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Thursday, February 4, 2010

Seaspan: Opportunity to Buy at 3-4x 2012E Distributable Cash Flow (as many investors shun the sector)

We again mentioned Seaspan in our post last Sunday and continue our discussion here. While Seaspan's stock recently began to push higher (not today as fear pressures the overall market), share prices of most shipping companies remain in the doldrums. Shipping is one of the few sectors yet to recover because of lingering economic concerns and a glut of new ships entering operation that were ordered during the easy money boom times. For more on this, please see scary NYTs article from 1/16/10: "New Ships Idle, Waiting for Cargo to Fill Them". A few points from the article:
  • "Most analysts say that container traffic will probably not recover to prerecession levels until 2012 or later. Drewry Shipping expects a 2.4 percent increase in global trade volume this year, after an estimated 10.3 percent decline last year.
  • “On the demand side, we do see some strength; we see continued strength in China,” said Vikrant S. Bhatia, chief executive of KC Maritime, a bulk-carrier shipping line based in Hong Kong. “The problem we see is really on the supply side.”
  • Until 2008, the liners were cresting; shipyards were humming, building ever larger ships as ports expanded and new services opened, underpinned by low-cost finance."
Nonetheless, the industry is working to reduce excess supply and, with the possible exception of a double dip recession (anything could happen, but we're not in this camp), we're fairly confident the world will need more ships in five years' time. For all of the negative articles regarding the sector, there are sometimes more positive takes, such as this 1/28/10 Bloomberg article: "Cheapest Route to Walmart From China May Skip Buffett’s Railway", which opens with the following points:
  • "Chinese toys and sneakers headed to Wal-Mart Stores Inc. and Target Corp. on the U.S. East Coast may bypass Warren Buffett’s $33.8 billion railway as the expansion of the Panama Canal slashes the cost of shipping them by sea.
  • The deeper, wider canal will allow A.P. Moeller-Maersk A/S, China Ocean Shipping Group Co. and other lines to ship more cargo directly to New York and Boston instead of unloading it on the West Coast for trains and trucks to finish the journey east. That could save exporters 30 percent, the canal operator said.
  • The $5.25 billion Panama Canal project, scheduled for completion during its centennial in 2014, may take business from ports including Los Angeles and Seattle, and railroads including Berkshire Hathaway Inc.’s Burlington Northern Santa Fe Corp. It costs as much as $1,000 more per cargo container to use trains than ships, said Lee Sokje, a shipbuilding analyst at Mirae Asset Securities Co. in Seoul."
Our bet is that shipping market will slowly recover over the next several years and the Market will realize that certain shipping companies such as Seaspan are inherently a stable operating businesses that can operate with a decent amount of leverage (although probably not with loan-to-value ratios of 80-90%, particularly when -- like real estate -- values are declining/down from peak levels).

We included our summary thesis for Seaspan in our "Which Way from Here?" presentation the other week. Seaspan is somewhat akin to a floating REIT with long-term charters to "liner majors" and a stable business model designed to distribute excess cash flow to shareholders in the form of quarterly cash dividends. The one caveat with the REIT comparison is that individual container ships have no terminal value at the end of their thirty year average lives. However, a well-run shipping company with a diverse portfolio of ships and customers having staggered lease expirations can certainly have a terminal value.

Seaspan's business model (from June investor presentation - link here):

Snapshot from the same presentation that shows contracted revenue and cash flow growth:
The growth is expected to occur despite ongoing economic weakness and excess industry capacity, although we can't fully ignore these risks. Market circumstances may impact ship values, debt covenants, and financing needs. Seaspan still needs to raise an additional $180 million to fund remaining "newbuilds", which implies incremental dilution (assuming equity offering at $10 per share = 18 million additional shares). We're including additional dilution in our estimated 3-4x purchase multiple.

In addition, operating risks are present. As an example, Seaspan reported the following in early January:
  • "on December 31, 2009 the CSCL Hamburg, a 4,250 TEU container vessel went aground in the Gulf of Aqaba en route to Singapore. Preliminary reports indicated that there were no personnel injuries or oil pollution as a result of the incident. The Company is coordinating with Egyptian authorities and other parties to inspect and refloat the vessel. Off-hire and repair costs are currently being assessed. Any repair costs are expected to be covered by insurance."
This could be a whole another post, but we share because it's interesting. Wikipedia describes the Gulf of Aqaba as follows:
  • The Gulf of Aqaba, like the coastal waters of the Red Sea, is one of the world's premier sites for diving. The area is especially rich in coral and other marine biodiversity and contains a number of underwater wrecks, some accidental shipwrecks, others vessels deliberately sunk in an effort to provide a habitat for marine organisms and bolster the local dive tourism industry.
As a result, a diving magazine and many others picked up on the story, with reporting here and a video below:




The good news: as of the last week of January, the CSCL Hamburg was moving again and is now out of the Red Sea sailing off the coast of Oman at approximately 10 nm/hour. We know this thanks to Seaspan's GPS tracking on the company's Web site:

Like all companies, Seaspan is not without risk. However, at the current price, we see the risk/reward profile as attractive given the company's inherently stable business model and anticipated growth of distributable cash flow. As the company's "built-in" growth continues, we expect to win two ways: (1) multiple expansion (i.e. 3-4x 2012E cash flow could be more like 8-10x, in our view) and (2) dividend increases (i.e. $0.40 reverts back toward Seaspan's initial $1.90 dividend, with potential for more depending upon capital needs). All the while, we anticipate collecting the current 4% dividend. Finally, we should add that Seaspan's founders own a large piece of the company and provided additional capital in 2009. We sleep well knowing they're truly behind the company with a owner's mentality.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SSW.

© 2010 Jeffrey Walkenhorst
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5 comments:

  1. Hi Jeff,

    What do you think of Ship Finance International(SFL) comparing to Seaspan?

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  2. Hello, thank you for the question. I am not very familiar with SFL as I've been more focused on pure-play container shipping companies. SFL has a diverse portfolio of ships, but is primarily an oil tanker company (albeit with a Seaspan-like average lease duration of ~10 years across its portfolio, which is good). SFL carries a lot of leverage, but like SSW appears to operate a fairly stable business. That said, I think the company's growth profile is less favorable and shares appear more expensive on a cash flow basis. Finally, SFL's fleet also looks older (although I'm uncertain of average age after a quick glance), with many vessels built in the 1990s. It's good news (for the company and broader shipping market) that they're able to sell "single-hull" vessels in the current market environment at/above book value.

    What do you think?

    JW

    ReplyDelete
  3. Hi Jeff:

    The one giant flaw that you are assuming is any type of dividend raise. This company has 2.18 billion, yes billion in debt. The new world is deleveraging and SSW is no different. You may see a dividend increase in about 10 yrs. Their model broke when the stock crashed and took down their source of currency for the new vessels.

    ReplyDelete
  4. Hello, two part response as it wouldn't fit - PART ONE:

    I agree that much of the world is deleveraging and needs to delever thanks to the easy money years. Indeed, I generally favor companies with limited debt that generate gobs of cash - please see my prior posts on JCOM, EBAY, PETS, and AOB. However, I see Seaspan as a special opportunity.

    In this case, I'm betting that the model IS NOT broken: previously contracted (and NOW arguably overpriced) ships will be delivered to liner companies per previous charter terms (NOW arguably overpriced) AND Seaspan will continue to borrow incremental capital to complete and deliver newbuilds under previously contracted credit facilities. Based on progress over the past year on delivering ships per original terms, this bet appears reasonable. I'm also betting that the ship supply/demand situation will right itself over the next 3-5 years and that global economic growth will continue with more container ships necessary in five years' time. Based on historic trade development across regions, the latter bet does not seem that aggressive. Finally, I'm also betting that liner companies will continue to outsource more ships and that Seaspan will capture more than it's fair share of this business. Based on outsourcing trends across industries over time, this bet also does not seem unreasonable.

    I misspoke in my post about the potential equity raise -- midpoint of range is $210 million per last quarter's press release:

    "As of September 30, 2009, the estimated remaining installments of the 27 vessels that we have contracted to purchase but have not yet been delivered amounted to approximately $1.8 billion. Seaspan has secured long term credit facilities to fund the newbuild vessels and does not have any credit facilities maturing until 2015. To fund the remaining portion of the price of the vessels the Company has contracted to purchase, we intend to raise in the range of approximately $180 million to $240 million in common or other equity and or other forms of capital starting in approximately the fourth quarter of 2010 or first quarter of 2011 and ending in approximately second quarter 2012. The current state of the global financial markets and current economic conditions may adversely impact our ability to issue additional equity at prices which will not be dilutive to our existing shareholders or preclude us from issuing equity at all. We continue to actively pursue alternatives which will allow us to defer or eliminate some or all of our current equity needs."

    ReplyDelete
  5. PART TWO:

    One other capital requirement I should mention is that SSW will need to pay accrued dividends on newly issued preferred shares (currently noncash) until these shares are converted into common (possible at or above $15 per share per my understanding).

    There are a number of potential scenarios that could unfold and it's impossible to know what will happen exactly -- maybe favorable economic/shipping trends continue and SSW moves higher yet, with an equity raise possible at $15-20. OR, maybe some equity is issued at $10 and, like REITs in 2009, the Market reacts favorably, enabling a later raise at a higher price. OR, maybe the Washington family agrees to purchase additional preferred shares.

    Regarding a potential dividend raise, nothing is certain. I'm not assuming, I'm only suggesting an increase should be a possibility if my above mentioned bets pan out and Seaspan's financial results scale as anticipated. On the other hand, perhaps the current $0.40 dividend is further reduced to cover newbuild requirements if equity can't be raised at appropriate levels -- over the past year across sectors, no dividend is sacred for asset heavy businesses that need incremental funding. Horzon Lines (HRZ) recently announced a dividend reduction (1/29/10) and the Market did not like the decision, although the move may be better for long-term shareholders over time.

    However, I come back to the anticipated growth already "built-in" to Seaspan's model. If I don't "win" from a dividend increase, I could "win" from multiple expansion as the Market sees and then appreciates growth in distributable cash flow (even if not distributed near-term). I could be wrong, yet I'm willing to wait and like the odds.

    JW

    ReplyDelete

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