ASC - Adding Ardmore Shipping To My Value Portfolio

2023-06-02 01:54:43 ET

Summary

• Ardmore Shipping is a maritime transportation company for petroleum and chemical products, benefiting from increased demand due to war-related dislocations.
• The company has successfully deleveraged, reducing debt to 15% of equity, and reinstated a dividend with a 6.7% yield.
• Despite being a cyclical stock, ASC's impressive valuation metrics and conservative use of earnings make it a promising addition to a value portfolio.

Today I'm introducing a new entry into my value portfolio. Ardmore Shipping ( ASC ) provides maritime transportation for petroleum and chemical products worldwide. It has a fleet of 26 ships, 22 of which are fully owned and 4 of which are chartered-in vessels. Shipping is generally a cyclical business (i.e. very dependent on the level of economic activity and prosperity), so everything I discuss below should be viewed through that prism.

ASC operates in an industry where capacity is forecast to remain relatively constant over the next few years, while demand grows.

The slide below from the most recent earnings call highlights this. In particular, the blue and gray bars show the recent and anticipated growth of the net worldwide fleet for transporting petroleum products and chemicals respectively. The green bars show the demand in terms of tonnes of product times the number of miles those products have to travel to get from suppliers to consumers. (This concept of "tonne-mile" is important as will be discussed below.)

Increased Demand Due to War-Related Dislocations

The biggest reason for which demand has been increasing is because of the Russian invasion of Ukraine and the resulting trade sanctions levied by many nations. These sanctions completely disrupted normal trade routes and have instead caused countries to ship products much further than they had prior to the war. Thus even though the number of tonnes of product shipped may be similar to what it had been previously, those products are travelling much further and hence worldwide "tonne-miles" have increased substantially.

The map on the following slide helps illustrate this, with the red arrows representing the pre-war trade routes and the green ones representing current routes.

The results of this new paradigm are clearly visible in ASC's revenues and cash flows from operations which have surged.

Conservative Use of Earnings

ASC has a well thought out capital allocation plan in which it prioritizes four items:

1. Authorize any capital expenditures necessary to maintain the fleet and to achieve high efficiency transport.
2. Keep debt leverage below 40%.
3. Have a "war chest" available in case deals arise in the ship market.
4. Return excess capital to investors via dividends and potential stock buybacks.

As can be seen from the graph of debt to equity below, ASC has successfully deleveraged itself such that debt only amounts to about 15% of equity (from a high of greater than 180%). Because the company could re-leverage if an alluring deal became available, essentially this fulfills both points 2 and 3 above.

The company has also reinstated a dividend, with the stock currently yielding 6.7%.

As to point 1, the company has been maintaining and even upgrading its fleet as highlighted in this slide:

Overall, going forward the reduced debt and therefore reduced interest payments should allow higher earnings than seen previously, even if revenues decline somewhat.

Cash on Hand

ASC has about $52M of cash on hand, and it has managed to maintain this level of cash for the past several years. Thus the risk of a dilutive financing in the near future is quite small.

Valuation

Of course the primary reason I have added ASC to my value portfolio is because it sports very impressive valuation metrics. In particular, the forward GAAP P/E and EV/EBIT ratios are stellar. Compare them to the sector median shown in the table below or use Seeking Alpha's handy "Peers" link to appreciate how they are among the best in the industry. (Note valuation metrics are with ASC trading at $11.88 per share.)

As noted above, ASC operates in a cyclical industry, so these may be peak metrics, but because they're so low and because of the company's massive deleveraging, I believe that the company will continue to outperform financially going forward. Or to put it another way, even if earnings are cut in half during the next cycle, that would still yield a P/E ratio of under 8 and a price to cash flow ratio of less than 6 at today's stock price.

Quant Ratings

Seeking Alpha's very helpful quant rating and factor grades are aligned with my verdict, with a "buy" rating and all factor grades being B+ or better (though it wouldn't surprise me to see the momentum factor deteriorate given the recent stock price action).

Options

ASC trades options, and they are liquid enough that I have used them to write out of the money ($15 strike) covered calls against my position. I think of this as an enhanced yield on the stock, as I plan to only write calls at least two strikes out of the money so that the chance of the stock being called away from me is lessened.

Risks

ASC is a cyclical stock and thus is greatly impacted by economic cycles. If demand for petroleum products and chemicals falls sharply due to recessionary forces worldwide, ASC's revenues and profits will be greatly affected. Similarly, if there's another pandemic or other demand shock ASC's earnings will plunge. These risks have been somewhat diminished by the company's deleveraging and by the lack of new ships being built worldwide, but the risks are very real nonetheless.

Summary

The Russian invasion of Ukraine changed the game for ASC and the company wisely used its windfall to deleverage rather than to expand. I believe the fruits of this will be higher profits and dividends in the future as well as the ability to opportunistically take advantage of any bargains (on ships or whole shipping companies) during a cyclical low. I am long a full position and intend to hold the stock long term.

For further details see: