2024-01-07 11:40:00 ET
Summary
- Danaos' strategic investment in Eagle Bulk, initially met with skepticism, has proven highly profitable.
- Eagle Bulk's merger with Star Bulk Carriers and a surge in dry bulk rates amid the Red Sea blockade have contributed to Danaos' share price rally.
- Still, significant upside prospects remain from Danaos' core investment case alone.
Note: Please be aware that I have previously discussed Danaos ( DAC ) on multiple occasions, so consider piece this as a follow-up to my earlier writings about the company.
When Danaos' leadership made the strategic decision to invest in Eagle Bulk ( EGLE ) last summer, acquiring a substantial 16.7% stake in the company, I initially harbored skepticism.
At the time, I couldn't help but feel a tinge of frustration and even mild irritation. Having endured several quarters of disappointment in Danaos' capital returns, the move to invest in Eagle Bulk seemed like the proverbial last straw in a series of underwhelming capital allocation decisions.
Danaos was then trading at a considerable discount to NAV (and continues to do so). Rather than prioritizing share buybacks, a direct route to immediate per-share value accretion, the management opted for exposure to the dry bulk market.
This decision appeared both unexpected and desperate, given that Danaos' fleet was exclusively composed of containerships prior to this. It conveyed an impression that, with the cash influx from contractual charters, management was unsure how to utilize the funds best and ended up venturing into "other investments" that only added uncertainty to an otherwise predictable multi-year cash flow outlook.
However, my initial skepticism turned out unnecessary, as Danaos' strategic investment in Eagle Bulk and the company's bold venture into the dry bulk industry, exemplified by the acquisition of five Capesize bulk carriers in the secondhand market, has yielded substantial returns.
While my initial concerns echoed those of many shipping investors, hindsight reveals that Danaos' management exhibited remarkable foresight, showcasing the significant results that decades of experience in the shipping industry can bring.
Danaos' winning move can be broken down into two parts:
- Eagle Bulk's merger with Star Bulk Carriers ( SBLK ).
- A sharp rise in dry bulk rates following the current Red Sea blockade.
Let's take a look at each catalyst.
The Eagle Bulk/Star Bulk Merger
The graph below shows Eagle Bulk's price returns since Danaos invested in the company ( June 26th when the full position was completed). The graph also points to the merger's announcement day (December 11th) with Star Bulk Carriers, after which, Danaos' investment became profitable.
EGLE's Performance since Danaos' Investment (Koyfin)
Eagle Bulk shareholders emerged victorious in this merger, set to receive a favorable exchange rate of 2.6211 shares of Star Bulk common stock for each share of Eagle common stock held. This represented not only a 13% premium, calculated based on the closing price of Eagle Bulk the day before but also a significant advantage, which lay in the nature of this stock-based merger. Unlike an acquisition with a fixed or partially cash-driven price, the stock-based structure left the upside potential for Eagle Bulk entirely "unlimited."
With Star Bulk's stock price continuing to rise in the following weeks due to substantial dry bulk rates amid the ongoing Red Sea challenges, Eagle Bulk stock has also continued to rise.
Danaos spent a total of $68.2 million to acquire 16.7% of Eagle Bulk stock, or 1,552,865 shares. This implies a cost basis of roughly $44.00. The stock is currently trading at $56.24. Danaos has already made nearly 28% on this investment, excluding dividends, or about $19 million.
This brings us to the second catalyst.
Dry Bulk Rates On The Rise Amid Red Sea Challenges
I won't go over why the ongoing Red Sea challenges are beneficial for shipping rates because the whole explanation can be found in my most recent article on Costamare ( CMRE ). Please read that article, which explains the rationale. Fellow S.A. Author Henrik Alex has also written a very informative article on the topic, but he focuses on ZIM Integrated ( ZIM ) instead.
In recent days, the situation hasn't changed at all. In fact, at this point, the Red Sea has been overwhelmingly abandoned, with most operators having diverted their journeys through via The Cape of Good Hope.
Container ships heading toward Europe and/or North America (Bloomberg Terminal)
Observe the remarkable resurgence in dry bulk rates over the past few weeks. Specifically, direct your attention to the upward trajectory of the blue line, indicative of the Capesize class – the very class into which Danaos strategically acquired five dry bulk vessels. In retrospect, this decision appears thoughtful and well-timed.
Notably, the ongoing rally extends across all classes, including those operated by industry leaders such as Eagle Bulk and Star Bulk. The sustained rally in rates has not only propelled the stocks of these companies higher but has also proven advantageous for Danaos, particularly through its holding in Eagle Bulk.
Note that January FFAs as of today (January 5th) climbed to $24.2K, signaling ongoing strength.
Cape Rates (braemarscreen.com)
Conclusion
In hindsight, my initial doubts about Danaos' investment in Eagle Bulk have been convincingly dispelled. The management's strategic decision, marked by a well-timed merger with Star Bulk and an entry into the dry bulk market just before the challenges in the Red Sea unfolded, has translated into significant returns.
Due to a backdrop of a thriving shipping industry, marked by increasingly favorable conditions for investors, rising net asset values of vessels in the wake of ongoing developments in the Red Sea, successful investments by Danaos, and a heightened commitment from management to rewarding shareholders, Danaos's stock has experienced a remarkable surge in recent weeks.
Danaos' 1Y Price Change & Stock Price (Koyfin)
Maintaining my conviction in Danaos, my fundamental thesis remains the same. Anchored in the anticipation of substantial cash flows fueled by the company's long-term leases, I continue to be bullish on the stock despite the ongoing market rally.
The dry-bulk-related gains and increased investor interest in Danaos due to the Red Sea situation are welcome, and I am happy they have been a catalyst for the stock to move higher.
Nonetheless, I am optimistic about the prospect of further gains, fueled by Danaos' robust revenue backlog, its trajectory towards achieving a net cash position, and the promising trajectory of improving shareholder returns.
For further details see:
Danaos: Eagle Bulk Stake Pays Off Big Amid Merger With Star Bulk, Red Sea Blockade