2023-08-25 03:20:59 ET
Summary
- The maritime transportation sector is subject to economic conditions and investor mania, leading to exceptional highs and lows for investors.
- Recent conditions in the industry have worsened due to fears of recession, inflation, and the war in Ukraine.
- We believe that the market has mis-priced Global Ship Lease due to the time charter nature of its business.
Background
In the world of investing, cyclical companies are not just subject to economic conditions, but to a degree of investor mania as well. Companies on the upswing are touted by bulls as if the good times will never end, while those are the downswing are often left by the wayside by disillusioned investors tired of the ride. Nowhere in the market is this more true than in the maritime transportation sector: a capital intensive, macroeconomic-sensitive industry that can deliver exceptional highs and lows for investors.
The last few years have provided a boom for shippers, overall, though in the last year conditions have worsened as fears of a worldwide recession, inflation, and the war in Ukraine have dampened demand for international seaborne shipment.
The above 10-year chart of the Baltic Dry Index showcases the spike in container prices during the Great Supply Chain Squeeze of 2021 (our non-official name for the event) and the subsequent grind down of container prices back to historic norms.
This return to more normalized pricing has not affected all shippers equally, and today we want to discuss a company which we believe has a bit of time on its side and which, in our view, is being mispriced by the market--Global Lease Shipping, Inc ( GSL ).
Let's dive in.
How It's Billed
There are a number of ways that shipping companies can make money--they can enter the spot market, offering up ships to those willing to pay the going rate per day. Companies can also pool resources with other companies and charter in vessels in hopes of earning a spread on the day rate versus what they pay the vessel owner. Another alternative for companies is to enter into charter out agreements, where a shipowner takes the other side of a charter in agreement and leases ships to another company hoping to make money on the day rate spread.
All of the methods described above have their own risks and uncertainties--in times when shipping capacity is scarce, spot charter participants have the chance to clean up while ship availability is low and spot prices are high. Those engaged in time charter business can set prices in advance, which may make for better sleep at night but also has the possibility of backfiring if going rates spike during the time charter contract, or if they are materially lower come renewal time.
Global Ship Lease engages in time charter operations, and it appears to have found itself in a best-of-all-worlds situation, with contracts set for its 68 container ships extending out into 2024 and as far out as 2028 (we only noted two ships, the GSL Elizabeth and the Maira with charter expiry's in 2023).
At this particular moment in time, Global Ship Lease has the good fortune of being a charter out operation, in that they lease out the use of their ships to other companies at pre-determined prices. They also happen to be leasing ships at an opportunistic time, when spot rates have fallen far below the rates at which previous contracts were negotiated.
This matters for Global Ship Lease, because according to the company's latest 6K filing on August 3rd, 2023, the company had 2.3 years remaining on a weighted average basis for its charter out fleet contracts, representing about $2 billion of locked in revenue. On the most recent conference call , management also noted that the remainder of 2023 is fully booked and that roughly 80% of 2024's owner's days are also booked.
Debt & Value
In a cyclical industry, the discipline of a management team can make or break a company. Thankfully for shareholders, Global Ship Lease has a capable and disciplined management team.
For example, none of the company's debt is fixed, but floats at a rate above SOFR. Global Ship Lease maintains an effective hedge, however, against their interest rate risk. In terms of debt, Executive Chairman George Youroukos noted on the conference call that:
Our floating rate debt remains fully hedged with SOFR capped at 64 basis points, and we still have headroom under the cap to accommodate additional floating rate debt should we incur it. Our overall cost of debt remains close to 450 basis points, which is way below interest rates prevailing in the market today.
It may seem tempting to say 'Oh, well of course they would hedge their debt,', but we believe that this should not be taken for granted and should be seen as a sign of prudent management. Interest rate hedging is no simple task: it requires time, expertise, and money, and readers would do well to remember that even many sophisticated banking operations with massive loan exposure were shown during the regional banking crisis earlier in 2023 to have maintained zero hedges against the interest rate risks sitting on their balance sheets.
As far as valuations are concerned, Global Ship Lease is quite cheap at today's levels, with forward valuations nearing three year lows, trading at just 2.2x forward earnings estimates and 3.2x EV/EBITDA. This tells us that the market is pricing in quite a bit of pessimism in the stock, which we'll touch on shortly in our reverse discounted cash flow model discussion.
Also notable is that, with a market capitalization of just over $650 million, the company's board recently approved a new authorization for $40 million of share buybacks, or roughly 6% of the company's market cap.
To further drive home the fact that the stock is cheap, the analysts who cover the company estimate that in FY 2024 and FY 2025 the company will generate combined EBIT (yes, EBIT, not EBITDA) of $676 million--more than its current market capitalization. We highlight EBIT because shipping is a capital intensive business with, generally, a lot of depreciation to record. The fact that the company is expected to out-earn its market cap prior to the deduction of depreciation (and we aren't even counting the expected remaining EBIT in 2023), is... well... not something you see every day.
So, why is the stock so cheap?
In our view, today's depressed prices reflect the market's uncertainty about the spot market and what the state of the charter market will be when the company's current contracts are up for renewal. Indeed, management noted that "the charter market seems to lack direction or strong conviction as reflected by a relatively short charter duration in most recent cases." We believe that today's inexpensive stock price is, at least in part, a reflection of current market uncertainties which may or may not exist when the company's contracts are set to renew.
What's Priced In?
Well, a lot of pessimism, mostly.
To arrive at today's stock price (roughly $18 around the time of this writing) using a reverse discount cash flow model, we had to model a 10% tax rate (even though the company currently pays little to no tax), and an annual 8% decline in revenues over five years. We also adjusted EBIT margins down after year two to a historical norm of 40%, which comports with the expectations of the lone analyst who projects EBIT for the company three years out. In our minds, however, a consistent 8% drop in revenues seems to be a lot--especially keeping in mind that if the company's tax rate doesn't rise, in fact, then revenues would need to sink much further than our projection.
Further adding to the pessimism implied in the stock is the fact that we utilized a 9% WACC, which accounts for the cost to the company of debt and equity as a source of capital. Given that the company can access credit facilities relatively cheaply (see the comments above from the Executive Chairman), we think that 9% is a fairly high estimate of the company's actual cost of capital.
The Bottom Line
At the end of the day, we understand the business that Global Ship Lease is in, and that markets have rarely--if ever--assigned market premiums to maritime shipping companies. However, we believe that the depressed valuations of the shares does not reflect the true value of the stock given its locked-in cash flows. We further think that the lack of growth and overall pessimism for future prospects that appears to be baked into today's stock price is not indicative of Global Ship Lease's true prospects, but rather to us the stock is a casualty of near-term market fears and a shipping spot market that has fallen back to Earth. For investors of a certain risk tolerance and ability to stomach high volatility, we think that Global Ship Lease presents an interesting opportunity today.
For further details see:
Global Ship Lease: Dirt Cheap For Locked In Revenues