2023-10-06 10:45:36 ET
Summary
- The shipping industry is volatile and unpredictable, but investing in companies with a forward backlog, such as GSL, improves stability and cash flow visibility.
- The company's capital allocation policy is reliable, with a healthy balance between generous dividends, share repurchases, debt reduction, and fleet expansion.
- Following GSL's recent dip, the stock offers a favorable range for accumulation, with high upside potential and a wide margin of safety.
- Choosing to sell Series B Preferred stock in favor of acquiring more common stock could be a prudent move given the latter's more favorable risk/reward profile.
After closely monitoring the dynamic shipping markets for the past two years, I've gained valuable insights into what makes this industry both captivating and, simultaneously, potentially perilous for many investors. The confluence of volatility driven by diverse macroeconomic factors impacting each shipping asset class, coupled with the unreliability of management teams and erratic capital allocation policies, transforms this industry into a thrilling roller coaster ride.
In response to this challenging landscape, I've strategically positioned my largest holdings in companies that provide a degree of predictability. Consequently, my primary investments are in firms with a forward backlog, ensuring high cash flow visibility for multiple years ahead. This approach adds a layer of stability to my investing journey in the shipping industry, mitigating some of the inherent turbulence.
Hence, my largest positions include names such as Global Ship Lease (GSL), Danaos Corporation (DAC), and SFL Corporation (SFL). Precisely due to their considerably better cash flow visibility compared to peers with more exposure to the spot markets, these companies have also been able to pay rather substantial dividends during the time I have held them.
Let's shift our attention to GSL today. The last time I covered the stock was this May, explaining my bullish thesis, which was driven by GSL's discounted valuation and notable dividends and buybacks.
The reason I am now revisiting the stock is that after its recent dip, I believe that the common shares once again trade at a very favorable range for accumulation. At present levels, the stock not only offers a notable yield but also presents a tempting combination of high upside potential and a wide margin of safety.
GSL's Stock Price Chart (Seeking Alpha)
Simultaneously, I believe that Global Ship Lease's Series B Preferred stock ( GSL.PR.B ), which I had previously suggested holding along with the common for its much safer ~8.5% yield, is now worth selling to buy more of the common stock.
GSL's Capital Allocation Doesn't Disappoint
I am becoming more optimistic about GSL whenever the stock experiences a dip, primarily because the company's capital allocation policy is highly reliable and unlikely to let you down.
To begin with, GSL's generous dividend is a central component of the company's capital allocation policy. At the stock's current levels, the $1.50 annual dividend translates to a yield of 8.6%, which ensures a predictable income stream in the face of the stock's inherent volatility.
Importantly, the dividend is highly reliable as it is very well-covered by GSL's earnings. This year's projected EPS of $8.61 implies a very comfortable payout ratio of just 17.4%.
GSL's EPS Estimates (Seeking Alpha)
Considering that GSL's dividend constitutes a mere fraction of its earnings and operating cash, the company is left with a surplus of excess cash every quarter. Its abundant liquidity provides opportunities for strategic capital allocation in share repurchases, debt reduction, and fleet expansion.
This is precisely why GSL has earned my admiration: The company's brilliant capital allocation strategy adeptly addresses these avenues, promising a highly accretive outcome for shareholders.
In contrast, I was very disappointed recently when Danaos announced that it had taken an equity stake in Eagle Bulk Shipping (EGLE). Taking a speculative bet in another asset class (from containerships to dry bulkers) most likely frustrated most DAC shareholders in my opinion.
Based on my observations of GSL, it's evident that their management is particularly adept at striking a commendable balance between enhancing the balance sheet, ensuring shareholder rewards, and fostering the company's growth.
Regarding improving the balance sheet, GSL has made significant progress in paying down its expensive debt, thereby reducing its leverage and its cost of debt. Its leverage has declined by an outrageous 8.4X at the end of 2018 to 1.9X as of H1-2023. Its cost of debt has also fallen from 7.6% to just 4.5% during this period.
GSL's Deleveraging Progress (Q2 Investor Presentation)
In the meantime, unlike its peers (looking at you again, DAC), GSL's management has shown eagerness with regards to buying back shares, and the recent dip should only further encourage them to retire more shares on the cheap.
In its most recent Q2 results , the company reported that a total of 2,027,882 Class A common shares had been repurchased under GSL's $40 million buyback authorization for about $37.0 million. Consequently, GSL's share count declined by about 4.8% compared to last year, translating to a significant "buyback" yield. This return comes on top of the hefty 8.6% dividend yield.
Regarding allocating cash toward fleet expansion, last May, GSL announced an agreement to purchase four 8,544 TEU vessels for $123.3 million. While opting for fleet expansion may not be praised by money during a shipping company's peak earnings cycle, I am happy about these purchases as they are going to be accretive to EPS.
GSL's Value-Generative Acquisitions (Q2 Investor Presentation)
These vessels are part of a package deal that includes charters, and each vessel's contract covers a minimum firm period of 24 months from their Q2 delivery date, with the option for a 12-month extension at the charterer's discretion.
Although these vessels have been around for a while (with an average age of 20 years), I'm optimistic about the potential returns from this transaction. Considering management's anticipated EBITDA estimates and scrap values, I'm confident that this deal ensures a decent profit even in a worst-case scenario.
Moreover, there's the possibility of a significant profit for the company if it can extend the life of these vessels further. In fact, management has expressed that this transaction offers a "very asymmetrical" balance between potential reward and risk, justifying the purchase over additional repurchases or debt paydown (not that these avenues wouldn't be ideal, too).
Trading The Preferred for More Common Stock
Previously, I advocated for the merits of retaining GLS's Series B preferred stock in conjunction with the common stock. The compelling 8.5% yield, coupled with the inherent low volatility of its preferred nature, forged a harmonious blend, bolstering predictability and stability.
Nevertheless, as the common stock now offers an equal, if not superior, yield compared to the preferred, I am inclined to recommend divesting from the preferred in favor of increasing exposure to the common stock. This inclination is reinforced by my assertion that the common stock's margin of safety isn't significantly distant from the preferred, considering the current undervalued stock price and valuation at approximately 1.4 times the projected EBITDA for FY2023/24.
GSL' Projected EBITDA for FY2023/24 (Koyfin)
Moreover, GSL's preferred stock has recently maintained a position above its par value of $25 per share. While this situation indicates investors factoring in the imminent quarterly dividend into the share price, it also implies an absence of upside potential from the preferred. In this context, opting to divest from the preferred in favor of the common stock can be likened to exchanging a moderately or slightly overvalued asset for one that is significantly more undervalued.
The more the common stock stays at these levels, the more undervalued it becomes. This is due to the company's $2 billion forward contracted backlog, which guarantees ongoing deleveraging. Consequently, this widens the gap between GSL's market capitalization and shareholders' equity.
To provide context, GSL's shareholders' equity reached $1.07 billion by the end of June, growing from $966.5 million recorded at the close of 2022. The notable increase in shareholders' equity occurred all while the company was allocating cash to reduce its share count and pay a generous dividend.
Seeing significant upside from GSL's current share price of $17.8 and the current market cap of $625.6 million, the stock will remain one of my largest holdings. Simultaneously, due to its lack of extraordinary returns, I am no longer a holder of the preferred stock.
For further details see:
Global Ship Lease: Buy The Dip On The Common, Sell The Preferred