TNP - Today's Best Picks In Shipping Markets

2023-10-04 09:00:00 ET

Summary

• Last year, I wrote a report on Seeking Alpha titled: "Excellent Time to Overweight Shipping Positions."
• This was controversial due to the challenging macro environment, but over the course of 1 year, the four picks in that report returned 36.7%.
• This was a nearly 20% outperformance of the S&P 500 and nearly 30% outperformance of the Russell 2000. I still believe selective shipping stocks are attractive today.
• I am most interested in the tanker sector, with a recovery play in dry bulk markets and a deep value play in containerships.
• This update reviews last year's report, addresses current industry dynamics, and shares my top 4 public picks at this juncture. Join the discussion below!

Global Shipping Market Conditions

Last September, I stated (in a public report on Seeking Alpha) "shipping stocks are offering investors one of the best investment setups I have seen in my career, with valuations rivaling record lows set in mid-2020. Meanwhile, most balance sheets are pristine, shareholder returns are ramping up, and the supply-side setup is the best in modern history."

A year later, many of these things are still true and we are also in the midst of a five-year rollout of the most extensive maritime environmental regulation in history: Engine design and efficiency standards ("EEXI") and carbon-emission regulations ("CII"). These regulations began in 2023, but the first year is just meant to establish an initial baseline, so we will not begin to see notable supply-side impacts until 2024. Between early-2024 and late-2027, each year will bring more stringent requirements which will significantly slow down much of the global fleet. These impacts will constrain a supply-side which is already the smallest in modern history in tankers and is also quite bullish in dry bulk.

The demand-side remains dynamic, depending upon the specific subsegment of shipping. Gas transport (e.g. LNG and LPG) markets have went gangbusters as LNG benefits from European stocking and LPG rates are surging due to unprecedented Panama Canal congestion . Tankers benefitted from Ukraine invasion-related disruptions and sanctions last year, but are now finding legs of their own based on robust global demand levels, which recently surpassed the previous peak levels of 2019. Dry bulk is heavily dependent on iron ore, coal, and grain flows and has been held back in 2023 by the lackluster reopening in China. Containerships are clearly post-cycle at this stage, but there are interesting dynamics upcoming considering the large quantity of old and obsolete vessels juxtaposed against a large orderbook and unprecedented environmental regulations.

These are exciting times in the shipping industry and thankfully for investors, there are still several interesting dislocations in the market. In this brief update, I review last year's top 4 picks (+36.7% total return in exactly one year) and then I share four new overall picks which I believe are attractive investments or speculations in the current environment.

Last Year's Setup and Results

I was incredibly bullish in last year's update , which was somewhat controversial considering the challenging macro environment, steadily rising interest rates, and uncertain prospects for most of the primary shipping segments.

I shared four picks in the report (listed alphabetically):

• Genco Shipping ( GNK )
• Global Ship Lease ( GSL )
• International Seaways ( INSW )
• Textainer Group ( TGH )

Over the course of one year, all firms have produced notable market-beating total returns and the average total return (+36.7%) has outperformed the average of the S&P 500 and Russell 2000 by more than 20%.

This is certainly not the first time our picks have outperformed the market, as we have an eight-year track record at Value Investor's Edge with a 43% IRR across our long-only model portfolios and tracked trades, but of course past performance does not guarantee future results. I stand by the public picks I will share today and look forward to reviewing the performance next year. Please set a calendar reminder to hold me accountable!

Today's Top Picks

After addressing the current shipping market dynamics and reviewing last year's performance, it is time to share our top current picks for September 2023. This selection includes two tanker names, one dry bulk selection, and a deep value containership play. The picks are shared in alphabetical order:

Danaos Corp: 'Fair Value Estimate' of $95.00 (44% Upside)

Danaos Corp ( DAC ) has been a long-term deep value favorite of mine, and I recently shared a one-year review focused on DAC and one of its peers. DAC is a container owner/lessor, which means they lease their ships to larger liner companies, which typically play a flat rate for 3- to 5-year to utilize the vessels, but the liner companies take the majority of the market risk.

I believe DAC has been unfairly punished due to a combination of investor misconceptions of the business model combined with a lack of strong shareholder returns from the management team. Danaos has a steady repurchase program, but they did not raise their dividend in early-2023 even though free cash flows covered the current payout by more than 7x. I expect record-breaking results in 2023 and for 2024 to also be a very strong year for the company. Eventually, I believe the market will improve their valuation of this firm, but it is clearly taking longer than I initially expected.

Genco Shipping: 'Fair Value Estimate' of $20.00 (41% Upside)

Genco Shipping ( GNK ) is well positioned for a potential dry bulk recovery since they have strong scale with their fleet 44 vessels, yet they also have a world-class balance sheet with a net debt-to-assets of just 8%. GNK has strong exposure to the spot market, which has been challenging in 2023, but this also means they will benefit immediately from any sustainable upturn in market conditions.

We have already started to see some seasonal and congestion-related strength across the dry bulk sector during September and although it is too early to reach a firm conclusion, it looks like the worst might already be behind us. GNK is the perfect firm to pick for an all-scenario situation because they will do just fine in a mediocre-to-poor market, but they also have the potential to return 100%+ in a bull market recovery. Patience is likely required here, but GNK looks like a great risk/reward buy at this juncture.

Scorpio Tankers: 'Fair Value Estimate' of $70.00 (37% Upside)

Scorpio Tankers ( STNG ) has the largest publicly traded product tanker fleet in the US markets and 100% of their vessels are modern eco-design. This means that STNG can enjoy the current strength of the market without any need or desire to renew or expand their fleet. Scorpio has repurchased a significant quantity of shares over the past 12-18 months and they have also completely revamped the balance sheet, which went from 'toxic' in Q1-22 to 'pristine' as of mid-2023.

Product tanker rates have been exceptionally strong throughout the summer and fall of 2023, but I believe investors have gotten confused by applying faulty y/y comps to the gangbusters 2022 season (2022 was the strongest year for product tankers in history). In reality, 2023 appears to be on track for the second strongest year in history, and 2024 might be even better yet. I especially like investing in STNG because of their discount to NAV (which we estimate at $75/sh) and strong level of recent accretive share repurchases.

Tsakos Energy Navigation: *Potential* to $40.00 (96% Upside)

Tsakos Energy Navigation ( TNP ) is a controversial selection in the tanker sector due to concerns about related-party transactions and potential conflicts of interest with capital allocation (i.e. the firm is more interested in growing the fleet than in sharing profits with shareholders). I believe some of these concerns have merit, but the discount is vastly overblown as TNP trades just over $20/sh, yet carries a current net asset valuation ("NAV") of over $60/sh.

If TNP continues to follow-through with improved dividends and ideally shifts to a share repurchase program, then I believe there is potential for these shares to trade closer to $40 by next year. At the present time, we utilize a massive discount at Value Investor's Edge, which drives a 'fair value estimate' of $26/sh; however, this discount will be immediately reduced if/when we see improved dividends or a share repurchase program.

This is definitely the riskiest selection of the basket, but where we might also see some of the most outsized gains into 2024. With this selection, the bet is less about the strength of the market and more about the rationality of the management team.

Conclusion: Buy Selective Shipping Stocks

As I mentioned last year (and many times in the past):

The best time to buy shipping stocks is when there is a significant disconnect between share price valuations and underlying segment fundamentals. This typically occurs when the global macro situation is challenging because generalist investors often associate shipping as a proxy to global growth without understanding the actual supply/demand dynamics.

We are once again seeing this today as several tanker stocks are being ignored by the markets despite strong fundamentals, dry bulk offers an interesting recovery proposition, and there is still some deep value in containership names.

I can never guarantee any sort of future return and I expect these stocks will likely be volatile over the next year, but I believe the risk/reward setup is excellent for the four names addressed in this report and I look forward to tracking their performance and checking back in next year.

For further details see: