JRNGF - 'Macro Drives Everything' Julian Lin And Romil Patel On ZIM Integrated

2023-06-28 07:30:00 ET

Summary

• Julian Lin and Romil Patel lay out their investment views on ZIM Integrated.
• Freight rates have plummeted and ZIM has turned from a cash flow monster to generating zero profits.
• Shipping sector and why macro drives everything.

Listen to the podcast below or on the go via Apple Podcasts or Spotify .

Romil Patel and Julian Lin lay out their investment views on ZIM Integrated ( ZIM ).

• 1:00 - Pay attention to why shareholders buy into a stock
• 7:00 - With freight rates plummeted, ZIM has turned from a cash flow monster to generating zero profits
• 23:00 - Is management aligned with shareholders?
• 32:00 - Shipping sector and why macro drives everything

This episode was recorded on June 21, 2023

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Transcript

Rena Sherbill: Julian Lin , who runs the Best of Breed Growth Stocks, the Investing Group on Seeking Alpha, and Romil Patel , who writes on Seeking Alpha, really happy you are both joining us to talk about ZIM's ( ZIM ) stock in particular and the shipping sector a little bit as well. Thanks for both joining us.

It's great to have you. Julian also runs Cannabis Growth Investors, so sometimes we talk about the cannabis sector , and we've had him on many times before talking about different sectors. So, it's amazing how many sectors that you cover.

And looking at ZIM’s stock, it's hard to find a true bull. Julian is, on record on Seeking Alpha as being a hold , and Romil is on record as being a bear, but I want to do a deep dive onto how you’re thinking about ZIM in particular. So, Romil, maybe we'll start with you and where you're thinking about the stock, how you're thinking about the stock these days?

Romil Patel: Sure. So, I mean, let me just give a real quick overview. I mean, most viewers are probably going to be familiar with what ZIM does, but real quick overview for those who aren't. It's an Israeli cargo shipping company. It's been around for many, many decades. But it just recently -- more recently IPOed in January of 2021. And the IPO was -- it went from anything, you know, even if you're really bullish on it, you would've said it was mediocre. If you were bearish, you would have said it was a terrible IPO.

In the sense that there was very little marketing of it. It was in an industry at least at the time in January 2021, that many people didn't like. It was in a niche market that many didn't like. Keep in mind, it's the same time that you're having GameStop ( GME ), going through the upside, and a lot of the hedge funds that originally were going to participate as IPO ended up pulling out. And this was in the middle of the SPAC bubble at the time. And so, it was an IPO where, you know, IPOed, but it was at a relatively low valuation and not a lot of investors at the time were interested in it.

And so, with that backdrop right there, initially, actually, by many it was seen as an undervalued IPO. And what ended up happening in 2021, 2020, or you know, 2021 going into the beginning of 2022 is that you saw rates skyrocket. And, basically, ZIM's model is to go ahead and lease out the – lease these ships, you know, at a fixed rate for a certain amount of time, and they go ahead and they, you know, go into the freight market, and they will essentially be collecting the spot rate and they're basically making the spread between the two.

And so, at the time, there was a supply shortage in 2021 and into the first half of 2022. And so ZIM was very, very profitable. And so what ZIM returned into and ZIM’s management has a policy of paying out a vast majority of its free cash flows straight to investors via dividend. And so, it's a quarterly dividend and it's variable. And so, really, what happened at the time was that you had company that went ahead and got public at a, you know, a relatively low valuation just due to the way that it went public.

And also, at the same time, you had earnings going crazy to the upside. And so, you had a very, very low PE ratio. And then combined with that, you've got a very, very high dividend yield. And your average retail investor oftentimes most screening for stocks. They just go out to a stock screener, and they'll plug in, you know, I want a PE ratio below 3x. I want a dividend yield of fill in the blank, right?

And they want a really high dividend yield and a really low PE ratio because that's what they think for the value. And so, you really like your situation where many retail investors were starting to buy into ZIM in 2021 first out of 2022. They really peaked around in about Q3 of 2022. It was around where it peaked. And it was basically because it was really just a quick yield point, right. You see a stock and it has and you don't know – you're not the wiser, right.

You don't know the risks that are involved. And all you do is, you look at it and you see it's got a triple digit yield on it, and you just go ahead and you buy it. And that's what a lot of these retail investors did. They saw low PE ratio. They saw high yield. They saw it was a deep value investment. So, they just went ahead and they bought into it. Now, of course, we're on the other side of this. Inflation has slowed down. Supply chain issues are starting to fix themselves. These rates are starting to come down. And so, now that we're on the other side of this, we've seen ZIM stock crash very, very significantly, close to 80% or so.

And this is because the very investors that got into this, because they had a low PE ratio, because the yield was high, really not understanding the risk that they were taking, thinking it was a deep value investment, not understanding that the dividend is variable and that at any time, you know, when the earnings collapse, the dividend will be cut to zero.

They don’t really understand that I don't believe. And I remember going through Seeking Alpha about a year back, and I would actually look at the articles on ZIM. And it would be strong buy, strong buy, buy-buy, strong buy, and it just seemed like everything was positive sentiment right there.

And they really weren’t -- there wasn't a long, amongst – not just Seeking Alpha contributors , but your average retail investor and even, you know, some institutional investors, on the sell side analysts, right? They really did understand the downside risk that can be possible here. And so, we really quickly turned into a value trap where the earnings started to collapse. And then eventually, most recently in the last quarter, you've had the dividend get cut to zero.

And so, there's not going to be any return at all the shareholders, and earnings will likely continue to stay negative for the next two years or so, because of how low rates have gone. And they're likely not to go higher because we're likely not to get back into the supply chain issue. And so, you've got extremely low rates, and you've got, you know, when it was first, you know, it turned into a valley trap, and then it, you know, the dividend traffic, the dividend got to zero.

And so, shareholders that are still here are left holding the bag down significantly on their investments, and they're saying they're going. Well I initially bought this because I thought it was cheap because of the low PE ratio. Now though that's gone due to the fact that the company reported negative quarterly earnings and will likely continue to. And the dividend has been cut. So, there's no direct return of capital to shareholders as we're sort of seeing there in bag holders wondering what to do.

And basically when I wrote that article, I said that you have to pay attention to why shareholders buy into a stock because that will then tell you why they will stop. And so, if, you know, shareholders are buying in, thinking that's an easy deal player they're buying in because you know, it's got a low valuation to it, but they really don't understand, you know, why it is the way it is. And then eventually, when all collapses, they're going to start selling pretty quickly. And I think that's the situation we're in with ZIM right now.

RS: I appreciate that. Julian, happy to hear your thoughts and happy to hear any kind of points that you would have directly to respond to anything that Romil said in addition.

Julian Lin: Yeah. I think that's a great summary. I think very similarly, as Romil mentioned, how ZIM was some of the risk of their business models underappreciated in terms of how they're remaining earning is spread, whereas their high dividends, high earnings might have implied greater amount of safety.

It's kind of similar to how in the tech sector, there were some fintech names that were generating very, very strong growth due to the zero interest rate environment. Some names to note might be, like, Opendoor ( OPEN ) or maybe more popular Upstart ( UPST ), right? These were names that were able to generate large profits, large growth, when interest rates were low because they could, kind of, you know, generate strong spreads by lending and they were seeing strong demand at the lower interest rate, but when the interest rates rose, they were unable to sustain any amount of demand let alone fund their platforms.

And then ZIM’s, obviously, it's not direct correlation with interest rates, but with freight rates having plummeted, they've somehow turned from becoming a cash flow monster to not – to generating zero profits. I think one data point I can mention is that, there's a definitely a deteriorating interest in ZIM stock, just noted by the articles I have posted.

The recent article I posted where I mentioned how I sold my very tiny position in the stock, has generated a lot less interest compared to just a year ago when ZIM was still paying a very large dividend. So, it does appear that probably a large number of the investors who are in ZIM Integrated for that dividend probably have already bailed on the stock.

RS: And what would you, well, first, Romil, anything that you want to say directly to that?

RP: Yeah. Yeah. So, in regards to the last point right there that was made that the investors are already starting to bail on the stock, I do agree with that, because I came out with my bearish article just about like, three weeks ago or so. And already says that we're down significantly, and oftentimes, what ends up happening with a lot of these plays is basically, you have a long period of time where just nothing happens.

It literally just chops sideways, you know, ZIM could go down to $10. They just chop sideways at $10 for quite literally the next 18 months. Oftentimes that's what happens with a lot of these plays because those who were bullish, who got into the value trap, they end up selling. For the ones that want to continue to hold, of course, like the insiders that are, of course, kind of holding their equity where those are long-term value investors, they continue to hold. And, you know, there's already a pretty high short interest, you know, 25% last I checked.

And so, you know, in my opinion, you know, I agree with that view right there. And, basically, I think at this point, it's basically just going to be, you know, stock, it's just going to, you know, trade sideways for very, very long periods of time where we could just see a chopping, you know, at around $10 or so, chopping sideways, you know, for the next 18 months or two years with very little volume and movement either way.

RS: What would you each say if you had to take a more bullish position or say that things are really going to click on all cylinders for ZIM going forward? How might that look, let's say, taking the other side of things?

JL: Yeah, I think that, I mean, obviously, as we saw during the pandemic, if freight rates were to soar again, I think ZIM is disproportionately exposed to the upside here. It definitely could see earnings. So dramatically management has shown a willingness to return cash to shareholders. So, I mean, clearly, this stock could take off if business conditions improve, but as Romil just pointed, I think perhaps an underappreciated aspect here may be the idea that this does have the potential to be a main stock.

Of course, as should emphasize, I don't have a position in ZIM Integrated , so I'm not trying to make an investment thesis based on the potential for bringing a meme stock. But, look, this is a name that has high short interest. I mean, to a retail investor that's perhaps not looking too closely, they might come with a view that this has a net cash balance sheet if you ignore the very hefty lease liabilities. And this is a name that once, you know, generate a lot of money.

So, I mean, it's not, you know, unrealistic to expect ZIM to generate some, kind of, you know, meme following similar to maybe a GameStop or ( AMC ), but again, I mean, those may not be more bullish cases, those might be just more potential risks to any bearish or short, you know, positions.

RP: Yeah. Yeah. So, I actually agree with a lot of that. And so, let me add on with some things here. So, of course, you know, freight rates go higher. That's very obviously bullish for ZIM. You know, I don't believe that's going to happen anytime soon. I don't believe, you know, drawing things that's going to happen to the point where, you know, it would be very bullish for ZIM, but you know, if for whatever reason we're wrong on that, but of course, ZIM would do well. And there is a high short interest right there, and so there could be a short covering rally.

The area where I find a lot of the initial investors that were just holding out to this pretty deal, of course they sold. Who is still holding on though? The ones that are still holding on right now tend to be a lot of these deep value investors, right? So, I've seen a lot of investors say, Oh, well, you know, I'm not concerned with the yield right now.

I'm not concerned with the PE ratio, you know, the fact that earnings have gone negative. You know, I'm not concerned with that. I'm a deep value investor. I can hold on for five years, right? You know, I can hold on for long periods of time, and I think this has a lot of value right here, because being undervalued if you look at some basic metric like price involved.

And, you know, my response to that would be, yes, you know, from just a traditional, you know, valuation method, yes, you know, from a price to book perspective, it is being undervalued. But I would say in this environment, valuation for ZIM really doesn't matter right. There's no point in buying the company below its value if it doesn't produce any cash flow. And that's basically a position ZIM is in.

If you are on top, well it doesn’t matter how well your price to book ratio is, if you’re unprofitable. And so, that's the main thing that I hear from a lot of these bulls is, well, you know, the value is really low, right? And there's a right price for everything. And this is a deep valley play right here and eventually will turn itself around. You know, whether it's two years from now, three years from now, its earnings are going to go up, and, you know, it's a deep value play right now.

The PE ratio is extremely low, and they've got enough cash on the balance sheet to weather this through. And you know what? They're probably right in the long-term, but you got to remember that you're letting go of the opportunity cost for the next, you know, two years to three years if you plan on doing that. And just also the fact that at the end of the day, I actually gave an analogy inside that article that I had written on this, in regards to the price to book ratio and why I really don't care what the PE ratio of the stock is, if it's unprofitable. And what I basically said is, if I were to gift you two things, I do give a choice between these two.

One of them is, I'll give you a $1 million worth of cash right now. It's going to be, you know, either cash or T-Bills something liquid. Okay. You have something that is a cash or cash equivalent on one side, or I’ll give you $5 million of let's say, super illiquid highly specialized equipment. The issue is, we can't find a buyer for that $5 million worth of equipment.

So, which one would you rather have? Initially, $5 million does sound better than a $1 million, but what you are taking into account is a fact that, okay, sure, you got $5 million right there on paper, but how are the shareholder actually going to be able to extract something from that, right? How are you going to be able to extract something for $5 million worth of illiquid assets? And the reality is, it doesn't matter if a company has a low P/B ratio, the shareholder doesn't get a benefit from that low P/B ratio. It just doesn't matter right?

So, I don't really care that, you know, yeah ZIM is trading at, you know, 70% discount or even higher than that at this point to book value, it just doesn't really matter because what benefit are you and the shareholder getting, right? You're not getting any dividends in your pocket. You're not getting any stock buybacks. The cash on the balance sheet is not going into your pocket.

It's not going to benefit you, you know, in the short to medium-term in any way. Yes, in the long run, it might help us in, and you know, they're going to weather through the storm, but in the short run, you know, using valuation metrics and ratios like this, like the price to book ratio to say that's undervalued, it really doesn't matter. You know, all that matters at the end of the day, especially with the stock like ZIM that hasn’t focused on return of capital to shareholders, is what is going in your pocket as a shareholder.

And the fact that it's going at, you know, a low P/B ratio, in my opinion, it just doesn't really matter right here. And so, you know, that is though the main thing that I hear from the bulls right here are these deep value investors because we look at it and say it's undervalued. And, yes, on paper it is undervalued. In reality, I don't think you should be buying company that's undervalued if it's going to stay unprofitable for the next two years.

JL: Yeah. Just to add to that. I think, I mean, as an investor in tech stocks, I think I'm very, I do quite frequently invest in unprofitable stocks, but there's definitely a clear distinction between the typical set clear growth story that I might invest in versus to them, whereas the longer time goes on, in theory, those secular growth names, they might realize operating leverage, and then they become more profitable. Kind of, or more importantly, their fates are a little bit more in their own, they have more control of their future. But whereas in the case of ZIM Integrated, they're not quite a secular growth story at play here. They're just more of a commodity play based on freight rates.

So, if in other words, if freight rates were to stay the same, and more time goes on, there isn't really a reason to believe that they will become more profitable or be able to change their profit picture. In fact, actually, I think Romil might have understated that the bearish picture there if, you know, things stay the way it is. Actually, I think things will get worse and worse because they'll just keep accumulating more and more debt as time goes on.

So, actually, yeah, actually, time is not really the friend of shareholders here, whereas you would have expected time to be the friend of shareholders if this was a typical dividend growth stock because you would just keep, you know, their earnings might go up. You might get dividends that you can reinvest. It's kind of the opposite at play here. But in regards to the price to book value, I would say that, yes, I have noticed especially among the – because I was interested in shipping stocks before the pandemic, before ZIM Integrated made shipping a little more mainstream, I think it deserves some credit there.

Prior to all of this fund, investing in shipping stocks, yeah, as Romil mentioned, was more of a deep value kind of mentality or – but it's very niche. The main idea there, if you were to follow any of the notable, you know, shipping investors, is they tend to look at book value or more specifically, I think it's called scrap value or, like, the market rates for, like, if you were to maybe sell off a ship. And then the idea, it will be, kind of similar to how maybe Eddie Lampert or someone might have justified investing in the Macy's (M) or something saying something like, oh, the real estate value was worth more than the stock.

So, even if the business sucks, I mean, you got some downside protection because the book value or the replacement value is much higher than where the value is. And so, I mean, that's not necessarily a bad thing, right? I mean, if things are working out properly, then that could be a catalyst for value.

If an activist investor can come and maybe force a sale of assets to return cash to shareholders, that actually is, I mean, that a big discount to the price to market value of your assets, that would be a good under valuation indicator, but the reason why I did not invest in shipping stocks before the pandemic was because I was of the view that – and I guess I'm still of the view now that these management teams are not really focused on necessarily extracting value based on that price to book value.

So, even though they might be able to generate real immediate shareholder returns by selling off, you know, certain, you know, vessels or, you know, things like that. And then just using that cash to repurchase shares they tend not to really do that materially. I know some of the lessors, basically, the companies that would lease these ships to or charter these ships to ZIM like Danaos ( DAC ). They have done some share repurchases in the past, but in my view, based on how cheap they are, based on earnings and based on price to book, it's very modest.

You would think based on how cheap these names appear on paper, they would actually be closing up shop and just selling their ships, repurchasing stock, but they're not. And okay. So, look, the optimist would be like, oh, that's not an issue, they're still cheap. You know, cheap is cheap. But the realest will probably point out that that's an issue, right? Because at the end of the day, you don't necessarily have cash access to that investment.

As Romil mentioned, that $5 million that's locked up. You don't have control of that. It's merely management that has control, and how management decides to run the business will impact what kind of returns you get as a shareholder.

So, if management is more focused on the way they put it is investing in growth. If they're more focused in investing in growth in a cyclical business, they're not going to be selling off their ships and taking advantage of the price to book value discount, which means, as Romil mentioned that price to book value discount tends to be, kind of meaningless, as long as the people in charge really don't seem to care about it.

RP: Right. Yeah, I agree with that. You know, when it comes to the lessors, I think that on their side, there's sort of two aspects to it. Obviously, number 1, there's the aspect that they want to try and manage their risk, and they just saw what happened with a lot of companies like ZIM, and they're well aware that there's risk right there that's involved. And, obviously, the lessors are they're locking in rates unlike, you know, ZIM that's on the other side of this. But they see the risk that's involved in.

So, I think that they're overly risk averse, and they're keeping a lot of cash on their balance sheet. So, maybe the optimists would look at it from that perspective. The pessimist though would probably say though that management isn't aligned with shareholders. A lot of these companies inside this industry. And then, you know, I would agree with that. A lot of companies and it's not just this industry, but I do think, yeah, it's a lot of industries, but any sort of industry like this or anything that's commodity related, I tend to see it more over there.

Where the company is more focused on Empire building. What I mean by Empire building is that let's say, you know, you're a CEO of a company. How does the CEO of a company – the CEO of the company’s compensation be calculated? It's really a calculation based on the market cap of the company, not necessarily how much the shareholders are making in returns?

So, you know, you could be the CEO of a $100 billion market cap company. And even if you return to shareholders, is not that good. You're still going to get a higher compensation than the CEO of a billion-dollar market cap company, who has really good return of capital to shareholders. And that's just because of the fact that the company is bigger. Honestly bigger company will give you a larger comp right there.

And so, oftentimes, management teams are focused on Empire Building. They're focused on, let's just build a bigger business, because at the end of the day, that's what helps them. And return of capital to shareholders, if they – if the management team doesn’t own a lot of stock inside the company, dividends will help them, because that's cash going out the door. It's not buybacks. Yes, that's going to help the shareholder, but it doesn't really help the management team.

And so I do think that there is a question right there of how much our management teams in this industry aligned with shareholders? Are they willing to return capital to shareholders via stock buybacks when the stock looks cheap or via dividends? And dividends really the way I view it as like an optional stock buyback. In that, you can take the dividend, reinvest it and buy more shares, but you don't have to if you don't want to, right?

So it's more of an optional stock buyback. And so dividends are really probably the most favorable way of going about it. But there is that question right there of, is management aligned with shareholders?

And I'll also add on to that. Even if you think the management is doing a good job with ZIM, there's a big issue with ZIM's, ZIM's, a business model and the way that it operates, there's very little user operator inside the business can do to change the current situations as ZIM is there.

So let's say, if you put yourself in the shoes of ZIM’s management right now, over the next two years, you're probably going to be unprofitable. So there's really not much you can change about that. You can't control freight rates. So you're at the mercy of the market right there. Yes, sure, you could try to cut down on some costs, but your biggest cost is the fact that you leased out all these ships. And so now it's too late to – you can't do anything about that now.

And so your biggest cost is there no matter what. And your revenue, which is these freight rates, that's at the mercy of the market. You had no control over freight rates. And so I think ZIM's management is also in a position right now where they have very little ability to maneuver and that there's very little that they can do in the current situation to change what's going to happen, right? They can just sit there and try to cut their cost, but cutting the cost is like putting a bandage over a tumor, right? It doesn't solve the root cause of the problem.

You're just sort of hiding the problem right there. I try to cut some cost. You're really not getting down to the root cause of the problem. So they can try to cut some costs. But otherwise, they can't do much else.

The revenue is going to be what freight rates are. They can't control freight rates. And their biggest cost, which is the fact that they leased out on these ships, they obviously already leased it out, right? So they can't do anything about that.

So they're really in a position where they're between, like, a rock and a hard place where it's like, what do we do at point, right? They can, in my opinion, really do much. And the only other play right there that is within stock, right? You can't really do a stock buyback because ZIM stock is a high risk play right now. It's unprofitable.

So would you really want to buy back stock of an unprofitable company? Can't do that. Okay. Do you want to go ahead and dilute the stock after the stock has already dropped a lot? You probably don't. And as they freak out a lot of shareholders and they're going to ask why in the world they're doing that? So you can't really do much with the stock from a capital allocation perspective.

And when it comes to the operations of the company itself, you can't really do much about it, you're at the mercy of the market. I think shareholders need to understand that if you're in a position of management, they really can't do much inside this situation right now. They're basically at the mercy of the market, freight rates go up, they win, but they go lower. It impacts their bottom line pretty heavily, and there's just not a lot management can do right here about this situation.

JL: Yes. I think that's reasonable. I think investors, they do – there's a strong corollary between what's happening here with ZIM Integrated as well as what happened with energy stocks, like, specifically oil, gas oil stocks. Prior to the pandemic from ever since oil prices crashed in 2016 from – for the next four years, oil stocks basically just – they didn't – I wouldn't even – I would call sideways calling it friendly because they really started trending downward and just stayed really low, right, these names. A lot of them didn't really have earnings.

So they were – it was really hard to value them, but still at the same time, there was the potential that oil prices will go up, so that's the reason why they didn't go all the way to zero. But the idea is that there wasn't really much valuation support keeping these from just heading lower. And there's definitely the risk that ZIM falls under the same pace as well. And also just adding to this idea of perhaps management not being aligned with shareholders.

I just checked the last time I covered Danaos that's that, that lessor DAC. I covered them last year in September. And in that report, I had mentioned how their – so if you're a shareholder in the stock, DAC, you have ownership of those profits as they lease these ships out to lessees like, ZIM Integrated.

But that company, the operations are run by another company called Danaos Shipping because I mean, so this is not really, like, a real estate landlord tenant kind of situation because even though Danaos would lease the ships out to lessees, they would still be – they would still have to cover the cost of operating the ships because it's very interesting, whereas the charters are really more of a financial agreement for the profits there.

But – so this Danaos Shipping is, again, it's owned by the same insiders of Danaos, but they charge a management fee that grows or shrinks based on the size of the fleet. So in other words, the same insiders running the company of Danaos, they are incentivized to grow the fleet, so that – I mean, yes. So there some investors will point that – point out that the management owns a large stake in this – in the company, typically, in these situations, that tends to be the case.

And by typically, I mean, like, if anyone's ever invested in external real estate investment trust, this is totally different. But it's a very similar concept where there's the great potential for management to be not aligned with shareholders just because they're more incentivized to grow their salaries versus drive a stronger, a higher stock price. So that that could in part be explaining why these management teams are not in a big rush to – they'll have their fleet and repurchase stock.

RP: Yes, yes. I agree with that. And I don't think I'm going to continue to talk about that, because I think we've killed that one enough. We emphasize right there. The management is not oftentimes aligned with shareholders. In regards to one of the things right here, I think, we're talking about macro and just freight rates and the fact that freight rates are really going to determine where this company goes.

One of the mistakes I see shareholders make, especially with companies like this that are cyclical because it depends obviously on the company that you're looking at. I know you look at – you, Julian, look at a lot of tech companies and such. And so that's not going to be cyclical in the same way that a company like this does.

But whenever you're looking at a lot of commodity-type companies, cyclical companies, you have to keep in mind that basically, the two only drivers that really matter are number one, macro; and number two, the quantitative aspect of things.

So what do I mean by this? Number one, macro drives everything. And what I mean by this is that, let me give you an example right here. An example right here is, you could have had, and there were actually some great oil and gas companies, and I had great operators from, like, the year 2014 to the year 2020. They're, like, they're wonderful operators. But what was the issue for 2014 to 2020? It was the fact that you weren't set a bear market in oil and gas.

And so even though the operators for these companies were great, the stock prices still crash in a big, big way, like, for example, one that I can pick off, off the top of my head is Journey Energy (JRNGF). I mean, it's a very – the guy that runs is Alex Verge, he is the big – he is one of the biggest insider shareholders inside the company. Because he's the one who found it, and he took it public in 2014 at the very top of the market. And he's a great operator. But basically, from 2014 to 2020, he had this massive tail – this massive headwind that he had to work against as an oil and gas operator, which is a macro environment.

And so because of that, in 2020, his company almost ended up going bankrupt. The stock was basically priced for bankruptcy, and basically he was able to negotiate with the lenders and able to restructure some things. And from there, they recovered and they're doing quite well right now. But that's an example of where macro really matters.

And the individual, I think, investor, especially, like I said the sort of the value investor types. They put far too much emphasis on the micro aspect of things. Like, they try and look at the individuals of the company and all the qualitative aspects. What they don't understand is that there's very little that that company has that they can control.

The reality is macro drives everything, right? You can be a terrible tech investor from the year 1996 to 2000, yet you could have been off big time because it was a dot-com bubble in the sense that it's just macro is going to drive everything. And so, really, that's where the emphasis should be put.

And so I know many try and say, well, I think the management team for X, Y, Z company is great. And there's the insider shipping sector, they're talking about it. And I just say, I really don't pay attention to that. The reason I say that is because in the long – it really doesn't matter because the macro is going to drive everything. And you could also have, you – I've seen situations that are the other way around, right? We all know situations – well, that's sort of overused, but I'll mention it right here is, like, for example, a bad portfolio manager that did well in 2020 and 2021 bad, in my opinion, but everybody else has their own opinion.

But, like, one, for example, is like Cathie Wood , right? Like she had an 80%-plus drawdown insider fund, buying companies that are off by revenue or to have revenue are very unprofitable, way overpaying for them, doubling down after the price goes down a lot, just things you're not supposed to do.

And in the long run, her performance has not done as well as in NASDAQ, but you know, what? She did great in late 2020 and in 2021. And so – and she was seen as the darling at the time. And so what it sort of goes to show is that you could be a bad portfolio manager, you could do good if the macro was helping you and it did help her, obviously, at the time there was a big tech boom.

And so what does that mean for the shipping industry? It means that even if you're a great operator, that the macro is terrible, you're going to get wiped out and vice versa, by the way. You can be a terrible operator. But if the macro is wonderful, and it's a massive tailwind to you, you're going to benefit from that.

And so I think what investors really have to keep in mind is that with cyclical stocks like this, number one, macro is driving everything. Then number two, when it does come to the individual stock fundamentals, it's really the quantitative side of things that's providing everything.

So an example of this is actually, this – there's something in the Magic Formula, right? Most investors are familiar with this, and it was Joel Greenblatt who had come out with it. He's a very well-known hedge fund manager. And basically, he said that he would take two things into account inside this Magic Formula, PE ratio and return on equity, right? These are the only two things he would take into account.

And you would just list out a bunch of stocks and you would look for the stock that have the lowest PE ratio and the highest return on equity, right? Return on equity representing quality and price-to-earnings ratio representing how cheap it is, right? So if you're asking at a low PE, high return on equity, he buy. And he just lifts it out and you take the first 30 stocks with the lowest PEs and highest return on equity and literally pay attention to nothing else as part of this formula. That's all he did, no qualitative aspect taken into account, and he would end up making a compound annual growth rate of 30% a year just by doing that.

And so what does it go to show right there? And this is especially true with cyclical stocks. But there are really only two things that matter. The quantitative aspects of the company itself; and number two, I think, the macro side of things, right? I think that if you can get those two things right with shipping stocks, you can get freight rates right, the macro side of things right. And if you can get the quantitative aspects right, you're pretty much hitting your home run in that.

I think a lot of the qualitative things that people like to pay attention to with individual, I think, investors are putting far too much emphasis on individual earnings policy. Well, earnings set – when there's an earnings call, the management set X, Y, and Z. And I think they're putting too much emphasis on these things. When in reality, they should just be really paying attention to.

Number one is a macroenvironment aligned with me. And number two, does the quantitative aspects for this company look right? If those two are right, I think the investors are going to have a good time and vice versa.

RS: Julian, I'm curious why you technically had a hold on your ZIM article?

JL: Yes. So, like, while the – well, the outlook looks quite grim for the restructures, I mean, as in, there's not really much to be hoping for as an investor. I think if one could take any takeaways from what happened during the pandemic, especially with the meme stock trades, and it could be very dangerous to short – their short stocks even if things look bad.

I mean, in the cases of ZIM Integrated, yes, I mean, I think if things sort of persist as currently over the next five years, I mean, and the longer it goes, yes, I mean, things will – could start looking worse. Maybe at some point, the risk of bankruptcy starts to increase over time. But as it stands right now, it's still in the beginning. The company is still benefited from the fact that it's greatly reduced leverage during the past couple of years. It's – there's a little bit of time. There's still some time before things get really bad, right?

So things are not imminently bad to the point where I would be prepared to say, oh, this is a sell. It's more because you would only – the – I think the more reliable returns from shorting a stock, if there's reliable returns, all it tends to become from – tends to come from stocks that are very close to bankruptcy and have a very clear path to bankruptcy, but that's just not quite the case here as of yet, I think.

RS: So what would you each say to investors looking at the shipping sector in general? How are you – I mean, I know that you've spoken about it a bit, but in general how would you – how are you each looking at the shipping sector? Somebody take the lead. Julian, let’s start with you.

JL: Yes, sure. So I think the most – a very important guideline I would have – I don't see talked about a lot is remembering that cyclical stocks, they don't deserve big multiples. So I mean, with ZIM Integrated and Danaos and these are important ones because they're two opposite sides of the spectrum in the shipping industry, but I think they both deserve the same treatment.

Like, for example, with ZIM Integrated, even – yes, I can see people trying to invest in the stock if they believe freight rates will eventually go up, or especially if they believe freight rates will go up very quickly. It's a very appealing trading vehicle for someone with that kind of investment thesis.

However, at the same time, it's important to remember that due to how cyclical it is, investors, they're not or at least they shouldn't be valuing the stock based on, like, a consistent generation of those kind of boom profits. It was very apparent.

I mean, even amidst the bubble over the last two years that investors, they were very cautious with ZIM Integrated. They weren't sure when the dividends payments were going to stop. They weren't valuing it based on, like, an annual dividend yield. They were basing it on how much of a dividend payout they would be getting in every single year. That's going to remain the same just because there's isn't any reason to expect freight rates to remain high for a long period of time.

But at the same time, this kind of mindset should also apply to the lessors like Danaos. I think they're – I've seen the argument made that with stock like DAC or Global Shipping Lease like ( GSL ), they deserve a bigger premium because there's sort of like a landlord in the shipping industry.

I do disagree with that kind of notion. I think that that kind of thinking is very dangerous. It would – it downplays the risk that the lessor has because I mean, think about it. If your tenants are going – are doing poorly at some point, that's going to impact the landlord or the lessor as well. We saw this with the mall REITs over the past couple of years.

I'm at for a long time, Simon Property Group, that stock is ( SPG ) or may search, they were trading at cap rates in 3%, 4% even though their tenants were all going bankrupt, a lot of them were going bankrupt at least. Eventually starting in 2018, 2019 and, of course, during the pandemic, their stocks finally fell down big time, and their valuations have never really recovered.

So I think if you're going to invest in a name like ZIM or Danaos, it's important to realize they're all cyclical. And I wouldn't say because Danaos is a lessor, it means that you could build a big position in it. I mean, that's going to be the biggest thing I want listeners to take away is that, I'm of the view that Danaos is still quite risky even though it's lessor.

And that in a similar way that I – if you're going to invest in ZIM, you're going to keep the position size very small like, 0.1% or even smaller, right? But Danaos deserves kind of a similar treatment just because of how – if things get bad for ZIM Integrated, then things will also be bad for Danaos because it would imply that at some point, maybe these charters – maybe these charter leases will need to be renegotiated, or maybe a lot of these lessees are going to not pay up on these rates just because they've agreed and contacted these freight rates doesn't mean that bankruptcies don't happen. And that those will impact the lessors and eventually, also these rates will get renegotiated at lower prices.

Yes. So I think – yes, it's just very important when trying to frame a bullish thesis to temper your expectations and to make sure that understanding that these are cyclical stocks have that shape how you model the valuations and you're expecting multiples for these names.

RP: Right. Yes. So I agree with that. I'm going to add on to that right there. So anytime someone is looking at a stock like ZIM, I would look to go ahead and in a way normalize the earnings. So what I mean by this is that many went ahead and bought the stock because they looked at it and said, “Oh, it's got a low PE ratio, right?” So you just go ahead and they buy it. What they don't understand is that that is very cyclical right there.

So try and avoid just blatantly looking at some sort of a ratio and just based on that going ahead and saying, well, it looks like it's going for a loan valuation, so I'm going to buy it. Instead, go ahead and actually you do a math and go through with freight rates over a long period of time and say where are freight rates normally going to be, right? What are my expectation, let's say, if you are a buy and hold investor for this kind of a stock, which is – it's hard to actually be a buy and hold investor for a cyclical stock.

But if you are sort of ask yourself over the next 10 years, where do I expect freight rates to be? And you can look at a chart going back in the past and based on that say, “Okay, here's where I expected to be going out into the future.” And based on that, you'll take different price points for freight rate and plug it into the revenue for ZIM and basically, do a stress test where you ask yourself, “Okay, how low do the freight rates have to go for ZIM present to be a break-even? How low does it have to go for ZIM to start burning a significant amount of cash? How high does it have to go for ZIM to have a decent PE ratio, right?” Whatever that is in your mind, right, there that you're looking for and plug in different points right there and basically normalize the earnings.

And so instead of just looking at recent earnings, which are very, very volatile, take freight rates over a longer period of time, plug it into the revenue for ZIM and actually ask yourself if the freight rates were to get to this level, which I would expect them to on an economic downturn, what would happen, right?

And plug in different scenarios and basically play out different scenarios in your head are sort of the worst-case scenario right here, or what the best-case scenario is, what the highest probability scenario is, and play all that out right there. And I think that's important to do on any sort of cyclical name that is influenced by an outside factor, right?

So it doesn't even have to be shipping. It can be something like a commodity producer. A commodity producer is impacted by outsized by an outside factor, which is the commodity itself, and the price of that commodity. And so you want to plug in different prices right there to try and normalize to what you think in the long run freight rates will be. And ask yourself, if the worst-case scenario plays out here, will this shipping stock have enough cash on the balance sheet to go ahead to weather a downturn? And you want to ask yourself that question right there if you're a buy and hold investor.

So that's how I'd look at it if I was a buy and hold investor. If I'm someone like myself, I tend to trade on macro over time frame, that might be as short as six months, as long as two years, okay? So I'm not buying and holding for long periods of time. Someone like me is simply using this more as a macro play.

In that case, of course, it’s all based on where your views on the macro environment are. But that's really the way that I think you got to look at it. You got to ask yourself first, am I going to be trading this? Or am I going to actually be investing in this long run? If I'm going to be trading this, it's really just a pure play macro play on where freight rates are.

I'm going to be investing in this long run. Go ahead and actually adjust how financials and make – look at the financials and adjust it out for what the potential risks here are and basically stress test it to its worst-case scenario and ask yourself, in the worst-case scenario, will – how much will I lose? And sort of the rule that Warren Buffett has rule number one, don't lose money; rule number two, don't predict rule number one. And so if you are that buy and hold investor, you really want to stress test this and see what the worst-case scenario is.

RS: Well, Romil and Julian, I really appreciate you both coming on. I feel like there's so much food for thought about ZIM, also about the sector, but I think also about kind of smarter ways to look at investing and sharper ways to look at investing. I really appreciate you both taking the time and I'd love to have you both on, again, talking a different stock or different topics in the marketplace. But I feel like our audience is going to really appreciate this conversation, so thank you.

RP: Thanks for having me on.

JL: Yes. Thanks for having us on, Rena.

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'Macro Drives Everything' Julian Lin And Romil Patel On ZIM Integrated