2023-11-30 10:29:36 ET
Summary
- Danaos Corporation stock has delivered a total return of 22.57% since my very first call in May 2021, outperforming the market. Time to update my thesis.
- Despite a drop in revenue, Danaos showcased resilience in Q3 FY2023 with a 90% charter cover and effective deleveraging.
- I believe that DAC's rally will continue, as its EPS figures appear to be underestimated and the stock seems to have already priced in most of the negative future developments.
- Danaos stock should be worth $87.82 by the end of FY2024 on a P/E of just 3x. Let it be my price target.
Introduction
I initiated coverage of Danaos Corporation ( DAC ) stock in May 2021. Since then, the stock has delivered a total return of 22.57%, significantly outperforming the broader market. In total, I have written 11 articles about Danaos - now you are reading my twelfth piece.
Seeking Alpha, Oakoff's 1st article on DAC stock
Today I decided to update my thesis after the company published its Q3 FY2023 results 2 weeks ago and the stock has risen even higher since then.
Seeking Alpha News, DAC
In view of the growth already achieved, I will try to answer the question: Does it still make sense to buy DAC shares at the current price level?
Recent Q3 FY2023 Results
In their recent Q3 report, Danaos fell slightly short of expectations with a Non-GAAP EPS of $7.26, missing estimates by $0.10. Despite the 8.0% YoY drop in revenue to $239.22 million, DAC surpassed consensus by $20.22 million.
Despite the decreased profitability in the liner industry and cost-cutting measures by major operators, Danaos showcased resilience. Q3 FY2023 Adjusted EBITDA amounted to $178.0 million, down $35.1 million from the same period in FY2022. Danaos successfully forward-fixed vessels above 10,000 TEU on profitable three-year charters for FY2024, resulting in a 90% charter cover.
Danaos emphasized effective deleveraging, maintaining a solid strategy, and a $2.5 billion charter backlog, providing cash flow visibility. As of September 30, 2023, the company's net debt was ~$111 million, with a favorable net debt to adjusted EBITDA ratio of 0.16x and total liquidity, including undrawn commitments, of $655.0 million (~48.5% of the market cap, which is a lot). Debt-to-equity keeps being extremely low:
In terms of FCF generation, Danaos remains a real cash machine: if we exclude last year's dividends from ZIM Integrated Shipping Services Ltd. ( ZIM ) from the calculation, DAC's 2023 [YTD] EBITDA and FCF from operations increased by 200% and 181% year-on-year, respectively:
CEO John Coustas announced an increased quarterly dividend and an additional $100 million share buyback authorization, demonstrating confidence in creating shareholder value. In parallel, the company is seeking to diversify into sub-sectors by investing in the Cape sector and holding a significant position [~16.7%] in Eagle Bulk Shipping Inc. ( EGLE ). They already acquired 4 Capesize dry bulk vessels and agreed to acquire 3 Capesize dry bulk vessels for $140.2 million, IR materials state.
I hear from various sources that analysts dismiss this diversification attempt as unnecessary and say they'd like to see more dividends or a more aggressive share buyback policy from Danaos. I don't think DAC's management is doing anything wrong: they have their own vision, and when I look at how the company's market capitalization is performing, that vision is working well so far.
In general, I am positive when it comes to allocating to dry-bulkers, whose fundamentals look quite good and promise a continuation of the bull market for the next few years - I have written about this in my previous articles regarding this sub-industry.
So to summarize the recent financials, I'd like to note that DAC's business continues to look good from a fundamental perspective.
DAC's Valuation Is Still Cheap
Following the publication of the Q3 results, analysts began to gradually raise the consensus forecast for the quarterly EPS figures.
The container shipping market, which witnessed an unprecedented peak in 2021 and 2022, is now facing intense pressure as consumers reduce spending, the global economy grapples with an inflation shock, and rapid rate increases occur. As a result, the Harpex index which reflects the worldwide price development on the charter market for container ships, is testing new lows :
Container spot rates have returned close to pre-pandemic levels, and container vessel charter rates, while dropping steeply, remain above pre-COVID levels. Container liners' profitability, which peaked at 50% in 2022, has sharply fallen, and a flood of new capacity is expected in the coming years, potentially leading to lower freight rates. The surge in orders for new container vessels, especially those focused on sustainability and dual-fuel capability, poses challenges amid a changing global trade landscape.
This is why the consensus EPS forecasts for DAC are so scary, as they predict a continuous decline until the last forecast year [FY2025]:
But even with such a sharp decline, it should be noted that DAC's earnings remain in positive territory and the implied P/E ratios do not even reach 3.5x after 'contracting by 26.43% in FY2025'.
Revenue is expected to be more stable than EPS.
That means Danaos will lose margin, which has been recovering lately [on a TTM basis].
It seems to me that the current EPS consensus estimates are too pessimistic with regard to the buyback program and should be revised upwards in the coming quarters. This process has already begun, as we have seen above.
Over the past 2 years, analysts have underestimated the company's EPS growth potential by about 8%, according to Seeking Alpha . If we assume the potential earnings surprise this time is 5%, then Danaos stock should be worth $87.82 by the end of FY2024 on a P/E of just 3x. Let it be my price target.
Your Takeaway
Investing in DAC comes with its fair share of risks tied to the shipping industry's ups and downs, market unpredictability, and reliance on things like charter rates and global economic shifts. The container shipping scene, where DAC operates, can be tricky with issues like overcapacity, changing freight rates, and shifting regulations. Global economic slowdowns, fuel prices doing their dance, and environmental rules add more layers to the risk cake.
Nevertheless, I believe that the rally will continue, as earnings per share appear to be underestimated and the stock seems to have already priced in most of the negative future developments. DAC is dirt cheap, as some say, with FWD P/E ratios of less than 3.5x and an FCF yield of almost 25%, which is falling, however.
Given the contractual nature of the company's earnings, I expect Danaos to continue to buy up its shares from the market, invest in dry bulk shipping, and pay dividends over the next few years - all of which combine to make DAC stock a good value play today, in my opinion.
For further details see:
Danaos Still Has A Lot Of Room To Run