ZIM - ZIM Stock: A 'Buy' In The Short To Medium-Term Despite Risks (Upgrade)

2024-01-10 09:50:03 ET

Summary

• I have sat out the entire downward cycle in ZIM, but I have no intention of rushing to get rid of my position.
• The Houthis are making an impact, as it becomes too risky and expensive to travel via the Red Sea. ZIM should keep rising thanks to its exposure to short-term rates.
• And this opportunity is still not priced in, judging by the earnings revisions we can see today.
• Moreover, the stock is already cheaply valued on a forward basis with an EV/EBITDA of 4.5x.
• I suggest considering ZIM as a good short to medium-term 'Buy' despite the risks I have in the back of my mind.

Instead Of An Investment Thesis

If you read my Seeking Alpha articles regularly, you know that I have had 'Buy' or 'Strong Buy' ratings on ZIM Integrated Shipping Services Ltd. ( ZIM ) since 2021. I only downgraded it in November 2023 as I expected another earnings miss based on my forecasting models. I did not call to buy the stock ahead of the earnings report and did not call for selling (and I did not sell myself). My position accumulated as I was averaging down at lower prices. Considering ZIM's 7.2% gain on Friday, my final position broke even (now it's even a small gain for me) considering all the dividends the company has paid since 2021. I have sat out the entire downward cycle, but I have no intention of rushing to get rid of my position.

On the contrary, I will continue to stick to the principle of regular purchases. Considering all the tailwinds surrounding ZIM today, the next averaging could be at a higher rather than a lower price. I am upgrading the stock to 'Buy' and expect the rally to continue in the medium term.

My Reasoning

The year 2024 began with a slight correction for the broad market. But this negative backdrop did not prevent ZIM stock from soaring by almost 48% in just one week:

What was the reason for such a rapid growth?

On November 27, 2023 , ZIM announced that it was temporarily changing the routes of some of its vessels to safeguard the safety of crews, vessels, and cargo due to potential threats in the Arabian and Red Seas. The firm's representatives said this reroute may lead to longer transit times for affected services, but the company is committed to minimizing disruptions.

On November 29, 2023 , the U.S. Department of Transportation Maritime Administration issued a warning to ship operators about the increasing threat of attacks in the Red Sea region. The alert advises caution and awareness of evolving threats, particularly for ships with Israeli connections due to the ongoing conflict in Gaza. Recent incidents include the seizure of a cargo ship by Yemen's Houthi rebels and a foiled attack on a Liberia-flagged chemicals tanker owned by Israel's Ofer family. In response to the heightened risks, some shipping companies have temporarily re-routed vessels (like we learned 2 days before that), leading to anticipated longer transit times.

Why is it important? According to Jim Bianco's data , between 12% and 15% of world shipping traverses the Red Sea. The Houthis are making an impact, as it becomes too risky and expensive to travel via this route: the insurance is now up 300% to 500% (0.2% to 0.7% of the value of the ship/cargo).

To ensure their safety, the ships must now circumnavigate Africa, which adds about 10 days and 3,300 miles to a one-way voyage. That's a lot and takes a long time, and it's not the container liner shipping companies like ZIM that pay for it, but the end customers. Hence the sharp recovery in shipping rates .

Asia-to-North Europe rates more than doubled to more than $4,000 per 40-ft. container in the past week, with Asia-to-Mediterranean prices jumping to $5,175, according to Seeking Alpha News citing Reuters. Due to its massive spot exposure of ~70%, ZIM turned out to be among the greatest beneficiaries of the ongoing disruptions.

Of course, when predicting the sustainability of the current dynamics of freight rates, fundamental factors cannot be taken out of the equation - namely the containership backlog. A few days ago The Wall Street Journal cautioned that the recent surge in container shipping rates may soon subside as new container fleets become operational this year. The combination of low fleet utilization and a rise in shipping capacity suggests that prices are likely to face continued pressure for an extended period. Indeed, according to MSI's forecast, containership fleet growth should increase by 7% annually in 2023 and 2024, with above-average growth expected in 2025. The higher the ship supply, the lower the freight rates, hence the lower ZIM's operating revenues.

So why do I remain positive and want to strengthen my position even further?

Because I think that the Street has systematically lowered its estimates for EPS figures in recent months while the stock has been on a steep downward trend. These projections of declines have been followed by rating downgrades - some of them just before the recent rerouting news.

Accordingly, ZIM stock was able to absorb enough negativity to price in the long-awaited contraction. But for now, there is no sign of the Red Sea situation easing - it should lead to higher freight rates for longer. And this is what the market consensus is still not pricing in as far as I can see:

From the current consensus data, I conclude that the market is expecting stabilization in January, otherwise revisions would be ubiquitous. However, I do not believe that ZIM and its competitors will abandon their rerouting plans - the risk is too great and the insurance is too expensive.

Moreover, the stock is already cheaply valued on a forward basis with an EV/EBITDA of 4.7x.

Imagine ZIM shows a positive EBITDA or a stabilization of FCF in the next quarters - what effect should we expect then? I can't answer this question, but I can assume that the positive effect on the stock will be large as the percentage of shares sold short is 19.2%, which is a lot.

Risks To Consider

Please be aware that investing in ZIM Integrated Shipping stock today comes with several key risk factors that investors should consider.

Firstly, the stock exhibits significant volatility, influenced by factors such as changes in the shipping industry, global economic conditions, and geopolitical events. This inherent volatility could lead to rapid and unpredictable fluctuations in your portfolio's value.

Secondly, a crucial risk for ZIM investors is the potential normalization of freight rates. Today's surge may turn out to be much shorter in duration than I assume in my conclusions. Additionally, the highly competitive nature of the container shipping industry may exert pressure on ZIM's profit margins and overall profitability as it contends with other major players in the market.

Another important risk factor is the company's upcoming need for debt. ZIM's relatively low debt-to-equity is actively expanding, and the firm was unprofitable in terms of EBITDA last quarter (YCharts data). So ZIM's credit risk should not be ignored.

Your Takeaway

In the long term, ZIM will certainly face headwinds due to the fundamental imbalance between supply and demand in its shipping niche. But in the medium term, i.e. in 1-2 years, I believe investors will definitely have the chance to make money on the recovery of ZIM's share price, as the stock's valuation has been able to absorb many risks related to the change in the cycle and the resulting consequences for the company's financial position. Now we see that the situation has changed dramatically: ZIM can catch up very quickly due to its large exposure to short-term freight rates. And this opportunity is still not priced in, judging by the earnings revisions we can see today.

Therefore, I suggest considering ZIM as a good short to medium-term 'Buy' despite the risks I sometimes have in the back of my mind.

Good luck with your investments!

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