ZIM - Buy Danaos Before The Q2 Report

• In my opinion, the fact that Danaos does not have such a high dividend yield is not a reason for value investors to pass the stock by.
• Danaos has a strong revenue backlog for years to come, and with the market pricing a recession, HARPEX's performance suggests that the industry's bull cycle is far from over.
• The sell-off we have seen in DAC seems to be overdone, and the stock is now trading well below its fair value.
• Management should announce a share buyback to attract more investors - then the market will feel support and DAC will likely rally at least to its $107 per share peak.
• I again rate Danaos stock as a strong buy, as Q2 results could bring back a sizable portion of investors who have recently divested from the stock.

Instead Of An Investment Thesis

If you have read my previous articles on containership owner/operator Danaos Corporation ( DAC ), you may have noticed that they were all bullish, but not all calls were profitable for potential buyers:

The maritime container shipping industry experienced unprecedented growth last year - many companies could easily pay dividend yields of 15-25%, and this could only attract value investors. In my opinion, the fact that Danaos does not have such a high dividend yield is not a reason for value investors to pass the stock by - at some point, I think buybacks should begin. In addition, Q2 2022 results should not disappoint - the company has a strong revenue backlog for years to come, and with the market pricing a recession, HARPEX's performance suggests that the industry's bull cycle is far from over. I re-rate Danaos Corp. as a strong buy after the strong selloff in its stock price.

My Reasoning

In the most recent quarter (Q1 2022), Danaos beat revenue and EPS consensus forecasts by 15.53% and 85.02%, respectively - in terms of earnings per share, this was an unprecedented surprise even against the backdrop of previous results that were also strong:

Last quarter, we found out that 99% of the vessels were contracted by the end of 2022, 78% by the end of 2023, and another 57% by 2024. At the same time, total contractual revenue through 2028 - was about $2.7 billion, down only $100 million (3.6%) from the end of 2021 (from the 2021 Annual Report ). In my opinion, such a slight decline is explained by seasonality, but not by the cycle turn, which is only possible if there is a sharp decrease in freight rates for this type of vessel, which we have not observed so far.

Rates have been stably high for more than a week - since the end of June, the decline has been less than 0.15%, which is entirely insignificant. Demand for container ships seems to remain strong despite fears of an impending recession. Against this background, shipping companies are fundamentally doing well, having contracted their ships for the next few years at still hot rates.

But as is so often the case, fundamentals do not immediately lead to rising stock prices but have a somewhat longer effect of playing out. When the market hears of the impending recession, it begins to ignore the free cash flows, thinking that the future will not be so bright - this is a consequence of the sharp decline in the shares of Danaos and its peers:

With fears of a recession and a decline in demand for ships worrying investors in this industry, I think it is an excellent time to average down or make an initial purchase as the quarterly report is coming up soon ( August 1, 2022 ), which can be a catalyst for strong recovery growth.

In Q1 2022, Danaos managed to beat EPS estimates thanks to the ZIM Integrated Shipping (ZIM) dividend ($17 per share). But even assuming the company achieves the same net income as in Q1 2021, but without the $110 million dividend, the company's projected EPS (Q2 2022) will be about $6.05 per share. Again, we assume no new dividends and no operational growth. However, we know that ZIM paid $2.85 per share on June 8.

The tax on dividends in Israel is 25% if the dividend is received from a non-resident. After selling 1.5 million ZIM shares in Q1, DAC still had about 5.7 million shares (or about 4.7% ) of all outstanding ZIM shares. Let us assume that DAC sold another 1.5 million ZIM shares in Q2 - 750,000 each before and after the ex-dividend date. Then DAC would have received $2.85 per 4.9 million ZIM shares before taxes. After taxes, that's about $10,553 thousand.

That means EPS, taking into account these after-tax dividends, will be about $6.56 per share if the company does not grow operationally and margins stay about the same. Investing.com's consensus EPS estimate is 6% lower:

Given the prevailing seasonality of the container shipping business, I expect that my assumption of a constant operating result will prove to be wrong and that we will see another good YoY growth rate - hence the surprises in sales and EPS will probably be even bigger than I have just roughly calculated.

I also expect Danaos' management to announce a share buyback, as they did in 2020, which should be an additional tailwind on the way to a future share price recovery. Room for growth is abundant now, in my opinion - regardless of past market cycles, Danaos' valuation has never been as low as it is now, while ROE has not been even close to what it is today:

I am hoping for the announcement of share buybacks in the upcoming earnings release - DAC will have enough liquidity to do so, and analogous to 2020-2021, the stock will have a more obvious (to the market) trigger for growth.

Risks And Takeaway

I see serious risks for my thesis and argumentation, which I absolutely have to point out to you.

First , I think the risks of recession are really too high now to ignore. With falling demand and huge order books for container ships, stocks in this industry could plummet, no matter how cheap they seem to us right now. On the other hand, DAC - like most other companies - has a lot of contracted revenue to protect itself.

Second , we do not know exactly how many shares of ZIM were sold and how this affects EPS - all my calculations in this article are indeed inaccurate. I did not claim to be accurate, just guessing - if one important factor disappears from my considerations, then my conclusions about the possible overshoot of the consensus forecast are completely wrong.

Third , I look at the TTM values of the market multiples and talk about undervaluation - that's not quite right for cyclical industries. However, if you look at the forward multiples, you will see that the stock's underestimation is still there, and it is still enormous.

Despite these serious risks, I conclude that the sell-off we have seen in DAC was overdone, and the stock is now trading well below its fair value. Management should announce a share buyback to attract more investors - then the market will feel support and DAC will likely rally at least to its $107 per share peak.

From a technical analysis perspective, in order to reach the previous high, the stock needs to first establish a foothold at the level above the descending price channel ($75, roughly the level of the 50-week exponential moving average) and then at the $86-87 per share level (the level of the anchored VWAP), which is strong support. The first target seems close enough - DAC is already starting to exit the local oversold zones (based on RSI).

Author's note: Special thanks to fellow SA contributor Danil Sereda (see our association in my bio description) for running the TrendSpider software to obtain the above information.

How it will actually be - history will tell, but for now it was interesting for me to read your opinion in the comments below!

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