2023-10-26 09:15:00 ET
Summary
- Danaos' management has consistently overlooked rewarding common shareholders despite operational excellence.
- Even though the company currently features one of the cleanest balance sheets in the industry, capital returns are still overshadowed by other investment initiatives.
- Unless the current paranoia over capital returns eases, shares are likely to remain muted, even in light of my generally optimistic outlook.
I have been covering Danaos ( DAC ) for more than two years at this point, and during this period, my frustration with the company has only grown. I'm not alone in this sentiment. Almost every shipping investor I've spoken to who holds Danaos shares seems to share a similar frustration. Even those who've steered clear of Danaos have done so primarily to avoid encountering this very frustration.
In this article, I aim to uncover the underlying "paranoia" that seems to permeate Danaos' management with respect to rewarding shareholders. Their actions have resulted in a growing sense of frustration among investors. Let's delve deeper into this perplexing scenario.
A Journey of Frustration
What's the source of this frustration I'm referring to? It can be summed up quite simply: the company's management appears to have consistently overlooked rewarding common shareholders despite their operational excellence. This is where the paradox lies.
When viewed from an operational perspective, one could argue that Danaos' management has done an outstanding job in navigating the dynamics of the industry to thrive. They secured long-term leases during the peak of the containership industry in 2021 and have diligently leveraged their substantial cash flows over the last two years to reduce debt significantly.
Further, Danaos' current contract backlog still promises substantial cash flows for the upcoming years. And, following this aggressive deleveraging, Danaos now brags one of the healthiest balance sheets among all shipping companies.
The bar charts below serve as a clear visual representation of this. At the end of Q2, Danaos boasted $295 million in cash and equivalents, bolstered by an additional $360 million available through its untapped credit facility, providing the company with a robust liquidity position totaling $653 million. Remarkably, Danaos maintains an extraordinarily low net leverage of just 0.2X, effectively positioning the company as debt-free.
Danaos' Cash, Cash Equivalents, and Net Leverage (Investor Presentation)
In fact, it's worth noting that Danaos is poised to shift from being an interest-paying entity to one that generates positive interest income in the upcoming quarters. For those closely monitoring the shipping industry, this development may seem astonishing, underscoring Danaos' robust and healthy balance sheet.
However, despite the company's operational success and meeting investors' expectations on that front, management has been reluctant to share the rewards with shareholders. For context, Danaos has generated a free cash flow of $450 million over the past 12 months, but buybacks and share repurchases have amounted to just $120 million during this period.
Danaos' FCF, Dividends, Buybacks (Koyfin)
The Disappointment Has No End
Up until a quarter ago, while the disappointment over Danaos' hesitation to share profits was there, there was a promising narrative left for investors. With Danaos approaching a net cash position, the prospect of a generous dividend increase or an aggressive buyback program became more promising.
With all debts settled and a robust $2.8 billion contract backlog poised to produce notable profits in the years ahead, Danaos' shareholders could now see a clear opportunity for the company to a) finally boost payouts or b) seize the moment to announce a tender offer, leveraging the currently subdued valuation of its stock to enhance shareholder value.
For context, Jefferies' latest estimates show that Danaos' NAV/share stands close to $135. It's not far from the estimate I shared in previous articles and where most shipping investors I talk to seem to be valuing the company. With shares of Danaos hovering close to half this price point, pretty much everyone agrees that this is a very advantageous moment for the company to buy back stock. At these levels, repurchases should be massively accretive to EPS.
Danaos' Discount To NAV (Company Data, Jefferies, Ed Finley-Richardson on X)
That narrative quickly faded, too.
In my view it's unfortunate that Danaos' management started utilizing its growing cash position to accumulate a roughly 16.7% stake in Eagle Bulk Shipping ( EGLE ), currently valued at about $70 million. The company also went on to acquire 5 Capesize bulk carriers built in 2010 through 2012 for a total of $103 million.
One could dedicate an entire article to explain the reasons this was a regrettable decision. Fortunately, S.A.'s very own J Mintzmyer has already done this . I highly recommend reading his analysis for a complete understanding of the situation.
Long story short, Danaos' management decision raises significant concerns for two key reasons. Firstly, it seems counterintuitive to purchase vessels at their full market value when the company's stock is currently trading at about half its book value. This choice essentially means missing out on a significant opportunity to acquire your own stock at $0.50 on the $1.00.
Secondly, the move to enter the dry bulk market appears perplexing, given Danaos' primary focus on container shipping, without apparent consideration for investor alignment. By diversifying into dry bulk, Danaos' cash flows transition from the stable, long-term lease model to the inherently more volatile realm of spot rates.
But the cherry on top was Danaos' very own John Coustas commenting on this issue in this year's Capital Link Forum:
It's better to keep the dividends for the growth of the company. (...) As far as share buybacks (...) we have committed $130m for bulker purchases. There's no way we can do buybacks for $130m without pushing the share price up 50%. So, it doesn't make sense.
Wait a second. Investors have been dying waiting for such an amount to be allocated toward buybacks, precisely because it would help the stock rally substantially. Mr. Coustas suggests he is acknowledging this sentiment, yet considers it an unwise choice in capital allocation.
This is the straw that breaks the camel's back. Evidently, this statement is confounding and infuriating, as Danaos investors have been starved of notable capital returns for years now.
The Big Why or... The Paranoia
Observing such actions from Danaos' management should prompt any investor to inquire: What motivates their earnest pursuit of alternative cash allocation strategies, rather than returning it? After all, Mr. Coustas himself owns around half the company. Doesn't he want his net worth to go up?
I believe this has to do with the "paranoia" surrounding shipping companies and capital returns. Shipping companies have a very tremulous history on that front. Many companies over-distributed dividends during past bull markets, which quickly turned disastrous once the fun times ended. Even Danaos' stock offered a massive dividend yield back in 2008-2009 before it tanked.
Numerous shipping companies continue to grapple with the aftermath of what could be aptly described as a form of "PTSD," leading to the sense of "paranoia" I allude to when discussing the concept of "over-distributing."
Nevertheless, the landscape has evolved significantly. Back then, the majority of shipping companies operated with substantial levels of leverage (a condition that still persists, albeit to a lesser extent), and this included Danaos. Today, Danaos stands out as a debt-free entity, removing any justification for such an overly cautious stance. Besides, even distributing just half of the profits would likely make Danaos' shareholders very happy.
In my view, if Danaos' stock is to approach its "fair value" or NAV/share, this paranoia has to end. Investors don't trust shipping companies, and Danaos' actions seem to epitomize this prevailing skepticism. Shareholders deserve a voice, and it is crucial for Danaos' management to treat their concerns with utmost seriousness if they aim to prevent the stock from trading at an even greater discount to NAV.
The stock's future performance won't primarily hinge on Danaos' upcoming earnings report, as investors have a clear understanding of the medium-term earnings outlook due to the multi-year contracts tied to the company's fleet.
Instead, Danaos' prospects will be shaped by the degree of trust investors place in the company's management, assessing their commitment to taking investors seriously and treating them with respect. Similarly, Danaos' significant discount to its NAV will likely continue to be inconsequential as long as management's inattentive behavior persists.
For further details see:
Danaos: Change In Capital Allocation Mindset Needed To Unlock Upside