HLAGF - Costamare: Red Sea Challenges Equal Tailwinds Not Priced Into The Stock Buy

2024-01-01 10:30:00 ET

Summary

• Costamare's shares have rebounded due to the safety issues in the Suez Canal, benefiting the company's dry bulk and containership fleets.
• Major shipping firms are rerouting vessels away from the Red Sea, leading to rising charter rates.
• The ongoing situation in the Suez Canal is expected to last, suggesting an enduring tailwind for vessel owners like Costamare.
• I believe that this tailwind, along with several others of Costamare's qualities, are not priced into the stock.

Shares of Costamare ( CMRE ) have rebounded notably in recent weeks. This can be attributable to the company's dry bulk and containership fleets, which are likely set to benefit notably from the ongoing safety issues in the Red Sea, averting vessel passage in the Suez Canal. However, I believe that the market has not priced the benefits of this ongoing disruption fully into the stock.

But first, let me provide some context to this story.

Unless you have been living under a rock lately, over the past few weeks, Yemen's Houthi rebels have not just been disturbing vessels attempting to enter the Suez Canal but also straight-up firing rockets. Last month, they even boarded Bahamas-flagged Galaxy Leader, a vehicle carrier. Looking at the footage was like these Somali Pirate videos on steroids.

With attacks intensifying week after week, prominent shipping companies, such as Mediterranean Shipping Company, Maersk ( AMKBY ), Hapag-Lloyd ( HPGLY ), and the oil company BP ( BP ) have all stated they are rerouting vessels away from the Red Sea. Trading from Asia to Europe now has to take place through vessels going all the way around through the Cape of Good Hope.

Due to an ever-riskier maritime environment, this means higher fuel costs, longer journeys, and higher insurance costs. The result? Higher rates. If someone is benefiting from this situation, it's the vessel owners, like Costamare.

What's worth noting here is that we are not used to this type of situation, and therefore, we may intuitively feel that it will get resolved soon. For decades, movement through the Suez Canal has been safe. Thus, the average person likely thinks this situation will be resolved sooner or later. Initiatives to restore order, such as Operation Prosperity Guardian led by the U.S., certainly alludes to that narrative.

However, the reality is far different.

Operation Prosperity Guardian failed before it even began. It quickly collapsed, with Italy, Spain, and France refusing to operate under U.S. command . Who can blame them? It's simply too risky. Sure, military vessels can shoot down a few drones attacking commercial vessels.

But how many of them can they shoot down, and how expensive is that? Warships carry a limited number of missiles, and they cost a lot. Houthis can send an "unlimited" amount of attack drones for chip change. A missile costs a couple of million dollars . A drone costs a few thousand dollars. It's simply "not a good business" to be in the suicide drone interception industry these days.

Therefore, while you may see some liners resuming operations in the Red Sea, such as Maersk , this is only due to some of their vessels having the luxury of being accompanied by U.S. warships. This doesn't apply to most vessels still forced to go around South Africa.

I expect that even current U.S. aid will fade in the area as it is ineffective. You cannot patrol and accompany every single vessel forever. It's just impossible. Thus, the current situation is destined to last for a long time. There's just no way to stop these attacks, and there is no incentive for the Houthis to stop as long as their demands are not met.

Shipping investors understand this. Evidently, spot rates across most shipping asset classes have skyrocketed. Let's take a look at the dry bulk first. Here are the FFAs as of December 28th.

January Capes above $23K and Cal24 just $20K are super profitable rates.

I believe that Costamare will benefit significantly from the surge in dry bulk rates. At the end of Q3, their 34 Newcastlemax/Capesize vessels had an average tenor of 1.1 years, while their 14 Kamsarmax/Panamax vessels had an average tenor of 0.4 years .

These are very short tenures, as is common in the dry bulk space, meaning that Costamare must have already started renewing many of its charters at much higher rates than the previously depressed levels.

In the meantime, the company's containerships, which boasts a contract backlog of about $2.7 billion with a TEU-weighted duration of 3.7 years, is set to keep producing resilient cash flows in the coming years, as has been the case quarter after quarter lately.

As soon as some of the company's containerships start coming out of their existing charters, like Dyros, Arkadia, and Virgo, as shown below, it's quite likely that Costamare will have the opportunity to renew their employment at higher rates.

As you can see, the Shanghai Export Containerized Freight Index jumped by 40.2% week-over-week to 1,759.57 on December 29.

This trend is likely to be sustained as an increasing number of containerships continue to avoid the Red Sea.

Evidently, Flexport Inc.'s latest data indicates a significant change in sea routes. About 299 ships, with a total capacity of 4.3 million containers, have either changed course or are planning to do so-double the number from just a week ago, making up roughly 18% of global shipping capacity.

These new routes around Africa can take up to 25% more time than the usual shortcut through the Suez Canal. According to Flexport, this means higher shipping costs, which could lead to increased prices for consumers across various goods, from shoes to food and oil, if these longer journeys continue.

I want to highlight again that I don't believe this will be a short-term issue. As recently as this past Friday (Dec. 29th), Mitsui O.S.K. Lines ( MSLOY ) and Nippon Yusen ( NPNYY ), Japan's largest shipping companies, also stated their vessels with links to Israel were avoiding the Red Sea area.

Hapag-Lloyd also affirmed that they will continue to reroute vessels around the Suez Canal for security reasons.

Despite these tailwinds for rates, forward EPS estimates for Costamare have not been revised upward. Wall Street seems to be largely sleeping on the ongoing Red Sea situation and the underlying benefit on company earnings that have been the result of the ongoing disruption.

Therefore, the stock is currently trading at about 5 times this year's expected EPS and at about 4 times next year's expected on what are rather pessimistic estimates, in my view.

Simultaneously, Costamare has $996.9 million in liquidity , which equals about 79% of its current market cap, and no significant loan/lease maturities until 2026. Corporate leverage on a Market Values basis remains below 37% as well.

The combination of:

• A healthy balance sheet with ample firepower for further expansion,
• an aligned management team with 64% insider/family ownership that has re-invested $149 million via Costamare's DRIP program,
• non-dilutive financing with ongoing buybacks ($60M over the past 12 months or 5% of current market cap,
• cheap current and forward valuation multiples,
• and ongoing Red Sea-related tailwinds that are likely not priced into the stock,

forms a compelling investment case, in my view. Accordingly, I remain bullish on CMRE stock.

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