KEN - Kenon Holdings: A Pretty Clear Yield Trap

2023-07-20 05:28:42 ET

Summary

• Kenon Holdings Ltd., an Israel-based company focusing on power generation facilities, is facing financial struggles, with a 20% decrease in share price and declining net profits.
• The company's high dividend yield of over 50% is likely to be unsustainable, and a significant dividend cut is expected due to the company's exposure to volatile markets.
• Despite having over $750 million in cash, the company's operating expenses and poor margins present a high risk, leading to a recommendation for investors to sell.

Investment Rundown

Container rates have been a struggling point for global shipping companies. With Kenon Holdings Ltd. ( KEN ), the appeal seems to come from the very high dividend yield of over 50%. In 2022 the company paid out over $700 million in dividends, a number I just don’t see as sustainable going forward. KEN might continue paying out a significant portion of its earnings to investors through dividends, but it will most certainly come at the cost of the share price decreasing to reflect this approach.

Starting on 2023 the share price is already down nearly 20% and down a hefty bit from the highs of over $70 when shipping rates were incredibly strong and favorable. It's a cyclical company and even if the history shows great returns for those that invented early and got out at the right time, there is nothing concrete that says we will see similar movement. Besides, net profits are going down for KEN as seen in the Q1 report . I find there to be too much risk present here to suggest investors either buy or hold the company. A sell rating is what I would suggest here.

Company Segments

Kenon was founded just back in 2014 but has since built itself into a large valuation with the market cap sitting at $1.24 billion currently, although down significantly from highs in 2022. The company is based in Israel and focuses on developing and operating power generation facilities in both Israel and the United States.

Within the business there are a few different segments, those being OPC Power Plants, CPV Group, and ZIM. Engaging in the generation and supply of electricity and energy hasn't been that successful in growing its balance sheet, unfortunately. In fact, over the last few years, the company has had an average decrease in total assets of 4.5%. This doesn't speak well for a buy case and shows the cracks in the fundamentals for KEN.

Markets They Are In

Kenon acts as a holdings company as well and has wide exposure to the utility sector and the shipment sector. Two markets that have seen lackluster progress in 2023. Some of the holdings the company have is the following, the company holds a 55% stake in OPC, a major player in the power generation industry in Israel and the U.S. It also owns 21% of ZIM, an international shipping company, and 12% of Qoros, a China-based automotive company. Kenon's primary exposure lies in the dynamic power markets, with a smaller influence from the global shipping market. Additionally, there is modest ownership in the risky China EV market, but the company has agreed to sell its remaining 12% interest in Qoros. This should help bolster up the balance sheet further and the influx of more cash will bring some stability to KEN. But it's not a saving grace, and they are still in need of reaching an even stronger financial position, with more cash and less debt.

This increases the risk profile of the company in my opinion. With exposure to very volatile markets, it's difficult to maneuver efficiently and remains robust in terms of financial results.

The supply chain issues and constraints we experienced as the world was battling the coronavirus helped raise the container rates significantly. This created a fantastic environment for KEN to operate in. But since then the rates are of course down as they were never sustainable at the rates they were at. I think investors should be aware that a significant dividend cut seems likely as KEN needs the support of higher rates to support one.

Earnings Highlights

On June 5 2023, KEN posted their Q1 results for 2023 and as many might have expected, the results showed a YoY decline. Net profits were $23 million, down from $33 million in Q1 2022 for OPC, and looking at ZIM it was even worse. A net loss of $58 million was the result for Q1 of 2023, compared to a net profit of $1.7 billion in Q1 of 2022 for ZIM. In terms of the holding for KEN that still generates the largest amount of revenues, it's still ZIM. In Q1 revenues decreased by 63% to $1.4 billion due to lower volumes and lower freight rates. In terms of catalysts for KEN, a recovery in shipping rates could indicate a stronger probability of high dividend payouts like previously, which could drive the share price higher. That sort of movement makes KEN an incredibly risky play right now in my opinion and shows why timing the shipping market efficiently in terms of investing is a fool's game. You often get burned for holding too long.

Margins were hard to retain for the OPC part, as the adjusted EBITDA did not decrease in unison with the revenues, rather the revenues had a slight increase of $1 million YoY, whilst the adjusted EBITDA lost $8 million. The primary operations are still in Israel, responsible for nearly 90% of the revenues.

But KEN remained active and entered into a purchase agreement to acquire a power plant in Kiryat Gat Industrial Zone for a total of $248 million approximately. This is a significant deal, but one that seems realistic given that KEN has over $750 million in cash currently. Time will tell if KEN is successful in transforming these acquisitions into sustainable growth. The acquisitions certainly don't remedy by sell case for the business though.

Risks

The risks that come with KEN have been pointed out here throughout the article. The strong earnings the company netted in 2022 as a result of the very high shipping rates made ZIM incredibly profitable. These profits were passed on to shareholders and we now have a TTM yield of 54% as a result. Going forward this isn't sustainable, as the ZIM holding netted a loss in Q1 2023 compared to a profit of over $1.7 billion a year prior.

The margins for KEN are also quite poor and show them losing the bottom line and I think we will see them bleeding cash to keep up operations if they do start diluting more shares. You have to see some of the positive at least with KEN here, they have only very recently started diluting shares, and never did that during 2022 to take advantage of the rich share price. This might have been their loss honestly as it would have set them up even better financially now. Total operating expenses are $571 million for 2022 and with the cash position sitting at $750 million, KEN won't have 2 more years of operations if they don’t significantly make improvements to the bottom line and consolidate margins. This presents why I find KEN incredibly risky right now.

Final Words

For investors seeking a great dividend play, I would urge them to look elsewhere. KEN is likely to cut the dividend to reflect the lower earnings they generate. This leaves a lot of downside potential in my opinion. A sell rating is the most fitting when evaluating this grim outlook for the business.

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