ESEA - Euroseas' 56% Discount To NAV And 9.3% Yield Remain Highly Attractive

2023-07-03 10:30:00 ET

Summary

• Euroseas' earnings are set to remain very strong in fiscal 2023, with newbuilds landing robust rates despite spot market weakness.
• The company generates sufficient cash to cover OPEX, fund its newbuild program, and sustain the 9.3%-yielding dividend, which remains very well covered.
• Despite shares gaining over the last six months, NAV/share has also risen. Hence, ESEA stock is still trading at a massive discount to NAV.

Back in December, I shared my bullish view on Euroseas ( ESEA ), supporting that the stock's 10.3% yield and 65% discount to NAV offered (at the time) a compelling investment case with a wide margin of safety.

Just over six months later, shares of Euroseas have performed in line with my expectations. The stock price has risen by about 13.4%, and the hefty dividend has pushed the total return to 18.8%. Not bad at all for such a short period of time.

Despite shares advancing higher, the stock's NAV has also risen since my previous update. Thus, shares still trade at a significant discount to NAV. Further, while the dividend has been reduced to 9.3% following the recent stock price gains, I believe it still presents an attractive tangible capital return that nicely complements the stock's total return prospects. For this reason, I am holding my ESEA shares tight and remain bullish on the stock.

Market and Fleet Employment Update

It is worth noting that even within the industry, the situation remains perplexing as to why rates have failed to stabilize, despite the fact that consumers' purchasing power remains remarkably robust. The prevailing perspective suggests that the current challenge lies in the temporary mismatch between import demand and consumer demand, stemming from inflated inventories resulting from the " bullwhip effect ."

However, Euroseas' strategy of employing its vessels under longer-term time charters has proven to be highly advantageous, somewhat insulating its cash flows. Some of these charters may not be as extended as some of Danaos Corporation's ( DAC ) or Global Ship Lease's ( GSL ) leases. However, they are still significant and, most importantly, highly profitable.

Wall Street expects that the company's EPS will decline sequentially, from $4.11 in Q1-2023 to $3.20 in Q2-2023, due to certain rates within the company transitioning to weaker ones. The table provided demonstrates this shift, with Hydra's daily rate expected to decrease from $20,000 to $15,000, while Astoria's rate is projected to drop from $65,000 (for a significant portion of Q1) to $50,000. Although some enhancements, such as the transition of SYNERGY KEELUN to a higher rate, are expected to mitigate these declines, overall, Q2 is anticipated to be a comparatively weaker quarter.

That said, I find the Q2 consensus estimate rather soft, especially since Gregos, Euroseas' newbuild hitting the water in the second quarter, has been employed at a highly attractive TCE of $48,000. Euroseas' upcoming newbuild, TERATAKI, has also been fixed at $48,000, with both employments lasting for three years. These are highly attractive fixtures in the current market environment, illustrating the rather robust demand for very modern and efficient vessels that are much more economical than similar-sized vessels built over a decade ago. Note that Euroseas' fleet has an average age per vessel of 17.9 years , which explains the significant difference between the rates on Gregos and Terataki versus the rates some of the older vessels attract.

Therefore, even though Euroseas' EPS is certainly going to decline on a year-over-year basis in fiscal 2023 due to the lack of some of last year's monster contacts, the company is poised to deliver a remarkably profitable fiscal year in 2023. The projected EPS is expected to exceed $11, and personally, I anticipate it to be closer to $12. However, for the sake of being prudent, let's consider Wall Street's estimates as they stand.

The 9.3% Yield and the Discount to NAV

Ever since Euroseas reinstated its quarterly $0.50 dividend, the stock's investment case has improved dramatically, as investors should now have a greater margin of safety. With shares now trading above $20, the yield has been reduced to the high single digits, but it still remains highly attractive.

Notably, the company demonstrates robust cash generation, effectively meeting its operational expenses, financing its newbuild program (along with the incurred debt to partially fund these new deliveries), and adequately supporting the dividend. In fact, the current dividend rate of $2.00 per annum indicates a payout ratio below 18%, based on Wall Street's EPS estimate of $11.18 for fiscal 2023.

Given the current high yield the dividend offers to investors, it appears unlikely that management intends to further increase the dividend in the future. This decision aligns with the necessity of retaining sufficient cash to fund newbuilds without excessive reliance on debt. Nonetheless, the existing dividend yield is already substantial enough, and I am content with the current payout rate.

In the meantime, the stock's discount to NAV presents a compelling opportunity for investors. Not only does it signify a substantial margin of safety, given the notable discount already factored into the stock's price, but it also presents the possibility of an upside in the stock price, assuming shares converge towards NAV.

While the stock has risen since my previous update, Euroseas' NAV also rose. Thus sustained their significant discount to NAV. Specifically, Euroseas' NAV rose from $48.4 in Q4-2022 to $49.3 in Q1-2023. This implies shares are currently trading at a significant 56% discount to NAV.

Also, note that this NAV is not calculated as shareholders' equity divided by the number of outstanding shares. Instead, management adjusts it by utilizing the charter-adjusted market value of vessels and the net change of newbuilding contracts. Thus, it should make for a very accurate estimate.

To take advantage of this count, management has been buying back stock, which should be massively accretive to EPS. Although repurchases have been somewhat soft, with just $7 million worth of stock repurchases between May 2022 and May 2023 (out of the $20 million share buyback program), they are certainly welcome.

Conclusion

Shares of Euroseas have performed very well over the past six months, especially when factoring in the company's hefty dividend. While results are certainly going to take a hit from last year's monumental levels, profitability should remain strong throughout fiscal 2023, especially once the newbuilds start contributing to earnings.

There are definitely risks to Euroseas' investment case, including a high containership orderbook and, as well as very weak spot rates, which could eventually adversely affect Euroseas' cash flows in the medium term if a notable rebound doesn't occur at some point soon. That said, Euroseas' well-covered dividend and massive discount to NAV should continue providing a wide safety net for investors against any downside potential.

Hence, Euroseas will remain one of my biggest shipping holdings for now.

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