2023-10-14 01:56:27 ET
Summary
- Danaos Corporation offers a strong balance sheet with ample liquidity, supporting opportunistic capital allocation.
- Its dividend yield may not be the highest, but is supported by great coverage and excellent free cash flow.
- No significant maturities until 2028 and about 2.5 years' worth of revenue in contract backlog makes Danaos well prepared to continue paying dividends.
Investment Thesis
Danaos Corporation (DAC) is under-appreciated given its strong balance sheet, large liquidity base, low leverage, and great dividend coverage. Priced at half its book value, DAC offers a somewhat low but relatively safe dividend yield, given its fundamentals and the market outlook for its containership subsegment.
This analysis compares DAC to three peers: Global Ship Lease (GSL), Costamare (CMRE), and MPC Container Ships (MPZZF). While GSL and MPZZF are pretty much similar to DAC, CMRE also owns a bulker fleet, making it somewhat different from the others.
Some illustrations were created using the author's calculations. These are explained in more detail in the appendix at the very end of the article.
Company Profile
Danaos Corporation is a container lessor with a fleet of 68 ships ranging from about 2,000 to about 13,000 TEU capacity, aggregating about 421,000 TEUs as of March 7, 2023. In addition, it has six ships on order.
Its business model is leasing their ships to liner companies on more extended charters. Founded in 1972, Danaos Corp. was listed on the NYSE in 2006. It is incorporated in the Marshall Islands and has located its management in Cyprus and Greece. According to its investor relations pages, it is "one of the largest independent owners of modern containerships."
Fundamentals
Share Price: A Wild Ride In The Last Two Years
The graph below tells the story of the supply crunch that shook markets going into a supply-constrained 2021. A crunch that went away during 2022 as container markets returned to a somewhat normal state:
For context, an investor that bought and held DAC on March 1, 2020, would have received nearly 1400% share price appreciation. Year to date, DAC is up 28%, while GSL, CMRE, and MPZZF are up 10%, 3%, and 1%, respectively.
Let's turn our attention to valuation multiples.
Price/Book and Price/Earnings: Cheap/Expensive
Let's begin by considering the P/B and P/E ratios. Interestingly, DAC is the least expensive as measured by price to book value - and the most costly as measured by price to earnings:
While DAC, GSL, and CMRE are more or less equal regarding P/B and P/E, MPZZF trades with markedly different P/E and P/B ratios. Later, when considering the dividend yield, we'll get one possible explanation for MPZZF's low P/E.
Financial Debt/EBITDA and EV/EBITDA: OK
DAC has a relatively low debt load compared to its peers. During the 2020s, it has worked to deleverage the company, according to its latest investor presentation .
What happens if we combine market capitalization and net debt to compare enterprise value to EBITDA?
I don't think there's anything remarkable in terms of the individual ordering of the companies. MPZZF and DAC still accomplish the lowest multiples.
Dividend Yield: Rather Low
Now, this is getting interesting. While DAC, GSL, and CMRE yield 3-8%, MPZZF yields 39% !? That kind of yield prioritizes shareholder returns as dividends instead of retaining capital for growth. In other words, the low P/E of MPZZF above might be due to its yield. That is reflected in its share price development, too.
Chasing high yields might be risky so we will look at two other metrics.
Dividend Cover: Great Coverage
In terms of how safe the dividend is, this graph is revealing. While DAC and CMRE have covered their dividend more than eight times by net income, MPZZF still needs to cover its dividend.
Free Cash Flow per Share: Ahead of The Pack
Considering cash flow per share strengthens the emerging impression: MPZZF can barely generate free cash flow, while DAC shines, generating a whopping $22.
Summary: There is Much to Like Here
I think we should go ahead and summarize what we have seen above. Each company has been awarded a score for each multiple according to its performance, where lower is better. For example, the lowest price/book ratio gives a score of 1, the second lowest a score of 2, and so on.
Of course, this is a simplified method of summarizing the differences between these companies. It is an indicator , one of several an investor should look at.
The results are shown in the table below.
(A lower score is better.) | DAC | GSL | CMRE | MPZZF |
Price/Book | 1 | 3 | 2 | 4 |
Price/Earnings | 4 | 2 | 3 | 1 |
Financial Debt to EBITDA | 2 | 3 | 4 | 1 |
EV/EBITDA | 2 | 3 | 4 | 1 |
Dividend Yield | 4 | 2 | 3 | 1 |
Dividend Cover | 2 | 3 | 1 | 4 |
Free Cash Flow per Share | 1 | 2 | 3 | 4 |
Score | 16 | 18 | 20 | 16 |
DAC is tied for 1st place together with MPZZF. However, GSL is trailing just behind, showing how closely these companies rate when compared along these dimensions.
However, based on what we have seen above, there are several factors an investor should consider concerning MPZZF:
- The table above also indicates a difference between DAC and MPZZF: DAC has a more conservative approach than MPCC. While the former generates a relatively large free cash flow and has its dividend covered eight times its net income, MPCC is much more aggressive. Its dividend coverage ratio is just 1.4, and its FCF per share is the lowest.
- For US investors in particular: MPZZF is listed on the Oslo Stock Exchange, pays its dividends in NOK (exchange rate risk), and is incorporated in Norway (25 percent withholding tax on dividends may apply to you).
One should also notice that Danaos and Costamare - the two companies with the lowest dividend yield - have the best dividend coverage.
Concluding the review of fundamentals, DAC presents a more solid case than MPZZF.
Let's turn our attention to the company review and see if circumstances could strengthen or worsen the impression of DAC.
Company Review
Management: Stability, and Son of Founder in Charge
DAC is led by Dr. John Coustas, who assumed the CEO position in 1987 from his father, who founded the company fifteen years prior. Its other members of current management have been with the company since 2005 and 1998. In other words, DAC has stability in its upper echelon. Its COO, however, is set to retire during the fourth quarter of 2023 but remain on the Board of Directors. He will be replaced by Filippos Prokopakis, who has been with Danaos Management since 2012, in what appears to be an orderly transition.
Ownership Structure
John Coustas owns about 44.5% of DAC through his family's investment vehicle. Its largest other shareholders (above 1%) consist of institutional investors, according to MarketScreener .
Contract Backlog
According to its latest investor presentation, DAC's contract backlog as of August 2023 is $2.5 billion through 2028. For comparison, DAC had $993 million in revenues in 2022 and $998 million in revenues LTM up to and including Q2 2023 - which means it has about 2.5 years of backlog.
Breaking this down further (pp. 6-7), the following number of ships have firm charters, up to and including:
- 2024: 41 of 68 ships
- 2025: 32 of 74 ships (+ an additional 8 entering optional charter periods)
- 2026: 24 of 74 ships
DAC will receive six new builds during the latter half of 2024, which will go straight into charters.
Capital Expenditure and Debt Repayments
DAC has no significant debt maturities until 2028. As of June 30, 2023, it had $293 million in cash and cash equivalents and an undrawn $360 million credit facility. Additionally, it reported that 62 percent of its debt is fixed rate. This is a reasonable strategy.
However, it has $312 million remaining payments on its new builds, due 2024-2025 ( 2022 annual report, p. 36 ).
Judging by its capital structure as of 2022, seen below, its revolving credit facility might be used, in part, to fund these ships.
Furthermore, the capital structure shows a company with a 16% debt load, allowing it to invest opportunistically.
Significant customers (counterparty credit risk)
The most important customers, as of 2022, of DAC, GSL, and CMRE are shown below using treemaps.
Of course, a collapse among the liner companies of Hanjin proportions could occur again. However, the trend toward consolidation in the container liner industry could increase transparency by limiting the number of actors. I believe none of the peers compared above is better or worse off.
(MPCC discloses only that Maersk and ZIM each "represented more than 10 percent of the Group's consolidated charter revenues in 2022" ( MPCC 2022 annual report , p. 52). Consequently, it is not included in the treemap above.)
Eagle Bulk Saga: Caught up in the Hold - and The Hatch Cover is Locked
DAC created waves in June when it was reported that it had acquired about 10 percent of NYSE-listed Eagle Bulk for $68 million. The Eagle Bulk board responded immediately by creating a poison pill , effectively preventing a hostile takeover. DAC was not amused and sent an open letter to the board of Eagle Bulk, where it questioned the actions of Eagle's board.
In its Q2 earnings call , DAC management commented:
With respect to Eagle, we were able to purchase shares in a company we believe had best-in-class corporate governance practices at a significant discount to our perception of the company's net asset value. [The actions taken by the Board in response] fundamentally alter our view of Eagle's corporate governance. We are concerned with these developments and are seeking clarification from the Board of Directors of Eagle.
Furthermore, CEO John Coustas cited "the strength of our balance sheet" as the reason DAC is "uniquely positioned to deploy capital in various ways to grow our revenue base and earnings" as its reasoning behind acquiring Eagle Bulk shares. And, "now we again see opportunity." In its latest investor presentation, dated August 7, 2023, DAC cites "diversification in the dry bulk sector" as part of its "Financial strategy" (p. 7), but none of the 37 slides that follow present an argument as to why an investor should care about "diversification into dry bulk." In contrast, seven slides argue why container freight market dynamics favor DAC's ability to generate shareholder value.
How much is $68 million to DAC? For comparison, it generated $285 million in free cash flow from twelve months to June 2023, and its total capitalization is about $3 billion. An amount comparable to a quarter of its annual free cash flow - or 2% of its total capitalization - has netted DAC a holding it cannot build, as it's prevented from adding to it - and cannot sell, as attempting to sell off a 16.7% stake would send the share price falling.
Finally, let's review the market outlook.
Market outlook
Supply Side: Large Global Orderbook - An Issue Mostly Affecting Larger Ships?
We're borrowing this image from MPCC's Q2 2023 presentation , p. 13:
It is immediately apparent that the more extensive segments (12,000 TEU and up) are characterized by a relatively young fleet and many new ships entering the market during the next few years. Conversely, the smaller segments (below 12,000 TEU, but especially the 3,000-8,000 TEU segment) are characterized by an aging fleet with fewer new ships set to enter the market. All else equal, this points to carriers serving smaller market segments being less vulnerable to downward pressure on freight rates.
Using each company's TEU capacity and age data, let's recreate the image above. The result can be seen below:
Most of Danaos' fleet falls in smaller classes (below 8,000 TEU), with 45 of its 69 ships in these categories. This is also true for its peer, Global Ship Lease, with 57 ships (out of 68) in the below 8,000 TEU classes.
In other words, it operates in market segments where pressure from incoming new builds is much smaller than for the 12,000+ TEU classes. In these more extensive classes, ships are also generally much younger. There are also older ships in <8,000 TEU classes, meaning there's more scrapping potential.
DAC also refers to sailing speeds, which have declined by 4.5% since 2022:
Decreasing sailing speeds has the effect of reducing the global supply of TEU capacity.
Demand Side: Intra-Regional Demand Forecasted to Exceed Supply
In its Q2 presentation (p. 12) , peer MPZZF argues that demand will exceed supply for intra-regional trades - the 5,200 TEU or smaller segment - in the following years:
Twenty-eight of DAC's 68 ships are less than 5,200 TEU.
DAC itself cites time charter rates stabilizing at higher than historical levels:
This is an indicator that DAC can re-contract its vessels at attractive terms.
Regionalization (de-globalization)
The world is getting less global and more regional. This WEF article argues that the world has been getting less globalized since 2008, citing "the 2008 financial crisis, trade wars, disenfranchised middle classes in developed economies and rising concerns about over-reliance on trade with single partners" as reasons. A Brookings Institution podcast discussed evidence for deglobalization. Among many things, it continued on the single trade partner issue: "It’s true that trade between the U.S. and China declined, but other countries picked up the slack. So, there was [a] reallocation of trade flows, but we didn’t see trade collapsing."
What could all of this - reallocation of trade flows in particular - mean for container shipping? A less globalized world and a China prepared to shift its economy into a services economy could spell the decline of China as the world's number one manufacturing and export hub opens up new opportunities that only some countries are ready to take over. This could mean that the market for mega-ships, going back and forth between huge hubs, is limited - and the medium-to-small markets grow.
Conclusion
This article has considered Danaos Corporation and compared it to more or less similar peers in the mid-size containership lessor industry. A fundamental analysis showed that DAC performs well, and a company review showed that it has a strong balance sheet, enabling opportunistic use of capital. However, it has recently entered a quagmire by acquiring a large share of NYSE-listed Eagle Bulk. The board of EGLE has employed a poison pill, which prevents DAC from proceeding. Fortunately, the investment in EGLE constitutes only a tiny amount relative to DAC's total capitalization.
One possible reason for its peer MPZZF's very aggressive dividend policy is the marketplace dynamics where it is listed. Shipping is a highly regarded sector on the Oslo Stock Exchange, and aggressive dividend payouts are the norm rather than the exception. A 4% yield won't turn any heads over there. However, as we have seen in this analysis, the kind of yield that MPZZF provides might need to be revised.
The market outlook for the mid-size containership industry seems promising, especially given that charter rates have stabilized at higher-than-pre-pandemic levels.
Appendix: Custom Calculations Explained
Significant customers . This calculation used information from each company's SEC filings (the 2022 20-F):
- Danaos Corp, p. 9
- Global Ship Lease, note 13, p. F-36
- Costamare, p. 15
Fleet composition by TEU and age. Fleet data from the four companies compared in this analysis was collected from their websites. Using the categories from the MPZZF slide mentioned above, the data was prepared by analysis by calculating what TEU size bin and age each vessel belonged to. The resulting data set allowed the creation of the graph seen above.
For further details see:
Danaos Corporation: Tough To Beat