate because OSG has a high explanatory

power. OSG’s upper bound cost of equity, using a 95% confidence interval and a beta

of 2.47, was calculated to be 19.66% and the company’s lower bound cost of equity is

11.87% using a 95% confidence interval and a beta of 1.32.

 

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Size Adjustment

Although CAPM is often used to estimate the cost of capital, the evidence

indicates that the model is incomplete. This is due to the “size effect,” which means

that smaller firms tend to generate larger returns in subsequent periods. The reason

this size effect is an issue is unclear. This size effect could be due to riskier returns

than CAPM indicates or incorrect pricing at the measured point of market capitalization

(Palepu & Healy). Though it can be accounted for through the size effect, this assumed

risk associated with smaller firms is not always correct. The method for estimating the

cost of capital using a size adjustment combines CAPM and a size premium (return in

excess of CAPM) associated with the market cap of the firm. The market cap for OSG is

612 million which includes OSG within the size premium risk bracket of 2.7%. The

method for estimating the cost of equity with the applicable size adjustment is shown in

the following formula:

                   

Since OSG uses a 2.7% size premium, this changes the aforementioned cost of equity

to 18.47%. This is not an unreasonable value because it falls within the original upper

confidence interval cost of equity equal to 19.66%. This size premium accounts for the

relative high risk of the firm since it is involved in shipping a global commodity

dependent on variable rates.

Alternative Cost of Equity

There is also an alternative to finding the cost of equity when valuing a

company. This alternative cost of equity is denoted by the following formula.

1

 

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Because we are solving for cost of equity, denoted KE, the previous formula can be

rewritten using simple algebra:

Overseas Shipholding Group’s price to book ratio is 0.39. The method used to

determine our forward return on equity rate is to take the average net income

forecasted over the next ten years and divide that by the average stockholder’s equity

forecasted over the next ten years. We used an estimated forward return on equity

rate of 11.87% and a growth rate of 11.998%. Through these estimates, we determine

that the alternative cost of equity is 11.66%. This value passes our “sniff test” because

it is between twelve and fifteen percent when compared to the original estimated cost

of equity. This is an acceptable amount, but not as acceptable as 18.47% due to the

long-term lease liabilities on OSG’s books.

Because our financial statements had to be restated, these versions of the

forecasted financial statements must be used to find a suitable alternative cost of

equity. Using the restated forward return on equity rate of 12.29% and a growth rate

of 9.83%, we determined the alternative cost of equity to be 16.12%. This estimate

also falls within the original cost of equity upper and lower bounds. The regression

analysis provided in the previous cost of equity section determines that the appropriate

cost of equity needs to be between twelve and nineteen percent. This proves that the

alternative cost of equity for the restated financial statements is between these bounds.

Our reasoning stands that the appropriate cost of equity remains around 18.47%.

 

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Cost of Debt

The cost of debt (Kd) is calculated by the weighted average of short and long

term liabilities over the total liabilities multiplied by each liability’s interest rate.

Overseas Shipholding Group’s liabilities are: current liabilities, obligations under

operating leases, deferred credits and other liabilities, minority interest, and long term

debt, totaling $2,167,194. The interest rates we used in our calculations were taken

from either the St. Louis AA Non-Financial Commercial Paper or the 10-yr. Treasury

Constant Maturity. The tables depicting cost of debt as stated and restated can be seen

on the following pages.

 

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Liability Structure (2008 RAW)

Short and Long-Term

Liabilities

Amount of

Each

Liability

Percent of

Total

Liabilities

Interest

Rates

Weight x

Rate

Resources for

Interest Rates

Accounts Payable $167,615 4.31% 2.92% 0.126%

St. Louis AA Non-

Financial

Commercial

Paper

Short-Term Debt and

Current Installments

on Long-Term Debt

$26,231 0.67% 2.92% 0.02%

St. Louis AA Non-

Financial

Commercial

Paper

Current Obligations

Under Capital Leases $1,092 0.03% 2.92% 0.001%

St. Louis AA Non-

Financial

Commercial

Paper

Long-Term Debt $1,396,135 35.89% 4.24% 1.522% 10-yr. Treasury

Constant Maturity

Deferred Credits and

Other Liabilities $474,355 12.19% 4.24% 0.517%

10-yr. Treasury

Constant Maturity

Minority Interest $101,766 2.62% 4.24% 0.111% 10-yr. Treasury

Constant Maturity

Total $2,167,194 100% 2.296% =Cost of Debt As Stated

 

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Total current liabilities listed on OSG’s 10-k totaled $194,938. These current

liabilities consisted of accounts payable, short-term debt and current installments on

long-term debt, and current obligations under capital leases. The interest rate used for

the current liabilities was 2.92%, which is the St. Louis AA Non-Financial Commercial

Paper rate. This commercial paper rate was used because it is the rate of return an

investor would get without taking any risk.

The long-term liabilities have a higher interest rate than short-term liabilities

because there is more risk involved in long-term debts considering the amount of time

associated with them. The largest long-term liability account is the long-term debt

account, which totals $1,396,135, and is 35.89% of total liabilities. The account named

long-term debt is the most substantial liability, and it drives the cost of debt. Other

long-term liabilities were deferred credits & other liabilities and minority interest,

totaling $1,972,256. For each non-current liability, we used the rate of 4.24% from the

10-year treasury constant maturity. Using the information in the previous table, we

added the weighted average short and long-term liabilities to calculate the total cost of

debt (Kd). OSG’s cost of debt is 2.30% which is determined an appropriate amount.

Because our financial statements required restating, we must derive cost of debt

through the restated liability structure. The restated cost of debt calculations can be

seen in the table below:

 

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Liability Structure (2008 Restated)

Short and Long-Term

Liabilities

Amount of

Each

Liability

Percent of

Total

Liabilities

Interest

Rates

Weight x

Rate

Resources for

Interest Rates

Accounts Payable $167,615 4.18% 2.92% 0.122%

St. Louis AA Non-

Financial

Commercial

Paper

Short-Term Debt and

Current Installments

on Long-Term Debt

$26,231 0.65% 2.92% 0.019%

St. Louis AA Non-

Financial

Commercial

Paper

Current Obligations

Under Capital Leases $1,092 0.03% 2.92% 0.001%

St. Louis AA Non-

Financial

Commercial

Paper

Long-Term Debt $1,396,135 34.82% 4.24% 1.477% 10-yr. Treasury

Constant Maturity

Obligations Under

Operating Leases $2,032,783 50.70% 4.24% 2.150%

10-yr. Treasury

Constant Maturity

Deferred Credits and

Other Liabilities $474,355 11.83% 4.24% 0.502%

10-yr. Treasury

Constant Maturity

Minority Interest $101,766 2.54 4.24% 0.108% 10-yr. Treasury

Constant Maturity

Plug for Liabilities $(190,802) -4.76% 4.24% -0.202% 10-yr. Treasury

Constant Maturity

Total Liabilities $4,009,174 100% 4.176% =Cost of Debt Restated

 

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Total liabilities on the restated balance sheet total $4,009,174. Because of our

long-term lease obligations, we had to restate OSG’s financials and calculate a restated

cost of debt. We found the restated cost of debt (Kd) to be 4.18% and conclude this is

a more suitable number considering OSG’s large amount of long-term lease obligations.

Weighted Average Cost of Capital

Every firm is financed either by its equity or debt. To value a company’s assets,

an analyst needs to calculate a rate at which to finance the firm. To effectively

determine this rate, “the analyst must discount abnormal NOPAT, abnormal operating

ROA, or cash flows available to both debt and equity holders. The proper discount rate

to use is, therefore, the weighted average cost of capital” (Palepu & Healy). To find the

WACC, the cost of debt is multiplied by the proportion of debt to the sum of debt and

equity. This value is then added to the cost of equity multiplied by the proportion of

equity to the sum of debt and equity. The method for determining the value of WACC

before tax is shown below.

                 

                

Determining WACC after taxes, however, applies an inverse of the tax rate

multiplied by the debt structure. The formula changes as follows:

                1    

                

 

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RAW MVD/MVA Cost of

Debt

Tax

Rate

Cost of

Equity MVE/MVA WACC

WACCBT 55.71% 2.30% 0 18.47% 44.29% 10.48%

WACCAT 55.71% 2.30% 35% 18.47% 44.29% 9.67%

WACCupper 55.71% 2.30% 0 22.36% 44.29% 12.20%

WACClower 55.71% 2.30% 0 14.57% 44.29% 8.75%

The values used in the calculation of various WACCs are provided above. For

Overseas Shipholding Group, the WACC before tax is 10.48%. This estimates that

before taxes, OSG needs 10.48% of its assets to finance its future business.

Furthermore, when OSG uses the effective tax rate of 35% as provided in its 10K, it is

determined that the WACC after tax is 9.67%.

According to our estimates of the weighted average cost of capital, OSG needs

between eight and twelve percent of assets to cover its capital structure and drive

future business. We believe that this is a reasonable range, since OSG has large

amounts of long-term liabilities in the form of leases on tankers. This assumption is

denoted by the market value of liabilities accounting for 55.71% of the entire

$3,890,061 of total assets. Usually companies try to keep about 60% of their assets

financed through debt, and 40% financed through equity. For the energy shipping

industry, companies require this much capital financed through debt due to the large

expense amounts of their long-term lease liabilities.

Because OSG’s long-term lease liabilities require restating the financial

statements, it also reflects the need for a restated WACC. The restated WACC before

taxes is 8.79% which is a significant decrease from 10.48%. This decrease is due to

OSG’s leases being restated and reflected on the financial statements. Capitalizing

 

Page | 153   

these long-term leases allows for less of the company’s structure to be financed by its

assets. The numbers used in calculation of the restated WACC are displayed below.

Restated MVD/MVA Cost of

Debt

Tax

Rate

Cost of

Equity MVE/MVA WACC

WACCBT 67.69% 4.18% 0 18.47% 32.31% 8.79%

WACCAT 67.69% 4.18% 35% 18.47% 32.31% 7.80%

According to the estimates provided above, we believe that the restatement of

OSG’s financial statements depicted an accurate value for the weighted average cost of

capital. This is evidenced by the fact that we estimated the cost of debt jumping from

2.30% to 4.18%. This jump is caused because the capital structure is financed by a

larger portion of debt through the restatements. The increase in debt as a proportion

of assets from 67.69% to 32.31% passes our “sniff test” since restating OSG’s financial

statements caused more of its long-term liabilities to finance capital. We feel that

between seven and nine percent is an accurate estimate of assets needed to fund the

company, given our restated financials.

 

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Valuation Methods

“Valuation is the process of converting forecasts into an estimate of the value of

the firm’s assets or equity” (Palepu & Healy). The two methods included in the

valuation of a company are method of comparables and intrinsic valuations. The

method of comparables compares the firms to its competitors using ratios. This method

has no real theory behind it and is not a good tool to use when valuing a company. The

intrinsic valuation models use forecasted financials in order to get a forward look at the

company. The intrinsic valuation models, unlike the method of comparables, have

theory behind them and therefore, are useful in correctly valuing a company.

Method of Comparables

The method of comparables ratios are used by analysts to determine the value of

a firm by using averages of other firms in the same industry. This is a popular and easy

way to calculate an appropriate price range for a share of stock by using information

available to the public. The problem with this method is that not all industries have

ratios that are comparable. These ratios do not measure if a particular firm is creating

value differently than its competitors or if a firm is creating value in areas that are not

taken into account by these ratios. Therefore, we will not put too much weight on the

method of comparables when valuing the firm later on.

The comparables that we will be using include trailing and forecast price to

earnings ratio, the price to book ratio, the price to earnings growth ratio, the ratio of

price to EBITDA, enterprise value to EBITDA, the price to free cash flows, and the

dividend to price ratio. A model will be considered fairly valued if it falls within a 15%

margin of safety on the valuation date. OSG’s closing price on April 1st, 2009, valuation

date, was $24.03. Therefore, a model price between $20.43 and $27.63 will be

considered fairly valued.

 

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Price/Earning Trailing

The price to earning trailing ratio is calculated by using the stock price of a firm

on April 1st, 2009 and the earnings of the previous year. The industry average price to

earning trailing ratio was found by adding the ratios found on Yahoo Finance and

dividing by the number of competitors. The energy shipping industry average P/E

trailing ratio was calculated to be 3.38. After multiplying that number by the earnings

per share for OSG (original and restated), we ended up with the computed price per

share. Both the $36.01 and $49.15 per share for the original and restated earnings of

OSG suggests that the current price is undervalued.

Price /Earnings Forecast

This ratio is similar to the previous one except that the forecasted earnings for

the following year are needed. The current price per share is divided by the future

P/E Trailing PPS EPS P/E Trailing Computed Price OSG 24.03 10.65 36.01 OSG (Restated) 24.03 14.54 49.15 Frontline 17.55 1.93 Teekay 14.51 5.76 Tsakos 14.42 2.45 Average 3.38

Forecasted P/E PPS EPS 1yr

Out P/E

Forecast Industry Avg.

P/E Computed

Price OSG 24.03 6.07 8.19 49.71 OSG (Restated) 24.03 7.74 8.19 63.39 Frontline 17.55 8.36 Teekay 14.51 9.44 Tsakos 14.42 6.78

 

Page | 156   

earnings per share to find the forecasted price to earnings ratio. The problem with this

ratio is that different analysts will have a different amount of earnings forecasted

because there are many factors that influence future earnings. For example, the current

recession leaves many questions for investors to consider. The impact of the current

economy on a particular industry and the length of the economic downturn are two

areas that investors may have differing opinions on which could ultimately affect the

estimated earning of the following year.

The industry average forecasted P/E that was calculated from information

provided by Yahoo Finance is 8.19. This number is than multiplied by the earning for

the following year, for both the original and restated future earnings, to find the model

price per share for OSG. The model prices of $49.71 and $63.39 for OSG (original and

restated) suggests that the current price per share of stock is undervalued.

Price /Book

Price/Book

PPS BPS P/B Industry Avg. OSG PPS

OSG 24.03 57.79 0.42 .52 29.91 OSG (Restated) 24.03 64.19 0.37 .52 33.38 Frontline 17.55 5.96 2.94 Teekay 14.51 36.94 0.39 Tsakos 14.42 22.45 0.64

The price to book ratio is found by dividing a firm’s current price per share by the

book value of equity per share. To obtain the industry average, it is once again

necessary to add the given P/B ratios of OSG’s competitors from Yahoo Finance and

divide by the number of competitors. The value of this average turns out to be .52 after

omitting Frontline’s number as an outlier. After multiplying this average by the book

value per share for OSG (original and restated), we end up with the model price per

 

Page | 157   

share for OSG. The model prices of $29.91 and $33.38 are above the 15% margin of

safety on April 1st, 2009 and suggest that the current price of OSG is undervalued.

Price Earnings Growth (P.E.G.)

P.E.G

P/E Growth PEG Industry Avg. OSG PPS OSG 2.26 0.222 16.59 39.22 OSG (Restated) 1.84 0.197 16.59 47.52 Frontline 1.93 0.127 15.20 Teekay 5.76 0.252 22.86 Tsakos 2.45 0.209 11.72

The price earnings growth model uses the price to earnings ratios that was

previously calculated and divides it by the expected growth in earnings. The P.E.Gs for

OSG’s competitors were found on Yahoo Finance and this information was used to

calculate the industry average P.E.G as 16.59. The model price per share is then

calculated by multiplying the industry average by OSG’s growth and earnings for both

original and restated financial statements. According to the model, OSG’s price per

share should be valued at $39.22. This is above the 15% margin of safety, suggesting

that the current price is undervalued. Since earnings and growth information changed in

the restated financial statements, the model price per share is also affected when using

the new numbers. The model price for OSG using the restated information is $47.52.

Since this is above the 15% margin of safety, this model also suggests that the current

price is undervalued.

 

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Price/EBITDA

The price/EBITDA model is a comparable that is calculated by taking the market

capitalization rate and dividing it by the earnings before interest, taxes, depreciation,

and amortization (EBITDA). The market capitalization rate is simply the current market

price per share times the number of shares outstanding. The market capitalization and

EBITDA for OSG’s competitors are found on Yahoo Finance, and are needed to find the

industry average. The model price per share is then found by taking the industry

average price/EBITDA and multiplying it by the EBITDA per share for OSG (original and

restated). The model price for the raw financials is $26.75 which is within the 15%

margin of safety which means the current price is fairly valued. The model price for the

restated financials is $32.73 which is above the 15% margin of safety, suggesting that

the current price is undervalued.

Price/EBITDA Market

Cap (billions)

EBITDA (billions)

P/EBITDA Industry Avg.

EBITDA/ Share

OSG PPS

OSG 0.72 0.52 1.54 17.37 26.75OSG (Restated)

0.72 0.63 1.54 21.25 32.73

Frontline 1.45 0.93 1.56 Teekay 1.1 0.84 1.31 Tsakos 0.58 0.33 1.76

 

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Enterprise Value/EBITDA

EV/EBITDA

EV (Bil) EBITDA (Bil)

EV/EBITDA Industry Avg.

OSG PPS

OSG 2.54 0.52 6.24 47.67 OSG (Restated)

4.38 0.63 6.24 8.91

Frontline 4.34 0.93 4.65 Teekay 7.08 0.84 8.44 Tsakos 1.85 0.33 5.64

The EV/ EBITDA ratio is calculated by dividing the enterprise value by the

earnings before interest, taxes, depreciation, and amortization. Enterprise value is

found by adding the market value of equity, or market capitalization, with the book

value of liabilities and then subtracting cash and investments. Analysts use this

comparable model because it ignores the firm’s capital structure. The industry average

used was found with enterprise value and EBITDA information available on Yahoo

Finance. The industry average of 6.24 is multiplied by OSG’s EBITDA to find the new

enterprise value for OSG. After adding back cash, subtracting book value of liabilities,

and dividing by the number of shares outstanding, the model price per share is found.

The model price per share for OSG is $47.67 and the restated price per share is

$8.91. Using a 15% margin of safety, the model suggests that the current price is

undervalued based on the original financial statements and overvalued based on the

restated financial statements. The reason behind the significant difference is because

the liabilities are larger after restating the operating leases of OSG.

 

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Price to Free Cash Flows (P/FCF)

Price/Free Cash Flows

Market Cap FCF P/FCF Industry Avg. OSG PPS

OSG 709.3 290 1.154 11.22

OSG restated 709.3 (1,228) 1.154 (47.53)

Frontline 1,453.60 797 1.82  

Teekay 1,016.90 2099 0.48  

Tsakos 590.3 (185) (3.19)  

*market cap and FCF in millions

The price to free cash flows model is also used to find an estimated market price

per share by dividing the market capitalization by the free cash flows. Free cash flows

are simply cash flows from operations plus/minus the cash flows from investing

activities. The industry average for is found by taking the average P/FCF for OSG’s

competitors found on Yahoo Finance, excluding any outliers. In this case, Tsakos was

excluded from the industry average and the resulting average is 1.154. From there it is

necessary to move backwards to find the model price. The average is multiplied by

OSGs free cash flows and then dividing by the number of shares outstanding. The

resulting model price per share turns out to be $11.22 and -$47.53 (original and

restated), which is below the 15% margin of safety. This model suggests that the

current price of OSG is overvalued.

Dividends/Price

Dividend/Price

PPS DPS D/P Industry Avg. OSG PPS OSG 24.03 1.5 0.06 0.089 16.87 OSG-restated 24.03 1.5 0.06 0.089 16.87 Frontline 17.55 8.3 0.47

Teekay 14.51 0.99 0.07

Tsakos 14.42 1.58 0.11

 

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The dividend to price model is the final comparable model used to measure an

estimated price per share for a firm. To find the D/P ratio, dividends per share is

divided by the current market price per share. An industry average D/P is found with

information provided by Yahoo Finance to find the competitors D/P. Frontline was not

included in the industry average calculation because it is an outlier. To find the model

price, dividends per share of OSG are divided by the calculated industry average or

.089. The computed price of $16.87 falls below the 15% margin of safety which

suggests that the current price of OSG is overvalued.

Conclusion

When taking into account a 15% margin of safety, the P/E trailing, P/E

forecasted, P/B, P.E.G, price/EBITDA restated, and original EV/EBITDA models suggest

that the current price per share of OSG is undervalued. The original P/EBITDA model

suggests that the current price is fairly value and the EV/EBITDA restated, P/FCF, and

dividend to price models suggest that the current price per share of OSG is overvalued.

As previously stated, we will not put too much weight in the method of comparables

since this is not the best way to accurately value a firm. To do this, we will focus on the

intrinsic valuation models.

Intrinsic Valuation Models

The intrinsic valuation models, when compared to the method of comparables,

offer a more accurate valuation of a firm. Unlike the method of comparables, the

intrinsic valuation models offer theory-based assumptions, making it easy to compute a

current stock price estimation for the firm. The discounted free cash flow model, the

residual income model, the dividend discount model, the abnormal earnings growth

model, and the long run residual income model are all included in the intrinsic

valuations. Sensitivity analysis can be used in order to explain how small changes in the

cost of equity or changes in the growth rate affect the time consistent price per share.

 

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We believe that the intrinsic valuation models are the best way to present an accurate

overall value of Overseas Shipholding Group.

Discounted Dividends Valuation

“Finance theory holds that the value of any financial claim is simply the present

value of the cash payoffs that the claimholders receive” (Palepu & Healy). Since the

stockholders receive cash payments through dividends, the discounted dividends

valuation model computes all present values of future dividends paid to stockholders.

This present value gives the current estimated stock price for the firm. The two inputs

for this valuation are expected dividends and the cost of equity. These expected

dividends are derived from future earnings growth rates and payout ratios.

The discounted dividends model is theoretically consistent; however, investors

buy shares at a rate higher than D1, which determine the inconsistency in theory. The

difference between theory and reality is because of expensive forecast errors in the

early part of the model. The forecast errors are because theory states that

Dividends/Net Income stays constant, which is not always the case for firms. The most

significant error with this theory is incorrectly computing growth rates. Since this model

is supposed to continue forever, a small change in the growth rate has a significant

impact on the present value. In theory firms have a constant growth for all future

dividends which is not always the case. Firms tend to set a dividend amount and

change it periodically. These dividend payouts usually stay consistent for a certain

period, and change at the firms’ discretion.

To calculate the present stock value for a firm, first the present value of the ten-

year forecasted dividends must be calculated. Then in the eleventh year, a perpetuity

present value must be derived for dividends expected to last forever. We estimated the

present value of OSG’s dividends per share at $6.19 until 2018. After 2018, we

estimate the present terminal value of the terminal value perpetuity to be $2.86. This

was discounted to be time consistent at 12/31/08 using the appropriate size-adjusted

 

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cost of equity of 18.47% and average dividend growth rate of 5.15%. These two

present values are then added together to equal $9.05 which is the stock price as of

12/31/08. However, since we are valuing OSG at 4/1/09, we grew the stock price three

months by multiplying the price times one plus the cost of equity raised to the (3/12)

exponential power (3/12 for growing the price three months). This final time consistent

price is then compared to the 4/1/09 observed stock price of $24.03 to determine if the

company is over, under, or fairly-valued. The estimated stock prices are seen in the

sensitivity chart below.

Growth > 0 1.72 3.44 5.15 6.87 8.59 10.310.0862 20.13$ 22.81$ 27.28$ 36.09$ 62.35$ N/A N/A0.1014 16.79$ 18.42$ 20.89$ 25.03$ 33.56$ 52.22$ N/A0.1167 14.34$ 15.39$ 16.88$ 19.13$ 23.02$ 31.26$ 60.31$ 0.1457 11.19$ 11.70$ 12.36$ 13.26$ 14.57$ 16.63$ 20.35$ 0.1612 12.00$ 10.36$ 10.82$ 11.41$ 12.23$ 13.43$ 15.33$ 0.1847 8.61$ 8.83$ 9.10$ 9.44$ 9.88$ 10.48$ 11.33$ 0.2236 6.98$ 7.09$ 7.22$ 7.37$ 7.56$ 7.79$ 8.09$

Discounted Dividends Model

Undervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

At a 15% Analyst Position

Restated Backdoor KeKe

Upper Ke

Backdoor KeLower Ke

Our calculated size-adjusted cost of equity was 18.47% and average dividend

growth rate of 5.15%. These estimates gave us a stock price of $9.44, which would

imply that OSG is overvalued when compared to the observed stock price of $24.03.

The lack of comparability, even at a 15% analyst position, is due to the variability in the

cost of equity and growth rates used. Though there is a lack of comparability, this does

not render the model useless. We determine this model accurately portrays what it is

designed to measure. When investors decide to purchase stock in a company, they are

not solely concerned with the dividends a company will pay out. Investors analyze

many other facets of a firm such as capital gains. This model is only designed to

portray the portion of stock price supported by firm dividends. Although there is

 

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variability in this model, which is seen with a wishful-thinking cost of equity, we

recommend that this determines that OSG is overvalued.

Discounted Free Cash Flows Valuation

The discounted free cash flows model is one of the valuation models used to

help determine the intrinsic value of a firm’s equity. This model is determined using the

present value of the free cash flow perpetuity and the present value of a firm’s year-by-

year free cash flow. To begin this model, both the present value of forecasted free cash

flows and the present value of the perpetuity must be calculated.

To find the present value of forecasted cash flows take the firm’s cash flows from

operations (CFFO) and subtract the firm’s cash flows from investments (CFFI). Both of

these figures can be found on the firm’s statement of cash flows. This calculation must

be done for each of the forecasted years. Once this new figure is produced from the

above calculation, it must then be multiplied by the present value factor to determine

the present value for each year forecasted. Now that every year has been discounted

back to its present value, we have the present value of equity starting in time 1 all the

way through time 10. These values are summed to get the total present value of the

year by year free cash flows.

In order to calculate the present value of the perpetuity we must use the

weighted average cost of capital before taxes (WACCBT). It is imperative to use the

before tax figure to avoid double taxation within the model. Net income has already

been taxed in the cash flows from operations figure used in the calculation for the

present value of the year by year free cash flows.

Now that both the present value of forecasted free cash flows and the present

value of the perpetuity have been calculated we must add the two figures together.

This value represents the total market value of assets within the firm. Since we are

valuing the firm’s equity, we must take the market value of assets and subtract book

 

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value of debt and preferred stock to get the firm’s market value of equity. Take the

firm’s market value of equity and divide it by the firm’s total number of shares

outstanding to get a price per share.

A time consistent price is needed for comparability within the model, so we used

the same method to find this number as in the discounted dividends model. Once a

time consistent price is found, it is then used to compare the actual market price found

on April 4, 2009 to the forecasted results.

The sensitivity analysis for the discounted free cash flows model is based on the

relationship between the growth rate and the weighted average cost of capital.

Manipulating the rates in this formula yields an outcome that can be compared to the

time consistent price. These numbers are then used to determine whether the firm is

under-valued or over-valued. The table uses the upper and lower bounds for Overseas

Shipholding Group’s weighted average cost of capital.

The growth rate must be greater than one as well as less than the cost of capital

in order for the model to work. This model also assumes that the perpetuity growth rate

stays constant to infinity, which is unrealistic. A company can only sustain a high

growth rate for a short amount of time. Eventually the company will attain a sustainable

growth rate. The tables below depict the sensitivity analysis for Overseas Shipholding

Group’s discounted free cash flows.

 

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Growth > 0 0.0174 0.0348 0.0523 0.0697 0.08700.0746 172.34$ 225.33$ 324.64$ 580.85$ 2,649.96$ N/A0.0875 123.61$ 156.22$ 210.38$ 318.85$ 638.15$ 22,987.90$ 0.0879 122.34$ 154.50$ 207.74$ 313.78$ 621.40$ 12,719.09$ 0.1048 78.36$ 96.94$ 124.75$ 171.33$ 263.68$ 534.50$ 0.1220 47.15$ 58.54$ 74.46$ 98.50$ 138.35$ 217.24$ 0.1385 25.24$ 32.70$ 42.66$ 56.73$ 77.82$ 112.92$ 0.1585 5.52$ 10.20$ 16.19$ 24.20$ 35.30$ 51.68$

Discounted Free Cash Flows

Upper WACC

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63At a 15% Analyst Position

Backdoor WACCLower WACC

Before Tax WACCRestated WACC

When implementing Overseas Shipholding Group’s initial weighted average cost

of capital before taxes and a 0% growth rate, the firm is fairly valued within a 15%

analyst’s view at a price of $24.56. When utilizing a margin of safety of 15%, only 4

fairly valued prices were produced within the free cash flows analysis. The majority of

the values created within the sensitivity analysis show Overseas Shipholding Group as

being undervalued.

We can gather from this table that this model is particularly sensitive to growth

rates because of the effect is has on the terminal value perpetuity. This is common

within the free cash flows model due to the fact that the cash flows are extremely

difficult to accurately forecast. Since free cash flows are such a difficult value to

forecast, this model becomes much less accurate than other intrinsic valuation models.

Since this model is one of the least accurate valuation models calculated, the results will

not hold much significance in our overall valuation.

 

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Residual Income Valuation

When compared to most other valuation models a firm can implement, the

residual income model is traditionally much more effective. Since this valuation model is

the least sensitive to growth rates, it is the most reliable and contains the highest

percent of explanatory power. This is due to the fact that the residual income model is

based on a firm’s book value of equity instead of terminal value like the previous two

models discussed. When a terminal value is used, there is a much higher risk of

calculating errors in the long run. Since the residual income model avoids terminal

values, it is the most accurate.

The first step to begin the computation of the residual income valuation model is

finding the forecasted net income figures and forecasted dividend figures on both the

forecasted income statement and statement of cash flows respectively. Next, find the

firm’s most recent book value of equity given in their most recently published 10-K.

Once these figures are found, the firm’s book value of equity can be forecasted through

the same amount of years as the net income and dividends. This is done by taking the

previous year’s book value of equity and adding the difference between the current

year’s net income and dividends.

After the firm’s book value of equity has been forecasted, the annual normal

income, or “benchmark” figure, must be calculated. This is done by taking the firm’s

initial cost of equity and multiplying that number by the current year’s book value of

equity. Once these figures have been calculated, the firm’s residual income can be

found. To find the residual income for the firm, the “benchmark” figure is subtracted

from the net income for a final value.

Since the residual income was forecasted over a 10 year time period, it is

necessary to calculate a present value factor for each year. The present value factor

can be computed by using the equation 1/ (1+Ke) ^ time. Once the present value

 

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factor is found, the residual income in present value terms can be found. This is done

by multiplying the annual residual income by the present value factor for that year. A

total figure for the present value of the year by year residual income can then be

calculated by summing up all the values just computed.

The next step in the computation of the residual income valuation model is

calculating the terminal value of the perpetuity. To begin this calculation, the annual

residual income in the year the perpetuity begins must be forecasted. This can be done

by finding a percentage change in the annual residual income each year and then

applying that change to previous year’s residual income figure.

Once the annual residual income in the year of the perpetuity is found then the

terminal value of the perpetuity can be easily calculated. Simply take the residual

income estimate in the year of the perpetuity and divide it by the initial cost of equity

(Ke) minus the perpetuity growth rate.

After the terminal value of the perpetuity is found, it can be added to the book

value of equity and the total present value of the year by year perpetuity to get the

firm’s market value of equity. Once the market value of equity is found, divide that

value by the firm’s total number of shares outstanding to get a model price. In order to

obtain a time consistent model price, the 3 months difference from OSG financial year

end must be reflected. This can be done by multiplying the model price by (1 + Ke) ^

(3/12).

The growth rate and initial cost of equity can now be manipulated within this

formula to obtain various time consistent price values. As a 15% analyst starting with

an observed share price of $24.03 on April 1, 2009, a fairly valued price could range

from a low of $20.43 to a high of $27.63. This means that any price calculated under

$20.43 would be overvalued as well as any price over $27.63 would be undervalued.

We also calculated the restated figures due to the capitalization of operating leases.

 

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Growth > -0.1 -0.2 -0.3 -0.4 -0.50.1014 62.08$ 60.33$ 59.44$ 58.91$ 58.56$ 0.1167 52.11$ 51.51$ 51.20$ 51.01$ 50.89$ 0.1457 38.22$ 38.76$ 39.06$ 39.24$ 39.37$ 0.1612 32.74$ 33.55$ 34.01$ 34.30$ 34.51$ 0.1847 26.23$ 27.22$ 27.80$ 28.18$ 28.45$ 0.2236 18.77$ 19.74$ 20.34$ 20.75$ 21.04$ 0.2600 14.17$ 15.01$ 15.55$ 15.92$ 16.20$

Backdoor KeLower Ke

Restated Backdoor KeKe

Residual Income - RAW

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

Growth > -0.1 -0.2 -0.3 -0.4 -0.50.1014 74.02$ 71.75$ 70.61$ 69.92$ 69.46$ 0.1167 61.93$ 61.10$ 60.67$ 60.40$ 60.22$ 0.1457 45.13$ 45.71$ 46.03$ 46.24$ 46.38$ 0.1612 38.51$ 39.44$ 39.96$ 40.30$ 40.54$ 0.1847 30.67$ 31.83$ 32.51$ 32.95$ 33.27$ 0.2236 21.70$ 22.86$ 23.57$ 24.06$ 24.41$ 0.2600 18.95$ 20.05$ 20.74$ 21.22$ 21.56$

Residual Income - Restated

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Backdoor KeLower Ke

Restated Backdoor KeKe

Upper Ke

The two charts shown above represent the sensitivity analysis of the residual

income and restated residual income growth models. Negative growth rates are used in

the sensitivity analysis based on the fact that in realistic markets, it is impossible for a

firm to consistently outperform their cost of capital. With a positive residual income as

well as a positive growth rate, OSG will continue to outperform their cost of capital

which is impossible.

 

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In order to restore equilibrium, a growth rate less than zero must be

implemented. If the growth rate continues to increase, there will be a much slower

return to equilibrium and vice versa. Since we feel that OSG will have a moderate return

to equilibrium, the most relevant growth rates will be the middle values.

When using the raw values in the sensitivity analysis a fairly valued price is

produced when both the initial cost of equity and a small growth rate of -0.1 or -0.2 is

implemented. Fairly valued prices are also produced when the upper bound for the cost

of equity and a bigger growth rate of -0.4 and -0.5 is used. As seen by the raw residual

income table, the majority of the analysis produced undervalued prices.

The restated table had somewhat similar results to the raw table, only that no price was

fairly valued when the initial cost of equity was used. Only when the upper bound cost

of equity, or a higher cost of equity, were implemented into the analysis was fairly

valued prices produced. The greater part of the restated analysis still resulted in

undervalued prices for Overseas Shipholding Group. Therefore, after subjecting the

observed share price to the various growth rates and costs of equity in both the raw

and restated figures, we find that OSG is undervalued.

Abnormal Earnings Growth Valuation

The abnormal earnings growth model is based on finding a forward price to

earnings per share ratio. The abnormal earnings are equal to forecasted net earnings,

plus dividend reinvestment earnings, minus the “benchmark” of normal earnings. Other

factors such as dividend reinvestment, cumulative dividend income, and normal

earnings are needed to estimate firm value. In order to calculate dividend

reinvestment, or DRIP, dividends from the previous year must be multiplied by the cost

of equity. This DRIP calculation assumes that investors will reinvest cash dividends paid

in a company’s stock with a return based on the cost of equity. Cumulative dividend

income is computed by adding net income to the calculated DRIP.

 

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Furthermore, normal earnings are calculated by multiplying net income from the

previous year by one plus the cost of equity. After computing normal earnings and

cumulative dividend income, AEG can be calculated. AEG year by year is derived by

subtracting normal income from cumulative dividend income for each year. To ensure

that AEG is correctly calculated, we compared it to residual income for each year. Since

these numbers matched for each year, we determine that our AEG is correctly valuated.

Next, the present value factor needs to be calculated to state AEG in 2009

dollars. This is simply done by multiplying AEG for each year by [1/(1+Ke)t]. Finding

the total present value of AEG is done by adding the present value of each year. The

next step in AEG valuation is to find the present value of the terminal value perpetuity.

The terminal value of the perpetuity is calculated by multiplying AEG for 2018 by a

growth rate. This growth rate is found by determining the year by year change in AEG,

then analyzing where this rate converges. Once the AEG perpetuity is calculated, we

multiplied this by the present value factor for 2018. Finally, to calculate the total

average net income of the perpetuity, we added the core net income, total present

value of AEG, and the present value of the terminal value of the perpetuity.

Computing the average net income allowed us to find the EPS of the perpetuity.

By dividing the total average net income of the perpetuity by the total shares

outstanding of 39,590,759, we calculated the earnings per share of the perpetuity to be

$3.85 as stated and $4.46 restated. Next we calculated the intrinsic value per share by

dividing the EPS of the perpetuity by the cost of equity and found the intrinsic value per

share to be as $20.86 stated and $24.15 restated. Next, these values needed to be

grown to show the price on a time consistent basis. To do this we took our intrinsic

value per share price times one plus the cost of equity to the 3/12 power. The graphs

below show the sensitivity analyses on an as stated and restated basis.

 

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Growth > -0.1 -0.2 -0.3 -0.4 -0.50.1014 69.48$ 69.05$ 68.84$ 68.71$ 68.63$ 0.1167 53.60$ 53.05$ 53.28$ 53.42$ 53.52$ 0.1457 33.43$ 34.37$ 34.89$ 35.22$ 35.45$ 0.1612 27.10$ 28.05$ 28.59$ 28.93$ 29.18$ 0.1847 20.41$ 21.26$ 21.76$ 22.09$ 22.32$ 0.2236 13.77$ 14.39$ 14.78$ 15.04$ 15.23$ 0.2600 11.94$ 12.48$ 12.81$ 13.05$ 13.22$

Backdoor Ke

Abnormal Earnings Growth - RAW

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Lower KeRestated Backdoor Ke

KeUpper Ke

Growth > -0.1 -0.2 -0.3 -0.4 -0.50.1014 82.89$ 82.57$ 82.41$ 82.32$ 82.25$ 0.1167 62.34$ 63.05$ 63.42$ 63.65$ 63.80$ 0.1457 39.12$ 40.37$ 41.06$ 41.50$ 41.80$ 0.1612 31.48$ 32.72$ 33.43$ 33.88$ 34.20$ 0.1847 23.45$ 24.55$ 25.19$ 25.61$ 25.91$ 0.2236 15.54$ 16.33$ 16.82$ 17.15$ 17.39$ 0.2600 13.38$ 14.05$ 14.48$ 14.77$ 14.99$

Backdoor Ke

Abnormal Earnings Growth - Restated

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Lower KeRestated Backdoor Ke

KeUpper Ke

By using negative growth rates we are able to drive earnings back to equilibrium

and ensure that OSG will provide return based on capital in the future. The above

sensitivities show that our company is fairly-valued using the original size-adjusted cost

of equity. On both an as-stated and restated basis, the models prove that OSG has a

fairly-valued stock price. However, using the alternative backdoor cost of equity, OSG

is deemed undervalued. This information derived from our sensitivity analyses

determine that an investor would want to purchase shares of OSG due to the backdoor

calculation of cost of equity.

 

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Long Run Residual Income Valuation

The long run residual income model utilizes many of the same components as

the original residual income model previously performed on the firm. The residual

income model incorporates the firm’s dividends to calculate the firm’s market value of

equity and these values are much too difficult to forecast in the long run. Since this

model is focused on the long run, a new formula to compute the firm’s market value of

equity must be used.

We begin calculating the long run residual income model by solving for the firm’s

forecasted average return of equity. This figure is found by dividing the net income for

the current year by the previous year’s book value of equity. Since our firm did not

produce values that we felt are stable around an average figure, we computed the

convergence value to get a more accurate number. Once we performed this calculation,

a convergence value of 12.95% was produced.

YEAR 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 ConvergenceROE 10.51% 12.25% 16.34% 12.70% 13.44% 13.84% 13.06% 13.19% 13.10% 12.86% 12.95%

After subtracting our convergence value of the firm’s return on equity from our

initial cost of equity value for each year forecasted, we came to a growth rate

convergence value of 4.4%. Now that the convergence values of the firm’s return on

equity and growth rates have been computed, the firm’s market value of equity can be

calculated. In order to find the firm’s market value of equity, we must implement our

initial cost of equity of 18.47%, convergence return on equity of 12.95%, convergence

growth rate of 4.4%, and book value of equity of 1,722,870,000 into an equation. The

equation used is MVE = BVE (1+(ROE – Ke)/(Ke – g)).

Now that the market value of equity of 1,046,950,000 for the firm has been

computed, we can solve for the initial share price. This is done by dividing the market

 

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value of equity by the firm’s number of shares outstanding. Once we performed this

calculation, we found the firm’s initial share price to be $26.44. We can now take this

initial share price and multiply it by (1+ Ke) ^ (3/12) to find the firm’s time consistent

price of $27.58.

Growth> -0.1656 0.0255 0.0440 0.0782 0.16050.1167 46.75$ 51.00$ 52.60$ 59.60$ 31.66$ 0.1457 42.67$ 38.95$ 37.84$ 34.21$ 94.29$ 0.1612 40.78$ 34.61$ 32.95$ 27.92$ N/A0.1847 38.24$ 29.65$ 27.59$ 21.87$ N/A0.2236 34.70$ 24.02$ 21.78$ 16.15$ N/A

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

ROE Constant at .1295

Lower KeRestated Backdoor Ke

Ke

Backdoor Ke

ROE> 0.1051 0.1152 0.1295 0.1447 0.16340.1167 37.59$ 43.80$ 52.60$ 61.95$ 73.46$ 0.1457 27.04$ 31.51$ 37.84$ 44.57$ 52.85$ 0.1612 23.55$ 27.44$ 32.95$ 38.81$ 46.01$ 0.1847 19.71$ 22.97$ 27.59$ 32.49$ 38.52$ 0.2236 15.57$ 18.14$ 21.78$ 25.66$ 30.42$

Growth Constant at .0440

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

Backdoor KeLower Ke

Restated Backdoor KeKe

Growth> -0.1656 0.0255 0.0440 0.0782 0.16050.1051 35.08$ 22.70$ 19.71$ 11.47$ N/A0.1172 36.65$ 26.15$ 23.62$ 16.62$ N/A0.1295 38.24$ 29.65$ 27.59$ 21.87$ N/A0.1447 40.21$ 33.99$ 32.49$ 28.34$ N/A0.1634 42.63$ 39.32$ 38.52$ 36.31$ 5.44$

Ke Constant at .1847

Return on Equity

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

 

Page | 175   

Growth> -0.1786 0.03294 0.06279 0.1068 0.24070.1167 46.67$ 51.56$ 55.35$ 102.56$ 40.11$ 0.1457 42.77$ 38.55$ 36.22$ 26.27$ 52.69$ 0.1612 40.95$ 34.01$ 30.62$ 18.85$ 63.18$ 0.1847 38.50$ 28.89$ 25.59$ 13.23$ 90.14$ 0.2236 35.05$ 23.18$ 18.98$ 8.89$ 297.58$

Restated Backdoor KeKe

Upper KeAt a 15% Analyst Position

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Lower Ke

Restated - ROE Constant at .1315

Backdoor Ke

ROE> 0.1050 0.1206 0.1315 0.1510 0.17270.1167 35.02$ 47.96$ 57.01$ 73.19$ 91.20$ 0.1457 22.91$ 31.39$ 37.30$ 47.89$ 59.68$ 0.1612 19.37$ 26.53$ 31.53$ 40.48$ 50.44$ 0.1847 15.71$ 21.52$ 25.59$ 32.84$ 40.92$ 0.2236 12.01$ 16.45$ 19.55$ 25.10$ 31.28$ At a 15% Analyst Position

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

Restated - Growth Constant at .0628

Backdoor KeLower Ke

Restated Backdoor KeKe

Growth> -0.1786 0.03294 0.06279 0.1068 0.24070.1050 35.43$ 21.56$ 15.71$ N/A 110.00$ 0.1206 37.38$ 26.22$ 21.52$ 8.04$ 97.35$ 0.1315 38.75$ 29.48$ 25.59$ 14.39$ 88.52$ 0.1510 41.18$ 35.32$ 32.84$ 25.76$ 72.71$ 0.1727 43.89$ 41.80$ 40.92$ 38.40$ 55.12$ At a 15% Analyst Position

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Restated - Ke Constant at .1847

Return on Equity

Since this model incorporates the firm’s return on equity and the firm’s book

value of equity it was necessary to perform a restated sensitivity analysis that took the

 

Page | 176   

restated net income and equity into consideration. After the restated figures were

implemented, both the growth rate and the return on equity grew to larger values. As

shown from the tables above, Overseas Shipholding Group is fairly valued at the initial

Ke and convergence values of growth and ROE in both the raw and restated analysis.

After varying the values of all three variables within the analysis we find Overseas

Shipholding Group’s prices to be undervalued a majority of the time. Overall, this is

consistent with the previous valuations performed.

Analyst Recommendation

Our analysis of the intrinsic valuation models leads us to deem Overseas

Shipholding Group as slightly undervalued. Our recommendation to potential investors

is to buy shares in this company in hope of long-term positive returns. Although most

of OSG intrinsic valuation models determine that it is undervalued, the discounted

dividends model suggests that OSG is overvalued. This model, though accurate, is not

the best measure because of the inability to forecast dividends exactly. Other than

discounted dividends, each intrinsic valuation model provides sufficient evidence that

OSG is slightly undervalued. We believe that these models are accurate because of the

high explanatory power of our beta coefficient, which determines that two-thirds of

each model is accurately explained. A large portion of OSG’s financial structure is

attributed through operating leases, for this reason, we needed to restate OSG’s

financial statements. Through these restated financials, we ran the intrinsic valuations

again and found OSG to be unanimously undervalued.

The discounted free cash flows model, abnormal earnings growth model, and the

long-run residual income model suggest that OSG is slightly undervalued. Also, in each

case that we used our estimated Ke of 18.47%, which we estimated using the backdoor

method, a growth rate equal to 9.99% (but the appropriate percent to use was 8.7%,

since 9.99% is too close to the WACC of 10.48%), which was the average future

earnings growth rate, and an ROE of 12.95%, we generated a price that was slightly

 

Page | 177   

undervalued. The energy shipping industry has been experiencing consolidation with

large public shipping corporations acquiring smaller independent operators. Through

this, we have also determined that OSG is in a position to expand in future years due to

firm mergers and acquisitions. OSG holds enough of the market share in the energy

shipping industry to compete with companies such as Tsakos, Teekay and Frontline.

Because of these future expansion opportunities, we would recommend that investors

should buy shares in Overseas Shipholding Group.

 

Page | 178   

APPENDICES

Appendix A: Sales and Expense Manipulation diagnostics

Net Sales/ Accounts Receivable (change) 2003 2004 2005 2006 2007 2008

OSG

19.38

3.66

8.43

1.67

1.43

29.91

Frontline

31.36

7.81

5.57

10.44

(62.35) n/a

Teekay

10.48

10.12

4.53

1.46

5.58 n/a

Tsakos

105.86

15.64

2.93

11,002.58

3.63 n/a

Net Sales/Cash from Sales (raw)

2003 2004 2005 2006 2007 2008

OSG 1.02 1.14 1.02 1.03 1.05 1.01

Frontline 1.02 1.05 0.96 1.00 1.00 n/a

Teekay 1.05 1.03 0.97 1.02 1.03 n/a

Tsakos 1.00 1.02 0.97 1.00 1.04 n/a

Net Sales/ Accounts Receivable (Raw)

2002 2003 2004 2005 2006 2007 2008

OSG 5.77 7.62 5.16 5.57 5.04 4.26 6.00

Frontline 11.33 17.15 11.88 16.13 15.78 12.63 n/a

Teekay 11.05 10.76 10.56 12.88 10.49 9.17 n/a

Tsakos 5.30 9.44 10.44 12.99 18.78 11.68 n/a

 

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Net Sales/ Cash from Sales (change)

2003 2004 2005 2006 2007 2008

OSG 0.35 1.33 0.72 1.14 1.55 0.94

Frontline 0.54 1.11 1.76 -10.58 1.01 n/a

Teekay 0.53 0.98 1.85 -1.47 1.08 n/a

Tsakos 0.46 1.05 2.26 1.06 1.38 n/a

Asset Turnover

2002 2003 2004 2005 2006 2007 2008

OSG 0.15 0.23 0.30 0.30 0.25 0.27 0.44

Frontline 0.18 0.27 0.44 0.34 0.34 0.35 n/a

Teekay 0.29 0.44 0.40 0.37 0.26 0.24 n/a

Tsakos 0.19 0.29 0.34 0.27 0.22 0.21 n/a

Asset Turnover (change) 2003 2004 2005 2006 2007 2008

OSG

(4.59)

0.52

0.28

0.05

(1.14)

(2.14)

Frontline

0.48

(6.32)

(1.42)

0.46

0.31 n/a

Teekay

0.92

0.34

1.26

0.02

0.17 n/a

Tsakos

0.85

0.68

(0.15)

0.15

0.19 n/a

CFFO/OI (raw)

2002 2003 2004 2005 2006 2007 2008

OSG 0.23 0.99 0.73 0.84 1.11 0.77 1.03

Frontline 1.56 1.11 0.81 1.14 1.04 1.05 n/a

Teekay 1.50 1.56 0.99 0.96 1.23 0.64 n/a

Tsakos 2.28 1.19 1.06 0.95 1.05 0.76 n/a

 

Page | 180   

CFFO/OI (change)

2003 2004 2005 2006 2007 2008

OSG 1.24 0.52 6.73 -0.09 1.51 1.41

Frontline 1.01 0.58 -0.26 2.71 1.01 n/a

Teekay 1.59 0.68 1.09 0.42 11.10 n/a

Tsakos 0.91 0.93 -0.72 1.35 -0.55 n/a

CFFO/NOA (raw)

2002 2003 2004 2005 2006 2007 2008

OSG 0.01 0.16 0.25 0.19 0.18 0.06 0.14

Frontline 0.05 0.02 0.31 0.30 0.27 0.22 n/a

Teekay 0.09 0.19 0.25 0.19 0.11 0.04 n/a

Tsakos 0.06 0.13 0.24 0.21 0.15 0.10 n/a

CFFO/NOA (change)

2003 2004 2005 2006 2007 2008

OSG -4.04 1.50 0.07 0.05 -1.52 -6.39

Frontline 0.01 -0.01 0.25 0.80 0.53 n/a

Teekay 0.56 0.42 6.72 -0.05 -0.27 n/a

Tsakos 0.51 -3.78 -0.09 0.09 -0.06 n/a

Total Accruals/Δ sales 2003 2004 2005 2006 2007 2008

OSG

(0.01)

(0.38)

(0.44)

0.95

(0.60)

0.02

Frontline

0.09

(0.32)

(0.35)

0.45

(0.10) n/a

Teekay

0.21

(0.01)

0.09

1.69

(0.36) n/a

Tsakos

0.12

0.11

0.35

0.07

(0.81) n/a

 

Page | 181   

Appendix B: Restating Financial Statements

2003

2003 245372004 2005 2006 2007 2008 Thereafter26,268$       24,813$     22,502$         22,521$     22,619$       51,244$               

forecastI‐rate 5.20% t Year Payment PV Factor Pay PV Ending Balance Depreciation Interest Principle Red

1 2004 26268 0.9505703 24970 119568 17328 7209 190592 2005 24813 0.903584 22421 100973 17328 6218 185953 2006 22502 0.8589201 19327 83721 17328 5251 172514 2007 22521 0.816464 18388 65554 17328 4353 181685 2008 22619 0.7761065 17555 46343 17328 3409 192106 2009 17081 0.7377438 12602 31672 17328 2410 146717 2010 17081 0.7012774 11979 16238 17328 1647 154348 2011 17081 0.6666135 11387 1 17328 844 16237

169967 Total 138,627$    31340 138627

2004

2004 486242005 2006 2007 2008 2009 Beyond63691 52250 42848 38690 30595 30461

I‐rate 5.20% t Year Payment PV Factor Pay PV Carrying Value Depreciation Interest Principle Red1 2005 63691 0.95057 60543 170236 37061 11563 521282 2006 52250 0.903584 47212 126838 37061 8852 433983 2007 42848 0.85892 36803 90586 37061 6596 362524 2008 38690 0.816464 31589 56606 37061 4710 339805 2009 30595 0.776106 23745 28955 37061 2944 276516 2010 30461 0.737744 22472 0 37061 1506 28955

Total 222,364$    222365

2005

2005 2136922006 2007 2008 2009 2010 Beyond

173890 194821 212309 208125 206655 503358

I‐rate 5.20% t Year Payment PV Factor Pay PV Carrying Value Depreciation Interest Principle Red1 2006 173890 0.95057 165295 1096187 150912 62779 1111112 2007 194821 0.903584 176037 958367 150912 57002 1378193 2008 212309 0.85892 182356 795893 150912 49835 1624744 2009 208125 0.816464 169927 629155 150912 41386 1667395 2010 206655 0.776106 160386 455216 150912 32716 1739396 2011 167786 0.737744 123783 311101 150912 23671 1441157 2012 167786 0.701277 117665 159492 150912 16177 1516098 2013 167786 0.666613 111848 0 150912 8294 159492

Total 1,207,297$  1207297

 

Page | 182   

2006

2006 2804832007 2008 2009 2010 2011 Beyond

232000 265517 275352 278997 239355 675531

I‐rate 5.20% t Year Payment PV Factor Pay PV Carrying Value Depreciation Interest Principle Red1 2007 232000 0.95057 220532 1435053 198081 82402 1495982 2008 265517 0.903584 239917 1244159 198081 74623 1908943 2009 275352 0.85892 236505 1033503 198081 64696 2106564 2010 278997 0.816464 227791 808248 198081 53742 2252555 2011 239355 0.776106 185765 610922 198081 42029 1973266 2012 225177 0.737744 166123 417513 198081 31768 1934097 2013 225177 0.701277 157912 214047 198081 21711 2034668 2014 225177 0.666613 150106 0 198081 11130 214047

Total 1,584,651$  1584651 1584651

2007

2007 $313,9142008 2009 2010 2011 2012 Beyond

341962 371991 368418 320325 238399 730636

I‐rate 5.20% t Year Payment PV Factor Pay PV Carrying Value Depreciation Interest Principle Red1 2008 341962 0.95057 $325,059 $1,682,654 $213,838 $100,076 $241,8862 2009 371991 0.903584 $336,125 $1,398,161 $213,838 $87,498 $284,4933 2010 368418 0.85892 $316,442 $1,102,447 $213,838 $72,704 $295,7144 2011 320325 0.816464 $261,534 $839,450 $213,838 $57,327 $262,9985 2012 238399 0.776106 $185,023 $644,702 $213,838 $43,651 $194,7486 2013 182659 0.737744 $134,756 $495,567 $213,838 $33,525 $149,1347 2014 182659 0.701277 $128,095 $338,678 $213,838 $25,770 $156,8898 2015 182659 0.666613 $121,763 $173,630 $213,838 $17,611 $165,0489 2016 182659 0.633663 $115,744 $0 $213,838 $9,029 $173,630

Total 1,924,540$    $1,924,540

20082008 308983

2009 2010 2011 2012 2013 Beyond410283 371337 364101 314714 261652 781852

I‐rate 5.20% t Year Payment PV Factor Pay PV Carrying Value Depreciation Interest Principle Red1 2009 410283 0.95057 390003 1728204 203278 105705 3045782 2010 371337 0.903584 335534 1446734 203278 89867 2814703 2011 364101 0.85892 312734 1157863 203278 75230 2888714 2012 314714 0.816464 256953 903358 203278 60209 2545055 2013 261652 0.776106 203070 688681 203278 46975 2146776 2014 211000 0.737744 155664 513492 203278 35811 1751897 2015 201725 0.701277 141465 338469 203278 26702 1750238 2016 181000 0.666613 120657 175069 203278 17600 1634009 2017 108127 0.633663 68516 76046 203278 9104 9902310 2018 80000 0.602341 48187 0 203278 3954 76046

Total 2,032,783$         2032783 2032783

 

Page | 183   

Appendix C: Financial Analysis

Liquidity Ratios

Current Ratio    2003 2004 2005 2006 2007 2008

OSG 1.44 3.22 2.91 3.72 3.77 3.48

OSG restated 1.44 3.22 2.91 3.72 3.77 3.48

Frontline 3.73 3.38 2.54 2.51 1.80 n/a

Teekay 1.75 2.22 1.36 0.97 1.10 n/a

Tsakos 1.40 1.93 2.10 2.20 1.73 n/a

Industry Avg. 2.08 2.69 2.23 2.35 2.10 n/a

Quick Ratio    2003 2004 2005 2006 2007 2008

OSG 1.28 3.11 2.62 3.26 3.20 2.89

OSG restated 1.28 3.11 2.62 3.26 3.20 2.89

Frontline 0.54 0.94 0.70 0.58 0.41 n/a

Teekay 1.60 1.54 0.84 0.69 0.76 n/a

Tsakos 1.20 1.70 1.79 1.87 1.29 n/a

Industry Avg. 1.16 1.82 1.49 1.60 1.42 n/a

Accounts Receivable Turnover    2003 2004 2005 2006 2007 2008

OSG 7.62 5.16 5.57 5.04 4.26 5.99OSG restated 7.62 5.16 5.57 5.04 4.26 5.99

Teekay 10.76 10.56 12.88 10.49 9.17 n/aFrontline 17.15 11.88 16.13 15.78 12.63 n/aTsakos 9.44 10.44 12.99 18.78 11.68 n/a

Industry Avg. 11.24 9.51 11.89 12.52 9.44 n/a

 

Page | 184   

Days Sales Outstanding    2003 2004 2005 2006 2007 2008

OSG 47.90 70.74 65.53 72.42 85.68 60.93OSG restated 47.90 70.74 65.53 72.42 85.68 60.93

Frontline 21.28 30.72 22.63 23.13 28.90 n/aTeekay 33.92 34.56 28.34 34.80 39.80 n/aTsakos 38.67 34.96 28.10 19.44 31.25 n/a

Industry Avg. 35.44 42.75 36.15 37.45 46.41 n/a

Working Capital Turnover    2003 2004 2005 2006 2007 2008

OSG 10.51 1.82 3.96 1.69 1.91 3.53OSG restated 10.51 1.82 3.96 1.69 1.91 3.53

Frontline 1.32 2.24 2.13 2.33 2.75 n/aTeekay 7.66 4.41 11.8 -147.9 25.29 n/aTsakos 7.22 4.26 2.95 3.53 4.29 n/a

Industry Avg. 6.68 3.18 5.21 2.52 2.98 n/a

Profitability Ratios

Gross Profit Margin 2003 2004 2005 2006 2007 2008

OSG 0.95 0.97 0.96 0.95 0.92 0.91OSG restated 0.95 0.97 0.96 0.95 0.92 0.91

Frontline 0.73 0.82 0.83 0.81 0.82 n/aTeekay 0.75 0.81 0.79 0.74 0.78 n/aTsakos 0.75 0.83 0.84 0.80 0.82 n/a

industry average 0.80 0.86 0.85 0.82 0.84 n/a

Operating Expense Ratio    2003 2004 2005 2006 2007 2008

OSG 0.53 0.40 0.53 0.64 0.82 0.80OSG-restated 0.54 0.35 0.46 0.60 0.76 0.64

Frontline 0.31 0.20 0.25 0.29 0.42 n/aTeekay 0.56 0.44 0.46 0.53 0.62 n/aTsakos 0.46 0.37 0.32 0.32 0.32 n/a

Industry Avg. 0.47 0.35 0.39 0.45 0.54 n/a

 

Page | 185   

Operating Profit Margin 2003 2004 2005 2006 2007 2008

OSG 0.50 0.63 0.52 0.38 0.19 0.21OSG restated 0.50 0.63 0.52 0.38 0.19 0.21

Frontline 0.41 0.61 0.57 0.52 0.40 n/aTeekay 0.19 0.37 0.32 0.21 0.17 n/aTsakos 0.29 0.46 0.52 0.48 0.50 n/a

Industry Avg. 0.35 0.52 0.48 0.40 0.31 n/a

Net Profit Margin 2003 2004 2005 2006 2007 2008

OSG 0.27 0.49 0.46 0.37 0.19 0.19OSG restated 0.27 0.49 0.46 0.37 0.19 0.19

Frontline 0.35 0.56 0.41 0.33 0.44 n/aTeekay 0.11 0.34 0.29 0.13 0.08 n/aTsakos 0.24 0.45 0.55 0.46 0.37 n/a

Industry Avg. 0.24 0.46 0.43 0.32 0.27 n/a

Asset Turnover    2003 2004 2005 2006 2007 2008

OSG 0.22 0.41 0.37 0.31 0.27 0.41OSG-restated 0.22 0.38 0.34 0.23 0.19 0.28

Frontline 0.38 0.43 0.36 0.35 0.28 n/aTeekay 0.58 0.62 0.36 0.38 0.31 n/aTsakos 0.35 0.39 0.31 0.39 0.25 n/a

Industry Avg. 0.38 0.46 0.35 0.36 0.28 n/a

Return on Assets 2003 2004 2005 2006 2007 2008

OSG 0.06 0.20 0.17 0.12 0.05 0.08OSG-restated 0.06 0.19 0.16 0.09 0.04 0.05

Frontline 0.13 0.24 0.14 0.12 0.12 n/aTeekay 0.07 0.21 0.10 0.05 0.02 n/aTsakos 0.09 0.17 0.17 0.18 0.09 n/a

Industry Avg. 0.09 0.21 0.15 0.12 0.07 n/a

 

Page | 186   

Return on Equity 2003 2004 2005 2006 2007 2008

OSG 0.15 0.44 0.33 0.21 0.10 0.17

OSG restated 0.15 0.44 0.33 0.21 0.10 0.17

Frontline 0.33 0.82 0.66 0.72 0.85 n/a

Teekay 0.12 0.46 0.26 0.12 0.07 n/aTsakos 0.22 0.46 0.31 0.32 0.24 n/a

Industry Avg. 0.17 0.45 0.30 0.22 0.14 n/a

Firm Growth Rate Ratios

Internal Growth Rate    2003 2004 2005 2006 2007 2008

OSG 0.05 0.19 0.16 0.11 0.04 0.07OSG restated 0.05 0.19 0.16 0.11 0.04 0.07

Frontline 0.02 0.00 -0.07 -0.03 -0.02 n/aTeekay 0.05 0.20 0.09 0.04 0.01 n/aTsakos 0.07 0.15 0.13 0.14 0.06 n/a

Industry Avg. 0.05 0.13 0.08 0.06 0.02 n/a

Sustainable Growth Rate    2003 2004 2005 2006 2007 2008

OSG 0.11 0.35 0.29 0.20 0.09 0.15OSG-restated 0.11 0.38 0.40 0.28 0.14 0.23

Frontline 0.08 -0.02 -0.45 -0.21 -0.16 n/aTeekay 0.11 0.49 0.22 0.12 0.05 n/aTsakos 0.18 0.26 0.24 0.36 0.17 n/a

Industry Avg. 0.12 0.27 0.08 0.12 0.04 n/a

Capital Structure Ratios

Debt to Equity    2003 2004 2005 2006 2007 2008

OSG 1.18 0.88 0.78 0.92 1.29 1.26OSG-Restated 1.33 1.04 1.43 1.63 2.35 2.44

Frontline 2.44 3.59 5.23 5.87 7.44 n/aTeekay 1.17 1.46 1.37 2.06 2.74 n/aTsakos 1.62 0.81 0.79 1.61 1.76 n/a

Industry Avg. 1.60 1.68 2.04 2.61 3.31 n/a

 

Page | 187   

Times Interest Earned    2003 2004 2005 2006 2007 2008

OSG 3.62 8.20 8.35 6.46 3.48 5.75OSG restated 3.62 8.20 8.35 6.46 3.48 5.75

Frontline 6.48 15.17 11.57 10.83 7.00 n/aTeekay 3.62 10.14 7.80 5.21 4.91 n/aTsakos 5.71 11.76 12.51 16.59 20.18 n/a

Industry Avg. 4.86 11.32 10.06 9.77 8.89 n/a

Debt Service Margin    2003 2004 2005 2006 2007 2008

OSG 15.63 26.05 30.46 31.22 11.74 25.67OSG restated 15.63 26.05 30.46 31.22 11.74 25.67

Frontline 3.19 5.42 5.84 4.96 3.25 n/aTeekay 5.45 9.74 7.28 6.23 3.05 n/aTsakos 2.79 5.08 4.86 7.12 6.31 n/a

Industry Avg. 6.76 11.58 12.11 12.38 6.09 n/a

Altman's Z-Score    2003 2004 2005 2006 2007 2008

OSG 1.83 2.59 2.31 1.88 1.83 1.97OSG-restated 1.68 2.32 1.54 1.26 1.16 1.24

Frontline 1.19 1.97 1.43 1.28 1.45 n/aTeekay 2.57 1.98 1.81 1.16 0.99 n/aTsakos 1.48 3.12 2.95 1.76 1.46 n/a

Industry Avg. 1.77 2.42 2.12 1.52 1.43 n/a

 

 

Page | 188   

Appendix D: Regressions

3 month

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.680674303R Square 0.463317507Adjusted R Square 0.455650615Standard Error 0.07797254Observations 72

ANOVAdf SS MS F Significance F

Regression 1 0.367402992 0.367402992 60.43093629 4.76735E‐11Residual 70 0.425580192 0.006079717Total 71 0.792983184

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020113469 0.009219895 2.181529201 0.032504642 0.00172497 0.038501969 0.00172497 0.038501969X Variable 1 1.783420949 0.229416264 7.773733742 4.76735E‐11 1.325864645 2.240977253 1.325864645 2.240977253

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.658239175R Square 0.433278812Adjusted R Square 0.423507757Standard Error 0.082012967Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.298257275 0.298257275 44.34309431 1.09312E‐08Residual 58 0.390115355 0.006726127Total 59 0.68837263

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.018223934 0.010855305 1.678804411 0.098570561 ‐0.00350532 0.039953189 ‐0.00350532 0.039953189X Variable 1 1.764924668 0.26504107 6.659061068 1.09312E‐08 1.234387329 2.295462007 1.234387329 2.295462007

 

Page | 189   

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.716746858R Square 0.513726058Adjusted R Square 0.503154885Standard Error 0.072097395Observations 48

ANOVAdf SS MS F Significance F

Regression 1 0.252608279 0.252608279 48.59688467 1.00671E‐08Residual 46 0.239109583 0.005198034Total 47 0.491717863

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.008769147 0.010813646 0.810933487 0.421579893 ‐0.012997592 0.030535887 ‐0.012997592 0.030535887X Variable 1 1.696207055 0.243318231 6.971146582 1.00671E‐08 1.206432866 2.185981244 1.206432866 2.185981244

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.735630343R Square 0.541152002Adjusted R Square 0.527656472Standard Error 0.076257561Observations 36

ANOVAdf SS MS F Significance F

Regression 1 0.233182076 0.233182076 40.09861247 3.19891E‐07Residual 34 0.19771733 0.005815216Total 35 0.430899406

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.01916017 0.01351358 1.417845604 0.165336275 ‐0.008302728 0.046623068 ‐0.008302728 0.046623068X Variable 1 1.713527037 0.270599063 6.332346522 3.19891E‐07 1.16360358 2.263450495 1.16360358 2.263450495

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.825772375R Square 0.681900016Adjusted R Square 0.667440925Standard Error 0.071988496Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.24440266 0.24440266 47.16064469 6.74588E‐07Residual 22 0.114011557 0.005182343Total 23 0.358414217

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.027636982 0.016530204 1.671908089 0.108706875 ‐0.006644563 0.061918526 ‐0.006644563 0.061918526X Variable 1 1.896660592 0.276184788 6.867360824 6.74588E‐07 1.323888402 2.469432783 1.323888402 2.469432783

 

Page | 190   

1 YearSUMMARY OUTPUT

Regression StatisticsMultiple R 0.674307961R Square 0.454691226Adjusted R Square 0.4469011Standard Error 0.078596682Observations 72

ANOVAdf SS MS F Significance F

Regression 1 0.360562496 0.360562496 58.36763923 8.40438E‐11Residual 70 0.432420688 0.006177438Total 71 0.792983184

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020191678 0.009295132 2.172285207 0.033222968 0.001653122 0.038730234 0.001653122 0.038730234X Variable 1 1.737069643 0.227368955 7.639871676 8.40438E‐11 1.283596566 2.19054272 1.283596566 2.19054272

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.652051649R Square 0.425171353Adjusted R Square 0.415260515Standard Error 0.082597519Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.292676323 0.292676323 42.89963388 1.66488E‐08Residual 58 0.395696307 0.00682235Total 59 0.68837263

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.017344555 0.010908647 1.589982288 0.117275402 ‐0.004491474 0.039180584 ‐0.004491474 0.039180584X Variable 1 1.702006385 0.259856983 6.549781208 1.66488E‐08 1.181846122 2.222166647 1.181846122 2.222166647

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.71148945R Square 0.506217237Adjusted R Square 0.495482829Standard Error 0.072651911Observations 48

ANOVAdf SS MS F Significance F

Regression 1 0.248916058 0.248916058 47.15837546 1.44187E‐08Residual 46 0.242801805 0.0052783Total 47 0.491717863

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007541107 0.010855201 0.69469991 0.490737567 ‐0.014309279 0.029391493 ‐0.014309279 0.029391493X Variable 1 1.635047253 0.238095337 6.867195604 1.44187E‐08 1.155786204 2.114308301 1.155786204 2.114308301

 

Page | 191   

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.733451438R Square 0.537951011Adjusted R Square 0.524361335Standard Error 0.07652309Observations 36

ANOVAdf SS MS F Significance F

Regression 1 0.231802771 0.231802771 39.58527091 3.60992E‐07Residual 34 0.199096635 0.005855783Total 35 0.430899406

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.018610812 0.013535794 1.374933137 0.178145833 ‐0.008897231 0.046118856 ‐0.008897231 0.046118856X Variable 1 1.661769089 0.264121567 6.291682677 3.60992E‐07 1.125009488 2.198528691 1.125009488 2.198528691

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.824431241R Square 0.679686871Adjusted R Square 0.665127183Standard Error 0.072238487Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.243609438 0.243609438 46.68279189 7.291E‐07Residual 22 0.11480478 0.005218399Total 23 0.358414217

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.029292514 0.016705776 1.753436339 0.093451095 ‐0.005353144 0.063938173 ‐0.005353144 0.063938173X Variable 1 1.859427888 0.272145357 6.832480654 7.291E‐07 1.295032964 2.423822812 1.295032964 2.423822812

 

Page | 192   

2 Year SUMMARY OUTPUT

Regression StatisticsMultiple R 0.679303941R Square 0.461453844Adjusted R Square 0.453760327Standard Error 0.078107805Observations 72

ANOVAdf SS MS F Significance F

Regression 1 0.365925139 0.365925139 59.97957407 5.39257E‐11Residual 70 0.427058046 0.006100829Total 71 0.792983184

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020762683 0.009243244 2.246254873 0.027845119 0.002327613 0.039197752 0.002327613 0.039197752X Variable 1 1.780264671 0.229870312 7.744648092 5.39257E‐11 1.321802797 2.238726546 1.321802797 2.238726546

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.656889746R Square 0.431504138Adjusted R Square 0.421702485Standard Error 0.082141278Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.297035638 0.297035638 44.02360978 1.19916E‐08Residual 58 0.391336992 0.00674719Total 59 0.68837263

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.018774779 0.01089203 1.723717248 0.090086112 ‐0.003027987 0.040577545 ‐0.003027987 0.040577545X Variable 1 1.760639028 0.265355137 6.635028996 1.19916E‐08 1.229473015 2.291805041 1.229473015 2.291805041

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.717112481R Square 0.514250311Adjusted R Square 0.503690535Standard Error 0.072058521Observations 48

ANOVAdf SS MS F Significance F

Regression 1 0.252866064 0.252866064 48.69897979 9.81577E‐09Residual 46 0.238851799 0.00519243Total 47 0.491717863

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.009059047 0.01081877 0.83734539 0.406727933 ‐0.012718007 0.030836101 ‐0.012718007 0.030836101X Variable 1 1.694249306 0.242782503 6.978465433 9.81577E‐09 1.205553481 2.18294513 1.205553481 2.18294513

 

Page | 193   

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.735026627R Square 0.540264142Adjusted R Square 0.526742499Standard Error 0.076331303Observations 36

ANOVAdf SS MS F Significance F

Regression 1 0.232799498 0.232799498 39.95551035 3.30825E‐07Residual 34 0.198099908 0.005826468Total 35 0.430899406

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.019154569 0.01352763 1.415958983 0.16588381 ‐0.008336882 0.046646019 ‐0.008336882 0.046646019X Variable 1 1.707350767 0.270106113 6.321037126 3.30825E‐07 1.158429106 2.256272429 1.158429106 2.256272429

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.825752828R Square 0.681867733Adjusted R Square 0.667407176Standard Error 0.071992148Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.24439109 0.24439109 47.1536267 6.75356E‐07Residual 22 0.114023127 0.005182869Total 23 0.358414217

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.027703545 0.016535567 1.675391334 0.10801435 ‐0.006589121 0.061996211 ‐0.006589121 0.061996211X Variable 1 1.891851812 0.275505051 6.866849838 6.75356E‐07 1.32048931 2.463214314 1.32048931 2.463214314

 

Page | 194   

5 Year

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.67770956R Square 0.459290248Adjusted R Square 0.451565823Standard Error 0.078264546Observations 72

ANOVAdf SS MS F Significance F

Regression 1 0.364209443 0.364209443 59.45947378 6.21876E‐11Residual 70 0.428773741 0.006125339Total 71 0.792983184

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.021549538 0.009271813 2.324198914 0.023022559 0.00305749 0.040041586 0.00305749 0.040041586X Variable 1 1.774630959 0.230142869 7.710996938 6.21876E‐11 1.315625486 2.233636432 1.315625486 2.233636432

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.655429268R Square 0.429587526Adjusted R Square 0.419752828Standard Error 0.082279626Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.295716295 0.295716295 43.68080574 1.32484E‐08Residual 58 0.392656335 0.006769937Total 59 0.68837263

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.019246838 0.010928205 1.761207715 0.083474019 ‐0.00262834 0.041122016 ‐0.00262834 0.041122016X Variable 1 1.750259841 0.264823919 6.609145614 1.32484E‐08 1.220157177 2.280362505 1.220157177 2.280362505

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.716607713R Square 0.513526614Adjusted R Square 0.502951106Standard Error 0.072112179Observations 48

ANOVAdf SS MS F Significance F

Regression 1 0.252510209 0.252510209 48.55810195 1.01643E‐08Residual 46 0.239207654 0.005200166Total 47 0.491717863

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.009319538 0.010837761 0.859913538 0.394296292 ‐0.012495744 0.03113482 ‐0.012495744 0.03113482X Variable 1 1.685335594 0.241855263 6.968364367 1.01643E‐08 1.198506208 2.172164979 1.198506208 2.172164979

 

Page | 195   

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.734771706R Square 0.53988946Adjusted R Square 0.526356797Standard Error 0.076362402Observations 36

ANOVAdf SS MS F Significance F

Regression 1 0.232638048 0.232638048 39.8952861 3.35544E‐07Residual 34 0.198261358 0.005831216Total 35 0.430899406

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.019458698 0.013550134 1.436052094 0.160125142 ‐0.008078487 0.046995883 ‐0.008078487 0.046995883X Variable 1 1.699041619 0.268994392 6.316271535 3.35544E‐07 1.152379247 2.245703991 1.152379247 2.245703991

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.825554406R Square 0.681540078Adjusted R Square 0.667064627Standard Error 0.072029212Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.244273654 0.244273654 47.08247624 6.83192E‐07Residual 22 0.114140564 0.005188207Total 23 0.358414217

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.028317492 0.016586135 1.707298962 0.101842702 ‐0.006080048 0.062715031 ‐0.006080048 0.062715031X Variable 1 1.884931628 0.274704614 6.861667162 6.83192E‐07 1.31522913 2.454634126 1.31522913 2.454634126

 

Page | 196   

10 Year

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.676217703R Square 0.457270382Adjusted R Square 0.449404735Standard Error 0.078920341Observations 71

ANOVAdf SS MS F Significance F

Regression 1 0.36209001 0.36209001 58.13512893 9.7051E‐11Residual 69 0.429760992 0.00622842Total 70 0.791851001

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.022089711 0.009429093 2.342718558 0.022034008 0.003279185 0.040900236 0.003279185 0.040900236X Variable 1 1.767543249 0.231819908 7.624639594 9.7051E‐11 1.305075192 2.230011306 1.305075192 2.230011306

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.654330884R Square 0.428148905Adjusted R Square 0.418289404Standard Error 0.082383318Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.294725988 0.294725988 43.42500478 1.42747E‐08Residual 58 0.393646642 0.006787011Total 59 0.68837263

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.019796707 0.010962929 1.805786332 0.076141793 ‐0.002147979 0.041741394 ‐0.002147979 0.041741394X Variable 1 1.741175922 0.264224275 6.589765154 1.42747E‐08 1.212273575 2.270078269 1.212273575 2.270078269

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.715982174R Square 0.512630473Adjusted R Square 0.502035483Standard Error 0.072178568Observations 48

ANOVAdf SS MS F Significance F

Regression 1 0.252069561 0.252069561 48.3842351 1.06124E‐08Residual 46 0.239648302 0.005209746Total 47 0.491717863

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.009719508 0.010864651 0.894599125 0.375658582 ‐0.012149901 0.031588916 ‐0.012149901 0.031588916X Variable 1 1.676869702 0.241072337 6.955877737 1.06124E‐08 1.191616263 2.162123141 1.191616263 2.162123141

 

Page | 197   

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.734446296R Square 0.539411362Adjusted R Square 0.525864637Standard Error 0.076402065Observations 36

ANOVAdf SS MS F Significance F

Regression 1 0.232432036 0.232432036 39.81858168 3.41658E‐07Residual 34 0.198467371 0.005837276Total 35 0.430899406

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.019924341 0.013583393 1.466816229 0.151615449 ‐0.007680434 0.047529116 ‐0.007680434 0.047529116X Variable 1 1.691371804 0.268037892 6.310196644 3.41658E‐07 1.146653273 2.236090334 1.146653273 2.236090334

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.825248627R Square 0.681035296Adjusted R Square 0.666536901Standard Error 0.072086276Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.244092733 0.244092733 46.9731489 6.95428E‐07Residual 22 0.114321485 0.005196431Total 23 0.358414217

Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.029104534 0.016654066 1.747593273 0.094479987 ‐0.005433885 0.063642953 ‐0.005433885 0.063642953X Variable 1 1.878618829 0.274103028 6.853696003 6.95428E‐07 1.310163944 2.447073714 1.310163944 2.447073714

 

Page | 198   

Appendix E: Methods of Comparables

Price/Earning Trailing

Price /Earnings Forecast

Price /Book

Price/Book

PPS BPS P/B Industry Avg. OSG PPS

OSG 24.03 57.79 0.42 .52 29.91OSG restated 24.03 64.19 0.37 .52 33.38

Frontline 17.55 5.96 2.94Teekay 14.51 36.94 0.39Tsakos 14.42 22.45 0.64

P/E trailing PPS EPS P/E Trailing Computed Price

OSG 24.03 10.65 36.01OSG restated 24.03 14.54 49.15

Frontline 17.55 1.93Teekay 14.51 5.76Tsakos 14.42 2.45

Average 3.38

Forecasted P/E

PPS EPS 1yr

Out P/E

Forecast Industry Avg.

P/E Computed

price OSG 24.03 6.07 8.19 49.71

OSG restated 24.03 7.74 8.19 63.39Frontline 17.55 8.36Teekay 14.51 9.44Tsakos 14.42 6.78

 

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Price Earnings Growth (P.E.G.)

P.E.G P/E Growth PEG Industry Avg. OSG PPS

OSG 2.26 0.222 16.59 39.22OSG restated 1.84 0.197 16.59 47.52

Frontline 1.93 0.127 15.20Teekay 5.76 0.252 22.86Tsakos 2.45 0.209 11.72

Price/EBITDA

Enterprise Value/EBITDA

EV/EBITDA

EV (Bil) EBITDA

(Bil)

EV/EBITDA Industry

Avg. OSG PPS OSG 2.54 0.52 6.24 47.67OSG

restated 4.38 0.63 6.24 8.91Frontline 4.34 0.93 4.65 Teekay 7.08 0.84 8.44 Tsakos 1.85 0.33 5.64

Price/EBITDA

Market Cap

(billions) EBITDA

(billions) P/EBITDAIndustry

Avg. EBITDA/shareOSG PPS

OSG 0.72 0.52 1.54 17.37 26.75OSG

restated 0.72 0.63 1.54 21.25 32.73Frontline 1.45 0.93 1.56 Teekay 1.1 0.84 1.31 Tsakos 0.58 0.33 1.76

 

Page | 200   

Price to Free Cash Flows (P/FCF)

Price/Free Cash Flows

Market Cap FCF P/FCF Industry Avg. OSG PPS

OSG 709.3 290 1.154 11.22

OSG restated 709.3 (1,228) 1.154 (47.53)

Frontline 1,453.60 797 1.82

Teekay 1,016.90 2099 0.48

Tsakos 590.3 (185) (3.19)

*market cap and FCF in millions

Dividends/Price

Dividend/Price PPS DPS D/P Industry Avg. OSG PPS

OSG 24.03 1.5 0.06 0.089 16.87

OSG-restated 24.03 1.5 0.06 0.089 16.87

Frontline 17.55 8.3 0.47

Teekay 14.51 0.99 0.07

Tsakos 14.42 1.58 0.11

 

 

Appendix F: Valuation Models

All Items in Millions of Dollars 1 2 3 4 5 6 7 8 9 10 Perp.2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income 181.05 227.15 331.95 293.29 342.57 391.34 411.82 460.84 508.71 555.11 Total Dividends -49.59 -49.59 -53.84 -53.84 -65.18 -65.18 -70.84 -70.84 -76.51 -76.51 -82.18BV Equity 1722.87 1854.33 2031.89 2310.00 2549.45 2826.85 3153.00 3493.98 3883.98 4316.18 4794.78CFFO 670.34 751.74 892.16 924.26 1032.54 1147.33 1247.32 1378.19 1517.42 1665.62CFFI -182.80 -253.48 -323.56 -355.92 -391.51 -430.66 -473.73 -521.10 -573.21 -630.53CFFF -49.59 -49.59 -53.84 -53.84 -65.18 -65.18 -70.84 -70.84 -76.51 -76.51Dividends per share (39,591 issued) 1.25$ 1.25$ 1.36$ 1.36$ 1.65$ 1.65$ 1.79$ 1.79$ 1.93$ 1.93$ 2.08$ Dividend Growth 0.0000 0.0857 0.0000 0.2106 0.0000 0.0868 0.0000 0.0800 0.0000Average Growth 0.0515PV factor 0.8441 0.7125 0.6014 0.5077 0.4285 0.3617 0.3053 0.2577 0.2175 0.1836PV Dividends 1.06$ 0.89$ 0.82$ 0.69$ 0.71$ 0.60$ 0.55$ 0.46$ 0.42$

Dollars RelativePV YBY Dividends 6.19$ 68%

TV perpetuity 15.58$ PV TV perpetuity 2.86$ 32%Model Price 9.05$ 100%Time consistent Model Price 9.44$ Observed Share Price (4/1/09) 24.03$ Initial Cost of Equity 0.1847Perp Growth Rate (g) 0.0515

Growth > 0 1.72 3.44 5.15 6.87 8.59 10.310.0862 20.13$ 22.81$ 27.28$ 36.09$ 62.35$ N/A N/A0.1014 16.79$ 18.42$ 20.89$ 25.03$ 33.56$ 52.22$ N/A0.1167 14.34$ 15.39$ 16.88$ 19.13$ 23.02$ 31.26$ 60.31$ 0.1457 11.19$ 11.70$ 12.36$ 13.26$ 14.57$ 16.63$ 20.35$ 0.1612 12.00$ 10.36$ 10.82$ 11.41$ 12.23$ 13.43$ 15.33$ 0.1847 8.61$ 8.83$ 9.10$ 9.44$ 9.88$ 10.48$ 11.33$ 0.2236 6.98$ 7.09$ 7.22$ 7.37$ 7.56$ 7.79$ 8.09$

PV10 of DPS Perp.

Discounted Dividends Model

Discounted Dividends Model

At a 15% Analyst Position

Restated Backdoor KeKe

Upper Ke

Backdoor KeLower Ke

 

Page | 200   

All Items in Millions of Dollars0 1 2 3 4 5 6 7 8 9 10 Perp.

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019CFFO (Millions) 670.34 751.74 892.16 924.26 1032.54 1147.33 1247.32 1378.19 1517.42 1665.62 1,725.500 CFFI (Millions) -182.801 -253.480 -323.560 -355.916 -391.508 -430.659 -473.725 -521.097 -573.207 -630.527 -650.000Yearly Growth Rate 0.1214 0.1868 0.0360 0.1172 0.1112 0.0872 0.1049 0.1010 0.0977 0.0360FCF Firm's Assets 487.543 498.259 568.596 568.342 641.033 716.669 773.595 857.093 944.217 1,035.093 1,075.500 PV Factor 0.9051 0.8193 0.7416 0.6712 0.6075 0.5499 0.4978 0.4505 0.4078 0.3691 0.3341PV YBY Free Cash Flows 441.295 408.214 421.651 381.483 389.459 394.109 385.060 386.152 385.052 382.070 Average 10 yr. Growth Rate 0.0999 % ValueTotal PV YBY FCF (millions) 3,592.475$ 14%FCF Perp 22,302.511$ 86% 60,421 Market Value of Assets (12/31/08) 25,894.985$ Book Value Debt & Preferred Stock 4,199.977$ 20.43$ 27.63$ Market Value of Equity 21,695.009$ Divide by Shares to Get PPS at 12/31 547.98$ Time Consistent Model Price (4/1/09) 534.50$ Oberved Share Price (4/1/09) 24.03$

WACC(BT) 0.1048 Growth > 0 0.0174 0.0348 0.0523 0.0697 0.0870Perp Growth Rate 0.0870 0.0746 172.34$ 225.33$ 324.64$ 580.85$ 2,649.96$ N/A

0.0875 123.61$ 156.22$ 210.38$ 318.85$ 638.15$ 22,987.90$ 0.0879 122.34$ 154.50$ 207.74$ 313.78$ 621.40$ 12,719.09$ 0.1048 78.36$ 96.94$ 124.75$ 171.33$ 263.68$ 534.50$ 0.1220 47.15$ 58.54$ 74.46$ 98.50$ 138.35$ 217.24$ 0.1385 25.24$ 32.70$ 42.66$ 56.73$ 77.82$ 112.92$ 0.1585 5.52$ 10.20$ 16.19$ 24.20$ 35.30$ 51.68$

Discounted Free Cash Flows

Upper WACC

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63At a 15% Analyst Position

Backdoor WACCLower WACC

Before Tax WACCRestated WACC

Discounted Free Cash Flow

PV10 FCF of Assets15% analyst between

Less than $20.43Greater than $27.63

 

Page | 201   

All Items in Millions of Dollars21.83 72.00 -90.03 5.05 -2.47 -39.76 -13.95 -24.17 -33.42 19.05

0 1 2 3 4 5 6 7 8 9 10 Perp.2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income (Millions) 181.05 227.15 331.95 293.29 342.57 391.34 411.82 460.84 508.71 555.11Total Dividends (Millions) 49.59 49.59 53.84 53.84 65.18 65.18 70.84 70.84 76.51 76.51 82.18Book Value Equity (Millions) 1,722.87 1,854.32 2,031.89 2,310.00 2,549.45 2,826.84 3,153.00 3,493.98 3,883.98 4,316.18 4,794.78

Annual Normal Income (Becnhmark) 318.214 342.494 375.290 426.657 470.884 522.118 582.359 645.338 717.371 797.198Annual Residual Income -137.17 -115.34 -43.34 -133.36 -128.31 -130.78 -170.54 -184.50 -208.66 -242.09 -223.04PV Factor 0.844 0.712 0.601 0.508 0.429 0.362 0.305 0.258 0.218 0.184YBY PV RI -115.78 -82.18 -26.06 -67.70 -54.98 -47.30 -52.07 -47.55 -45.39 -44.45Percent Change in RI -0.1591 -0.6243 2.0773 -0.0379 0.0192 0.3040 0.0818 0.1310 0.1602 0.2169Average percentage change in RI 0.2169

% Value % Backdoor KeBook Value Equity (Millions) 1,722.87 163% 87% 20.43$ 27.63$ -460.151Total PV of YBY RI -583.47 -55% 11%Terminal Value Perpetuity -84.4922 -8% 2%MVE 12/31/08 1,054.90 100% 100%Divide by Shares 39.591Model Price on 12/31/08 26.65Time Consistent Price 27.80$ Growth > -0.1 -0.2 -0.3 -0.4 -0.5Observed Share Price (4/1/2009) $24.03 0.1014 62.08$ 60.33$ 59.44$ 58.91$ 58.56$ Initial Cost of Equity 0.1847 0.1167 52.11$ 51.51$ 51.20$ 51.01$ 50.89$ Perpetuity Growth Rate (g) -0.3 0.1457 38.22$ 38.76$ 39.06$ 39.24$ 39.37$

0.1612 32.74$ 33.55$ 34.01$ 34.30$ 34.51$ 0.1847 26.23$ 27.22$ 27.80$ 28.18$ 28.45$ 0.2236 18.77$ 19.74$ 20.34$ 20.75$ 21.04$ 0.2600 14.17$ 15.01$ 15.55$ 15.92$ 16.20$

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

Backdoor KeLower Ke

Residual Income - RAW

Restated Backdoor KeKe

15% analyst between

Less than $20.43Greater than $27.63

PV10 FCF Perp.

Residual Income - RAW

 

Page | 202   

All Items in Millions of Dollars19.78 74.96 -102.79 0.97 -7.83 -49.05 -21.34 -33.00 -43.79 22.41

0 1 2 3 4 5 6 7 8 9 10 Perp.2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income (Millions) 230.78 284.02 402.27 363.84 422.07 480.16 507.75 567.11 625.77 683.427Total Dividends (Millions) 49.59 49.59 53.84 53.84 65.18 65.18 70.84 70.84 76.51 76.51 82.18Book Value Equity (Millions) 1,913.67 2,094.85 2,329.28 2,677.71 2,987.72 3,344.60 3,759.58 4,196.49 4,692.76 5,242.02 5,848.93

Annual Normal Income (Becnhmark) 353.455 386.920 430.218 494.574 551.831 617.748 694.394 775.091 866.752 968.200Annual Residual Income -122.68 -102.90 -27.95 -130.73 -129.77 -137.59 -186.64 -207.98 -240.98 -284.77 -262.36PV Factor 0.844 0.712 0.601 0.508 0.429 0.362 0.305 0.258 0.218 0.184YBY PV RI -103.55 -73.32 -16.81 -66.37 -55.61 -49.77 -56.98 -53.60 -52.42 -52.29Percent Change in RI -0.1612 -0.7284 3.6781 -0.0074 0.0603 0.3565 0.1143 0.1587 0.1817Average percentage change in RI 0.4058

% Value % Backdoor KeBook Value Equity (Millions) 1,913.67 155% 81.90% 20.43$ 27.63$ -541.287Total PV of YBY RI -580.71 -47% 15.85%Terminal Value Perpetuity -99.3902 -8% 2.25%MVE 12/31/08 1,233.57 100% 100.00%Divide by Shares 39.591Model Price on 12/31/08 31.16Time Consistent Model Price 32.51$ Growth > -0.1 -0.2 -0.3 -0.4 -0.5Observed Share Price (4/1/2009) 24.03$ 0.1014 74.02$ 71.75$ 70.61$ 69.92$ 69.46$ Initial Cost of Equity 0.1847 0.1167 61.93$ 61.10$ 60.67$ 60.40$ 60.22$ Perpetuity Growth Rate (g) -0.3 0.1457 45.13$ 45.71$ 46.03$ 46.24$ 46.38$

0.1612 38.51$ 39.44$ 39.96$ 40.30$ 40.54$ 0.1847 30.67$ 31.83$ 32.51$ 32.95$ 33.27$ 0.2236 21.70$ 22.86$ 23.57$ 24.06$ 24.41$ 0.2600 18.95$ 20.05$ 20.74$ 21.22$ 21.56$

Residual Income - Restated

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Backdoor KeLower Ke

Restated Backdoor KeKe

Upper Ke

15% analyst between

Less than $20.43Greater than $27.63

PV10 RI Perp.

Residual Income - Restated

 

Page | 203   

All Items in Millions of DollarsWACC(AT) 0.0651 Kd 0.042 Ke 0.158

0 1 2 3 4 5 6 7 8 9 102008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income (Millions) 181.05 227.15 331.95 293.29 342.57 391.34 411.82 460.84 508.71 555.11 575.50Total Dividends (Millions) 49.59 49.59 53.84 53.84 65.18 65.18 70.84 70.84 76.51 76.51 82.18Dividends Reinvested at 18.07% (Drip) 9.16 9.16 9.94 9.94 12.04 12.04 13.08 13.08 14.13Cum-Dividend Earnings 236.31 341.11 303.24 352.52 403.38 423.85 473.93 521.79 569.24Normal Earnings (Benchmark) 214.49 269.11 393.26 347.46 405.85 463.62 487.88 545.96 602.66Abnormal Earning Growth (AEG) 21.83 72.00 -90.03 5.05 -2.47 -39.76 -13.95 -24.17 -33.42 -30.00

PV Factor 0.844 0.712 0.601 0.508 0.429 0.362 0.305 0.258 0.218PV of AEG 18.42 51.30 -54.14 2.57 -1.06 -14.38 -4.26 -6.23 -7.27Residual Income Check Figure 21.83 72.00 -90.03 5.05 -2.47 -39.76 -13.95 -24.17 -33.42

Market Value (added/destroyed) 99.75 277.75 (293.14) 13.89 (5.73) (77.87) (23.06) (33.72) (39.36)49.2% -163.0% 94.1% -8.5% -38.3% 24.8% -11.2% -10.3%-81.50

Core Net Income 181.05Total PV of AEG -15.05 15% analyst between -61.8845PV of Terminal Value -13.4619 20.43$ 27.63$ Total Average Net Income Perp (t+1) 152.53 Less than $20.43Divide by Shares to Get Average EPS Perp 3.85$ Greater than $27.63Intrinsic Value Per Share 20.86$ Time Consistent Implied Price 21.76$ Observed Share Price (4/1/2009) 24.03$ Ke 0.1847 Growth > -0.1 -0.2 -0.3 -0.4 -0.5g -0.3 0.1014 69.48$ 69.05$ 68.84$ 68.71$ 68.63$

0.1167 53.60$ 53.05$ 53.28$ 53.42$ 53.52$ 0.1457 33.43$ 34.37$ 34.89$ 35.22$ 35.45$ 0.1612 27.10$ 28.05$ 28.59$ 28.93$ 29.18$ 0.1847 20.41$ 21.26$ 21.76$ 22.09$ 22.32$ 0.2236 13.77$ 14.39$ 14.78$ 15.04$ 15.23$ 0.2600 11.94$ 12.48$ 12.81$ 13.05$ 13.22$

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Lower KeRestated Backdoor Ke

KeUpper Ke

AEG Valuation - RAW

Backdoor Ke

% Change in AEG

Abnormal Earnings Growth - RAW

At a 15% Analyst Position

 

Page | 204   

All Items in Millions of DollarsWACC(AT 0.0651 Kd 0.042 Ke 0.158

0 1 2 3 4 5 6 7 8 9 102008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income (Millions) 230.78 284.02 402.27 363.84 422.07 480.16 507.75 567.11 625.77 683.43 725.50Total Dividends (Millions) 49.59 49.59 53.84 53.84 65.18 65.18 70.84 70.84 76.51 76.51 82.18Dividends Reinvested at 18.07% (Drip) 9.16 9.16 9.94 9.94 12.04 12.04 13.08 13.08 14.13Cum-Dividend Earnings 293.18 411.43 373.79 432.01 492.19 519.79 580.19 638.85 697.56Normal Earnings (Benchmark) 273.40 336.47 476.57 431.04 500.02 568.84 601.53 671.86 741.35Abnormal Earning Growth (AEG) 19.78 74.96 -102.79 0.97 -7.83 -49.05 -21.34 -33.00 -43.79 -38.63

PV Factor 0.844 0.712 0.601 0.508 0.429 0.362 0.305 0.258 0.218PV of AEG 16.69 53.41 -61.82 0.49 -3.35 -17.74 -6.51 -8.50 -9.53Residual Income Check Figure 19.78 74.96 -102.79 0.97 -7.83 -49.05 -21.34 -33.00 -43.79 22.41

Market Value (added/destroyed) 90.38 289.15 (334.69) 2.66 (18.16) (96.06) (35.27) (46.05) (51.58)54.2% -178.7% 102.8% -9.8% -42.2% 26.7% -12.7% -11.8%

Core Net Income 230.78 -199.61Total PV of AEG -36.87PV of Terminal Value -17.3361 -79.6944Total Average Net Income Perp (t+1) 176.57 20.43$ 27.63$ Divide by Shares to Get Average EPS Perp 4.46$ Intrinsic Value Per Share 24.15$ Time Consistent Implied Price 25.19$ Observed Share Price (4/1/2009) 24.03$ Ke 0.1847g -0.3 Growth > -0.1 -0.2 -0.3 -0.4 -0.5

0.1014 82.89$ 82.57$ 82.41$ 82.32$ 82.25$ 0.1167 62.34$ 63.05$ 63.42$ 63.65$ 63.80$ 0.1457 39.12$ 40.37$ 41.06$ 41.50$ 41.80$ 0.1612 31.48$ 32.72$ 33.43$ 33.88$ 34.20$ 0.1847 23.45$ 24.55$ 25.19$ 25.61$ 25.91$ 0.2236 15.54$ 16.33$ 16.82$ 17.15$ 17.39$ 0.2600 13.38$ 14.05$ 14.48$ 14.77$ 14.99$

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Lower KeRestated Backdoor Ke

KeUpper Ke

AEG Valuation - Restated

Backdoor Ke

Abnormal Earnings Growth - Restated

15% analyst between

Less than $20.43Greater than $27.63

 

Page | 205   

Numbers In Millions 0.1847 Ke 0.1167 KeROE ROE‐Ke ROE ROE‐Ke

%change in spread %change in spreadROE 0.1295 1 0.105085 ‐0.0796155 1 0.105085 ‐0.01162Ke 0.1847 2 0.122499 ‐0.0622006 ‐0.218738 2 0.122499 0.005799 ‐1.49929G 0.0440 3 0.163370 ‐0.0213295 ‐0.657085 3 0.163370 0.04667 7.047425

BVE 1,722.87           4 0.126966 ‐0.0577339 1.7067588 4 0.126966 0.010266 ‐0.780035 0.134371 ‐0.0503293 ‐0.128254 5 0.134371 0.017671 0.7212666 0.138436 ‐0.0462637 ‐0.080779 6 0.138436 0.021736 0.230072

MVE 1,046.95           7 0.130611 ‐0.0540893 0.1691516 7 0.130611 0.013911 ‐0.36002Divide by shares 39.59                 8 0.131896 ‐0.052804 ‐0.023763 8 0.131896 0.015196 0.092398Model Price at 12/31/08 26.44$               9 0.130975 ‐0.0537246 0.0174348 9 0.130975 0.014275 ‐0.06058Time Consistent Price 27.59$               10 0.128611 ‐0.0560885 0.0440004 10 0.128611 0.011911 ‐0.16559Observed Share Price 24.03$               Converge 0.129500 Converge 0.129500

0.044 ‐0.16559

ROE ROE‐Ke ROE ROE‐Ke ROE ROE‐Ke%change in spread %change in spread %change i

1 0.105085 ‐0.040615461 1 0.105085 ‐0.056115 1 0.105085 ‐0.118522 0.122499 ‐0.02320057 ‐0.42877491 2 0.122499 ‐0.038701 ‐0.31034033 2 0.122499 ‐0.1011 ‐0.146943 0.163370 0.017670476 ‐1.761639729 3 0.163370 0.0021705 ‐1.05608383 3 0.163370 ‐0.06023 ‐0.404264 0.126966 ‐0.018733876 ‐2.060179481 4 0.126966 ‐0.034234 ‐16.7725195 4 0.126966 ‐0.09663 0.6044275 0.134371 ‐0.011329268 ‐0.395252324 5 0.134371 ‐0.026829 ‐0.21629476 5 0.134371 ‐0.08923 ‐0.076636 0.138436 ‐0.007263736 ‐0.358852165 6 0.138436 ‐0.022764 ‐0.15153348 6 0.138436 ‐0.08516 ‐0.045567 0.130611 ‐0.015089319 1.077349661 7 0.130611 ‐0.030589 0.34377412 7 0.130611 ‐0.09299 0.0918898 0.131896 ‐0.013803996 ‐0.085180973 8 0.131896 ‐0.029304 ‐0.04201868 8 0.131896 ‐0.0917 ‐0.013829 0.130975 ‐0.014724625 0.066692913 9 0.130975 ‐0.030225 0.03141649 9 0.130975 ‐0.09262 0.01003910 0.128611 ‐0.017088529 0.160540911 10 0.128611 ‐0.032589 0.07821122 10 0.128611 ‐0.09499 0.025521

Converge 0.129500 Converge 0.129500 Converge 0.1295000.160541 0.078211 0.025521

0.1612 Ke 0.2236 Ke0.1457 Ke

Long‐ Run Residual RAW

 

Page | 206   

Growth> -0.1656 0.0255 0.0440 0.0782 0.16050.1167 46.75$ 51.00$ 52.60$ 59.60$ 31.66$ 0.1457 42.67$ 38.95$ 37.84$ 34.21$ 94.29$ 0.1612 40.78$ 34.61$ 32.95$ 27.92$ N/A0.1847 38.24$ 29.65$ 27.59$ 21.87$ N/A0.2236 34.70$ 24.02$ 21.78$ 16.15$ N/A

ROE> 0.1051 0.1152 0.1295 0.1447 0.16340.1167 37.59$ 43.80$ 52.60$ 61.95$ 73.46$ 0.1457 27.04$ 31.51$ 37.84$ 44.57$ 52.85$ 0.1612 23.55$ 27.44$ 32.95$ 38.81$ 46.01$ 0.1847 19.71$ 22.97$ 27.59$ 32.49$ 38.52$ 0.2236 15.57$ 18.14$ 21.78$ 25.66$ 30.42$

Growth> -0.1656 0.0255 0.0440 0.0782 0.16050.1051 35.08$ 22.70$ 19.71$ 11.47$ N/A0.1172 36.65$ 26.15$ 23.62$ 16.62$ N/A0.1295 38.24$ 29.65$ 27.59$ 21.87$ N/A0.1447 40.21$ 33.99$ 32.49$ 28.34$ N/A0.1634 42.63$ 39.32$ 38.52$ 36.31$ 5.44$

ROE Constant at .1295

Lower KeRestated Backdoor Ke

Backdoor Ke

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Growth Constant at .0440

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Upper Ke

Backdoor KeLower Ke

Restated Backdoor Ke

Long Run Residual RAW

Ke Constant at .1847

Return on Equity

At a 15% Analyst Position

Upper Ke

Ke

Ke

 

Page | 207   

Numbers In Millions 0.1847 Ke 0.1167 KeROE ROE‐Ke ROE ROE‐Ke

%change in spread %change in spreadROE 0.1315 1 0.120593 ‐0.060107 1 0.120593 0.003893Ke 0.1847 2 0.135578 ‐0.045122 ‐0.249313 2 0.135578 0.018878 3.849443G 0.0628 3 0.172703 ‐0.007997 ‐0.822759 3 0.172703 0.056003 1.966496

BVE 1,722.87        4 0.135878 ‐0.044822 4.6045803 4 0.135878 0.019178 ‐0.657565 0.141267 ‐0.039433 ‐0.120237 5 0.141267 0.024567 0.2810166 0.143561 ‐0.037139 ‐0.058177 6 0.143561 0.026861 0.09338

MVE 970.97           7 0.135055 ‐0.045645 0.2290417 7 0.135055 0.018355 ‐0.31668Divide by shares 39.59              8 0.135139 ‐0.045561 ‐0.00185 8 0.135139 0.018439 0.0046Model Price at 12/31/08 24.53$           9 0.133348 ‐0.047352 0.0393139 9 0.133348 0.016648 ‐0.09714Time Consistent Price 25.59$           10 0.130375 ‐0.050325 0.0627901 10 0.130375 0.013675 ‐0.17859Observed Share Price 24.03$           Converge 0.131500 0.06279 Converge 0.131500 ‐0.17859

ROE ROE‐Ke ROE ROE‐Ke ROE ROE‐Ke%change in spread %change in spread %change in spread

1 0.120593 ‐0.025107108 1 0.120593 ‐0.040607 1 0.120593 ‐0.103012 0.135578 ‐0.010121643 ‐0.596861469 2 0.135578 ‐0.025622 ‐0.3690355 2 0.135578 ‐0.08802 ‐0.145483 0.172703 0.027002575 ‐3.667805662 3 0.172703 0.0115026 ‐1.4489398 3 0.172703 ‐0.0509 ‐0.421764 0.135878 ‐0.009822209 ‐1.363750811 4 0.135878 ‐0.025322 ‐3.2014382 4 0.135878 ‐0.08772 0.723515 0.141267 ‐0.004432939 ‐0.548682069 5 0.141267 ‐0.019933 ‐0.2128278 5 0.141267 ‐0.08233 ‐0.061446 0.143561 ‐0.002138866 ‐0.517506131 6 0.143561 ‐0.017639 ‐0.1150896 6 0.143561 ‐0.08004 ‐0.027867 0.135055 ‐0.010645215 3.977037084 7 0.135055 ‐0.026145 0.48225032 7 0.135055 ‐0.08855 0.1062788 0.135139 ‐0.010560775 ‐0.007932145 8 0.135139 ‐0.026061 ‐0.0032296 8 0.135139 ‐0.08846 ‐0.000959 0.133348 ‐0.012351949 0.169606274 9 0.133348 ‐0.027852 0.06873064 9 0.133348 ‐0.09025 0.02024810 0.130375 ‐0.015325184 0.240709819 10 0.130375 ‐0.030825 0.10675143 10 0.130375 ‐0.09323 0.032944

Converge 0.131500 0.24071 Converge 0.131500 0.106751 Converge 0.131500 0.032944

0.2236 Ke0.1457 Ke 0.1612 Ke

Long Run Residual Restated

 

Page | 208   

Growth> -0.1786 0.0329 0.0628 0.1068 0.24070.1167 46.67$ 51.56$ 55.35$ 102.56$ 40.11$ 0.1457 42.77$ 38.55$ 36.22$ 26.27$ 52.69$ 0.1612 40.95$ 34.01$ 30.62$ 18.85$ 63.18$ 0.1847 38.50$ 28.89$ 25.59$ 13.23$ 90.14$ 0.2236 35.05$ 23.18$ 18.98$ 8.89$ 297.58$

ROE> 0.1050 0.1206 0.1315 0.1510 0.17270.1167 35.02$ 47.96$ 57.01$ 73.19$ 91.20$ 0.1457 22.91$ 31.39$ 37.30$ 47.89$ 59.68$ 0.1612 19.37$ 26.53$ 31.53$ 40.48$ 50.44$ 0.1847 15.71$ 21.52$ 25.59$ 32.84$ 40.92$ 0.2236 12.01$ 16.45$ 19.55$ 25.10$ 31.28$

Growth> -0.1786 0.0329 0.0628 0.1068 0.24070.1050 35.43$ 21.56$ 15.71$ N/A 110.00$ 0.1206 37.38$ 26.22$ 21.52$ 8.04$ 97.35$ 0.1315 38.75$ 29.48$ 25.59$ 14.39$ 88.52$ 0.1510 41.18$ 35.32$ 32.84$ 25.76$ 72.71$ 0.1727 43.89$ 41.80$ 40.92$ 38.40$ 55.12$

Lower Ke

Restated - ROE Constant at .1315

Backdoor Ke

Long Run Residual Restated

Upper Ke

Restated Backdoor KeKe

Upper KeAt a 15% Analyst Position

Overvalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Restated - Growth Constant at .0628

Backdoor KeLower Ke

Restated Backdoor KeKe

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

At a 15% Analyst PositionOvervalued < $20.43 $20.43 < Fairly Valued > $27.63 Undervalued > $27.63

Restated - Ke Constant at .1847

Return on Equity

 

Page | 209   

0 1 2 3 4 5 6 7 8 9 10 11

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Income 431.55$ 483.95$ 574.35$ 595.01$ 644.72$ 738.62$ 802.94$ 887.24$ 976.88$ 1,072.28$

Total Dividends 49.59$ 49.59$ 53.84$ 53.84$ 65.18$ 65.18$ 70.84$ 70.84$ 76.51$ 76.51$ 82.18$

BV Equity 1,722.87$ 2,104.83$ 2,539.19$ 3,059.70$ 3,600.87$ 4,180.41$ 4,853.85$ 5,585.95$ 6,402.35$ 7,302.72$ 8,298.49$

ROE 0.2505 0.2299 0.2262 0.1945 0.1790 0.1767 0.1654 0.1588 0.1526 0.1468

ROE - K 0.2236 0.0269 0.0063 0.0026 -0.0291 -0.0446 -0.0469 -0.0582 -0.0648 -0.0710 -0.0768

Restated

Net Income 230.78$ 284.02$ 402.27$ 363.84$ 422.07$ 480.16$ 507.75$ 567.11$ 625.77$ 683.43$

BV Equity 1,913.67$ 2,094.86$ 2,329.28$ 2,677.72$ 2,987.72$ 3,344.60$ 3,759.58$ 4,196.49$ 4,692.76$ 5,242.02$ 5,848.93$

ROE 0.1206 0.1356 0.1727 0.1359 0.1413 0.1436 0.1351 0.1351 0.1333 0.1304

-0.1030 -0.0880 -0.0509 -0.0877 -0.0823 -0.0800 -0.0885 -0.0885 -0.0903 -0.0932

 

 

Industry Terms Glossary (Directly from OSG 10-K)

Aframax—A medium size crude oil tanker of approximately 80,000 to 120,000

deadweight tons. Because of their size, Aframaxes are able to operate on many

different routes, including from Latin America and the North Sea to the U.S. They are

also used in lightering (transferring cargo from larger tankers, typically VLCCs, to

smaller tankers for discharge in ports from which the larger tankers are restricted).

Modern Aframaxes can generally transport from 500,000 to 800,000 barrels of crude oil.

Articulated Tug Barge—ATB is the abbreviation for Articulated Tug Barge, which is a

tug-barge combination system capable of operating on the high seas, coastwise and

further inland. It combines a normal barge, with a bow resembling that of a ship, but

having a deep indent at the stern to accommodate the bow of a tug. The fit is such that

the resulting combination behaves almost like a single vessel at sea as well as while

maneuvering.

Bareboat Charter—A Charter under which a customer pays a fixed daily or monthly

rate for a fixed period of time for use of the vessel. The customer pays all costs of

operating the vessel, including voyage and vessel expenses. Bareboat charters are

usually long term.

CAP—The Condition Assessment Program of ABS Consulting, a subsidiary of the

American Bureau of Shipping, which evaluates a vessel’s operation, machinery,

maintenance and structure using the ABS Safe Hull Criteria. A CAP 1 rating indicates

that a vessel meets the standards of a newly built vessel.

Capesize Bulk Carrier—A large Dry Bulk Carrier (any vessel used to carry non-liquid

bulk commodities) with a carrying capacity of more than 80,000 deadweight tons that

mainly transports iron ore and coal.

 

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Charter—Contract entered into with a customer for the use of the vessel for a specific

voyage at a specific rate per unit of cargo (‘‘Voyage Charter’’), or for a specific period of

time at a specific rate per unit (day or month) of time (‘‘Time Charter’’).

Classification Societies—Organizations that establish and administer standards for

the design, construction and operational maintenance of vessels. As a practical matter,

vessels cannot trade unless they meet these standards.

Compressed Natural Gas or CNG—CNG is the abbreviation for compressed natural

gas. CNG is a gas that has been compressed for transportation in pressurized containers

and can be transported on ships, barges or trucks. In many parts of the world, gas

fields that cannot be readily connected by pipeline or are not large enough to support

the cost of developing LNG facilities are excellent candidates for CNG development.

Commercial Management or Commercially Managed—The management of the

employment, or chartering, of a vessel and associated functions, including seeking and

negotiating employment for vessels, billing and collecting revenues, issuing voyage

instructions, purchasing fuel, and appointing port agents.

Commercial Pool—A commercial pool is a group of similar size and quality vessels

with different shipowners that are placed under one administrator or manager. Pools

allow for scheduling and other operating efficiencies such as multilegged charters and

Contracts of Affreightment and other operating efficiencies.

Condition Assessment Scheme—An inspection program designed to check and

report on the vessel’s physical condition and on its past performance based on survey

and IMO’s International Safety Management audit reports and port state performance

records.

 

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Contract of Affreightment or COA—COA is the abbreviation for Contract of

Affreightment, which is an agreement providing for the transportation between

specified points for a specific quantity of cargo over a specific time period but without

designating specific vessels or voyage schedules, thereby allowing flexibility in

scheduling since no vessel designation is required. COAs can either have a fixed rate or

a market-related rate. One example would be two shipments of 70,000 tons per month

for the next two years at the prevailing spot rate at the time of each loading. Another

example is lightering services that are provided to the Company’s customers in the

Delaware Bay region pursuant to contracts under which it commits to provide such

services using a vessel of the Company’s choice. When choosing the vessel, the

Company takes into account vessel positioning and capacity at the time the inbound

vessel is ready to discharge its cargo.

Consecutive Voyage Charters or CVC—CVC is the abbreviation for Consecutive

Voyage Charter, which are used when a customer contracts for a particular vessel for a

certain period of time to transport cargo between specified points for a rate that is

determined based on the volume of cargo delivered. The Company bears the risk of

delays under CVC arrangements.

Crude Oil—Oil in its natural state that has not been refined or altered. Cubic Meters or

cbm—cbm is the abbreviation for cubic meters, the industry standard for measuring the

carrying capacity of a LNG Carrier.

Deadweight tons or dwt—dwt is the abbreviation for deadweight tons, representing

principally the cargo carrying capacity of a vessel, but including the weight of

consumables such as fuel, lube oil, drinking water and stores.

Demurrage—Additional revenue paid to the shipowner on its Voyage Charters for

delays experienced in loading and/or unloading cargo that are not deemed to be the

responsibility of the shipowner, calculated in accordance with specific Charter terms.

 

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Double Hull—Hull construction design in which a vessel has an inner and an outer side

and bottom separated by void space, usually two meters in width.

Drydocking—An out-of-service period during which planned repairs and maintenance

are carried out, including all underwater maintenance such as external hull painting.

During the drydocking, certain mandatory Classification Society inspections are carried

out and relevant certifications issued. Normally, as the age of a vessel increases, the

cost of drydocking increases.

Handysize Product Carrier—A small size Product Carrier of approximately 29,000 to

53,000 deadweight tons. This type of vessel generally operates on shorter routes (short

haul). Also, may be referred to as an MR Product Carrier.

IMO—IMO is the abbreviation for International Maritime Organization, an agency of the

United Nations, which is the body that is responsible for the administration of

internationally developed maritime safety and pollution treaties, including MARPOL.

International Flag vessel—A vessel that is registered under a flag other than that of

the U.S.

Jones Act—U.S. law that applies to port-to-port shipments within the continental U.S.

and between the continental U.S. and Hawaii, Alaska, Puerto Rico, and Guam, and

restricts such shipments to U.S. Flag Vessels that are built in the U.S. and that are

owned by a U.S. company that is more than 75% owned and controlled by U.S.

citizens.

Lightering—The process of off-loading crude oil or petroleum products from deeply

laden inbound tankers into smaller tankers and/or barges.

 

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LNG Carrier—A vessel designed to carry liquefied natural gas, that is, natural gas

cooled to _163_ centigrade, turning it into a liquid and reducing its volume to 1/600 of

its volume in gaseous form. LNG is the abbreviation for liquefied natural gas.

MARPOL—International Convention for the Prevention of Pollution from Ships, 1973,

as modified by the Protocol of 1978 relating thereto. This convention includes

regulations aimed at preventing and minimizing pollution from ships by accident and by

routine operations.

OPA 90—OPA 90 is the abbreviation for the U.S. Oil Pollution Act of 1990.

Panamax—A medium size vessel of approximately 53,000 to 80,000 deadweight tons.

A coated Panamax operating in the refined petroleum products trades may be referred

to as an LR1.

Product Carrier—General term that applies to any tanker that is used to transport

refined oil products, such as gasoline, jet fuel or heating oil.

Pure Car Carrier—A single-purpose vessel with many decks, designed to carry

automobiles, which are driven on and off using ramps.

Scrapping—The disposal of vessels by demolition for scrap metal.

Special Survey—An extensive inspection of a vessel by classification society surveyors

that must be completed within five years. Special Surveys require a vessel to be

drydocked.

Suezmax—A large crude oil tanker of approximately 120,000 to 200,000 deadweight

tons. Modern Suezmaxes can generally transport about one million barrels of crude oil.

 

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Technical Management—The management of the operation of a vessel, including

physically maintaining the vessel, maintaining necessary certifications, and supplying

necessary stores, spares, and lubricating oils. Responsibilities also generally include

selecting, engaging and training crew, and arranging necessary insurance coverage.

Time Charter—A Charter under which a customer pays a fixed daily or monthly rate

for a fixed period of time for use of the vessel. Subject to any restrictions in the

Charter, the customer decides the type and quantity of cargo to be carried and the

ports of loading and unloading. The customer pays all voyage expenses such as fuel,

canal tolls, and port charges. The shipowner pays all vessel expenses such as the

Technical Management expenses.

Time Charter Equivalent or TCE—TCE is the abbreviation for Time Charter

Equivalent. TCE revenues, which is voyage revenues less voyage expenses, serves as

an industry standard for measuring and managing fleet revenue and comparing results

between geographical regions and among competitors.

U.S. Flag vessel—A U.S. Flag vessel must be crewed by U.S. sailors, and owned and

operated by a U.S. company.

Vessel Expenses—Includes crew costs, vessel stores and supplies, lubricating oils,

maintenance and repairs, insurance and communication costs associated with the

operations of vessels.

VLCC—VLCC is the abbreviation for Very Large Crude Carrier, a large crude oil tanker

of approximately 200,000 to 320,000 deadweight tons. Modern VLCCs can generally

transport two million barrels or more of crude oil. These vessels are mainly used on the

longest (long haul) routes from the Arabian Gulf to North America, Europe, and Asia,

and from West Africa to the U.S. and Far Eastern destinations.

 

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Voyage Charter—A Charter under which a customer pays a transportation charge for

the movement of a specific cargo between two or more specified ports. The shipowner

pays all voyage expenses, and all vessel expenses, unless the vessel to which the

Charter relates has been time chartered in. The customer is liable for Demurrage, if

incurred.

Voyage Expenses—Includes fuel, port charges, canal tolls, cargo handling operations

and brokerage commissions paid by the Company under Voyage Charters. These

expenses are subtracted from shipping revenues to calculate Time Charter Equivalent

Revenues for Voyage Charters.

V-Plus—A large crude oil tanker of more than 350,000 deadweight tons. Modern V-

Pluses can transport three million barrels of crude oil and are mainly used on the same

long haul routes as VLCCs.

Worldscale—Industry name for the Worldwide Tanker Nominal Freight Scale published

annually by the Worldscale Association as a rate reference for shipping companies,

brokers, and their customers engaged in the bulk shipping of oil in the international

markets. Worldscale is a list of calculated rates for specific voyage itineraries for a

standard vessel, as defined, using defined voyage cost assumptions such as vessel

speed, fuel consumption and port costs. Actual market rates for voyage charters are

usually quoted in terms of a percentage of Worldscale.

 

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Sources Cited

1. Wall Street Journal – Marketplace. January 26, 2009. Page B1

2. Wall Street Journal. Crude Slides 9.1% to $45. Brian Baskin. January 28, 2009.

http://online.wsj.com/article/SB123305551487219113.html 

3. Wall Street Journal. Oil Tankers Will Slide on Fears OPEC’s Cuts Will Slow 2009

Demand. David Benoit. December 22, 2008. http://online.wsj.com/article/BT-CO-

20081222-707359.html

4. Wall Street Journal. Pension Deficit Disorder. John Jannarone. February 12,

2009. http://online.wsj.com/article/SB123438982726574581.html

5. Wall Street Journal. Oil Prices: Have They Bottomed Out? A Hint on the Seas.

Keith Johnson. January 28, 2009.

http://blogs.wsj.com/environmentalcapital/2009/01/28/oil-prices-have-they-

bottomed-out-a-hint-on-the-seas/

6. Wall Street Journal. Oil Price Falls 9.1% as inventories are expected to rise. Brian

Baskin. January 28, 2009.

http://online.wsj.com/article/SB123309785807621723.html

7. Wall Street Journal. Oil Traders Do a Little Contango. Liam Denning. January 9,

2009. http://online.wsj.com/article/SB123143754965364993.html

8. Wikinvest Website – Overseas Shipholding Group Page.

http://www.wikinvest.com/stock/Overseas_Shipholding_Group_(OSG)

9. Business Analysis & Valuation 4e. 2008. Palepu & Healy. Thompson South-

Western. Mason, OH.

10. Houston Chronicle - “World's tanker fleet is 'close to 100 percent utilization.”

11. All Business Website. www.allbusiness.com

12. Investopedia Website. www.investopedia.com

13. Wikipedia Website. www.wikipedia.com

14. OSG’s website. www.osg.com

15. Teekay’s website. www.teekay.com

 

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16. Tsakos’ website. www.tnn.gr

17. Frontline’s website. www.frontline.bm

18. OSG 10-K, annual report as of 2007, 2004, 2002

19. Teekay’s 10-K, annual report as of 2007, 2004, 2002

20. Tsakos’ 10-K, annual report as of 2007, 2004, 2002