2023-11-30 10:00:00 ET
Summary
- Danaos announced an increase in its dividend and the renewal of its share buyback program, reflecting a positive stance on returning value to shareholders.
- The company's strong performance persists, and with the ongoing surge in dry bulk rates, Danaos' debt-free vessels could further boost results.
- While certain investors may view Danaos' capital returns as underwhelming, the management has demonstrated prudence and a positive shift in the right direction.
A Recap of My Previous Update
In late October, I penned an update on Danaos ( DAC ), providing some constructive criticism on management's capital allocation practices. I highly recommend you read the whole piece for the full context of Danaos' "Journey of Frustration". While commending their operational excellence, I couldn't help but highlight a consistent oversight in rewarding common shareholders.
For followers of Danaos, it's evident that this aspect significantly influences the stock trajectory. With the lion's share of the company's revenues contractually secured, the primary uncertainty revolves around the strategic allocation of Danaos' substantial operating cash flows.
On the one hand, I give kudos to management for their deleveraging efforts and for extending their existing multi-year leasing contracts. On the flip side, the lackluster capital returns relative to earnings and some eyebrow-raising moves-like tossing money into Eagle Bulk Shipping ( EGLE ) and buying dry bulk vessels instead of snagging some of their own stock on the cheap-have left investors feeling a bit meh.
Q3 Results: A Breath of Fresh Air for Investors
While the Danaos investment journey has left many of us with a sense of stagnation, the company's Q3 results reported on November 14th breathed new life into the stock's investment case, pointing towards a more promising future. The company's operating results were robust, but more importantly, Danaos raised its quarterly dividend, continued to buy back stock, and announced another major share repurchase program.
Let's take a deeper look.
A Look At The Income Statement
Danaos' income statement didn't hold any surprises, with the majority of the company's vessels contractually secured under multi-year leases. Operating revenues decreased by 8.0% to $239.2 million, mainly due to slightly lower charter rates on some vessels and vessel disposals (average number of vessels down to 68 from 71). Operating Income also came robust, at $145.6 million.
Looking further down, there are some noteworthy items:
- Interest expenses declined from nearly $16.0 million to $4.3 million due to continuous deleveraging.
- Loss on investments of $8.4 million reflects a negative change in the fair value of Danaos' stake in EGLE (unrealized -$9.3 million) and dividends received from EGLE (realized +$0.9 million) during this period.
Excluding such items (like the $80.3 million in losses last year due to ZIM), Danaos' performance was pretty much stable. In particular, Adjusted EBITDA (which excludes such one-off items) of $178.0 million wasn't far from last year's $213.1 million.
Danaos' Q3 Income Statement (Danaos' Q3 Results)
A Look At The Cash Flow Statement
As I mentioned, Danaos' investment case overwhelmingly revolves around management's capital allocation priorities. Therefore, the cash flow statement is far more interesting. I have highlighted the items of interest in red.
Danaos' Cash Flow Statement (Danaos Q3 Results)
Moving down from the $149.5 million the company reported as cash from operating activities, we see a $98.3 million outflow related to vessel advances paid for Danaos' containership new builds and recently acquired dry bulk vessels. The screenshot below is from the relevant part of Danos' most recent 6K filings, should you need a broader explanation.
Fixed Assets, net & Advances for Vessels Acquisition and Vessels under Construction (6K)
While this was a significant outflow, I am happy that the company is self-funding these vessels and doesn't undertake any debt to expand its fleet. Management highlighted that 44 of its container vessels and four recently acquired dry bulk vessels are debt-free.
In fact, given that dry bulk rates have surged recently , these purchases are likely to be highly profitable for Danaos over time, given the lack of finance costs (i.e., interest expenses had they been funded through debt).
Speaking of debt, the second item I highlighted is Danaos' debt repayment of $6.9 million. The rather small amount clearly indicates that Danaos has slowed down when it comes to deleveraging. This makes total sense, as Danaos' net debt and net debt to LTM EBITDA hit a meager $111.1 million and 0.16X in Q3.
Finally, the third item I have highlighted is the $16.6 million Danaos' spent on repurchasing shares. In fact, by the time the Q3 report came out (November 13th), Danaos had repurchased a total of $97.4 million worth of stock under its share repurchase program of up to $100 million, announced in June 2022. While it took some time, the company repurchased and retired a noteworthy amount of stock during this period, reducing its share count by 6.1%.
Dividends On The Rise, More Buybacks Ahead
As previously highlighted, Danaos has successfully reduced its leverage, providing management with increased flexibility in capital allocation.
Indeed, a substantial portion of funds is directed towards new builds and vessel acquisitions, a segment that introduces an element of skepticism into Danaos' investment proposition, as discussed in my introductory paragraph. However, because not as much of the operating cash flows are now directed toward paying down debt, Danaos' leadership can consider returning higher amounts of capital to shareholders more confidently.
The recent dividend increase announcement and renewal of its share repurchase program strongly reinforce this perspective. Specifically, Danaos' quarterly dividend was raised by 6.7% to $0.80, while the Board authorized another share buyback program of up to $100 million.
But Is This Enough?
The market has reacted positively following Danaos' Q3 results, with shares currently trading near their 52-week highs. Clearly, investors appear to like management's positive direction toward returning higher amounts of capital.
However, I find that capital returns remain weak. The 6.7% dividend increase is almost hilarious for us, who have been frustrated by Danaos' lack of noteworthy capital returns. The $3.20 annualized dividend rate still implies a payout ratio of just over 10% against this and next year's consensus EPS estimates (see table below). Consequently, the recent dividend increase seems more like a placating gesture from the company to appease investors rather than a meaningful hike.
Danaos' EPS Estimates (Seeking Alpha)
Nevertheless, both the dividend hike and the updated repurchase program do indicate management's willingness to increase capital returns. So, while many investors, including myself, have criticized management on this topic, it has become increasingly challenging to cast a negative perspective on Danaos' leadership in light of these advancements.
This is particularly evident considering Danaos' management's prudent capital allocation strategy, underscoring their seriousness, even as shareholders also raise valid concerns of their own.
For the time being, I will continue holding my shares, collecting the 4.6% yield, and hoping that Danaos' undervaluation gap will continue to close.
Suppose management initiates the deployment of the new $100 million at a steady pace, and the debt-free dry bulk vessels continue to yield substantial profits amid increasing rates, alongside the consistent and robust cash flows generated by the main fleet.
In that case, it becomes highly probable that the stock will attract a notably higher valuation. This holds true even if a substantial portion of the cash is allocated towards fleet expansion and CAPEX. Simultaneously, the clean balance sheet, contract backlog, and low valuation should provide a wide margin of safety.
For further details see:
Danaos Q3: Dividends On The Rise, Buybacks Persist - Is It Enough?