2023-06-15 11:45:37 ET
Summary
- This is a follow-up to a contrarian idea I first introduced on ZIM last September.
- At that point, the prevailing sentiment on ZIM was quite bullish and the stock featured a dividend yield of over 100%.
- Indeed, since then, the dividend trap has exploded, the stock suffered large total losses, and the valuation collapsed.
- Today, in case you are attracted to its discounted valuation(0.55x TTM P/E and 0.31x P/B), I will explain why it looks like a value trap to me.
Thesis
In September 2022, I saw ZIM Integrated Shipping ( ZIM ) as a contrarian bearish opportunity against the bullish trend. At that time, the prevailing investor sentiment on the stock was strong for several reasons. And the main ones are a high current dividend yield (107% at that time) and an expectation for reasonable shipping volume and profitability ahead.
The goal of my article was to argue against these reasons. To me, the dividend was a trap, and the fundamental headwinds (which I elaborate on below) are too strong. No rational mind would hope the 100%+ yield to last. It is just many bulls expected the dividend payments could compensate for the risks before the cut (or elimination). However, my view was that the cut could come sooner, and the dividends could not make up for the deterioration in its fundamentals. That is indeed what happened next. Since last September, ZIM has announced that there will be no dividend for Q1 2023. The stock suffered a large price correction of ~44% and a total loss of ~13%, in contrast to the S&P 500’s 18% gain.
After such large price/total losses, the stock is trading at a heavily discounted valuation. To wit, at the price as of this writing, its P/E is only 0.55x on a TTM basis and P/B only 0.31x. In case you are attracted to its discounted valuation, the remainder of this article will explain why I see its current setup as a value trap.
Current valuation is indeed cheap
The valuation is indeed attractive across all metrics. As seen, its TTM P/E stands at 0.55x, TTM P/B stands at 0.31x, and TTM EV/EBITDA stands at 0.8x. These multiples are not only cheap on an absolute basis, but also heavily discounted on the sector average.
However, I see a textbook value trap here for two main reasons. First, I see strong headwinds for its earnings to deteriorate so that FWD P/E is not cheap at all. And second, I see the combination of profitability deterioration and the use of high leverage as very likely to cause book value losses. And as a result, its FWD P/B is not cheap either.
FWD P/E not cheap due to profitability headwinds
The shipping industry is highly cyclical, and freight rates have been declining since their peak in 2021 (see Drewry’s data in the next chart). This is due to a number of factors, including the easing of supply chain disruptions and the increase in new vessel capacity.
The renormalization of the shipping rates has caused ZIM’s earnings to decline sharply over the past 1~2 years. As seen in the next chart, its EPS peaked at more than $12 per share in early 2022 and has declined to the current negative $0.5 in the most recent quarter. The EBITDA, a key measure for shipping stocks due to the capital-intensive requirement, declined 85% YOY in its most recent earnings report . And looking ahead, consensus estimates projected ZIM’s EPS to stay in the negatives for the next 2 years. Actually, consensus estimates see a worsening in earnings for the next two years (see the second chart below). To wit, they estimated a loss of $2.55 per share for 2023 and a loss of $2.9 per share for 2024.
Source: Seeking Alpha data Source: Seeking Alpha data
I agree with such a pessimistic outlook and see a range of strong challenges against ZIM in the near future. Admittedly, many of these challenges would impact the entire shipping sector such as fuel/inflation costs, lower shipping rates, or lower shipping volume due to a potential global economic slowdown or trade frictions. But I will argue that ZIM will suffer a more sensitive impact from these headwinds at least for a few reasons. First, ZIM’s geographical exposure is more concentrated on the transpacific routes. Due to the macroeconomic uncertainties in the Asia-pacific region (especially the trade tension between U.S. and China), the shipping volume of these routes is more uncertain. Its other competitors (such as Hapag-Lloyd) have exposure to other routes and will be less exposed to such risks. For example, Hapag-Lloyd has a strong presence in Europe and North America. Besides geographical exposure, the impact of inflation and high fuel costs would be uneven also. Both ZIM and its close peers have suffered profitability (both in absolute dollar amount and also in terms of margins) headwinds in the past year or so. However, the decline experienced by other peers (such as Hapag-Lloyd and Maersk) has not been as sharp as ZIM's decline. The top factor (again, besides different routes) in my mind is that ZIM's fleet is older and less efficient than the fleets of its peers (especially compared to some of the more recent entrants such as Maersk).
Next, I will analyze its balance sheet and argue why the valuation is not appealing in terms of its FWD P/B ratio either.
FWD P/B is not cheap due to balance sheet risks
ZIM is currently priced only at ~0.3x of its book value, near the lowest point in the past year (see the top panel of the chart below). However, I am concerned that the P/B ratio is not as low as on the surface due to the loss of its book value. As seen, the company has lost a substantial amount of its BV and also TBV (tangible book value) in the past quarter. To wit, its BV declined from ~$5.9B in the past quarter to the current ~$5.1B (i.e., a decline of about 14% in one quarter). And the TBV declined to a similar degree, from about $5.8B a quarter ago to the current ~$5.0B, also about 14% QoQ.
Looking ahead, I am concerned that the losses will continue and hence its FWD P/B can be substantially higher than 0.3x. In particular, ZIM used to have a net positive cash position, which is a key asset for the company. For example, in 2022 Q1, it had a net positive cash position of ~$280M on its ledger, representing more than 10% of its total market cap at that time. However, due to declined cash flow, CAPEX spending, debt service, and dividend payments, its cash position deteriorated by $353M in the past quarter (see the next chart below) and now its cash position has become net negative.
I do not see how the above issues can be resolved in the near term. For example, it will take time (if possible at all) to change its routes and shift its geographical exposure substantially. And the same arguments apply to its fleet. I do not see the shipping rates improving in the near future too. In its recent earnings call, ZIM reaffirmed its 2023 EBITDA guidance (in the range of $1.8 to $2.2B). However, this guidance hinges on the assumption of a recovery in BOTH shipping volume AND spot shipping rates. I see both assumptions as questionable. As a matter of fact, on the earnings call, ZIM management said they have not seen any signs of shipping volume improvement yet. And as such, I expect the loss of BV and TBV to persist in the meantime.
Other risks and final thoughts
I’ve focused on the downside risks for its profitability and balance sheet so far. Other downside risks include the continuation or even escalation of the ongoing Russian/Ukraine war and the trade wars among major global economies such as the U.S. and China. At the same time, I will point out some of the upside risks that could counter my thesis. As an extreme case, the government of certain regions and countries may interfere with freight rates to stabilize them. Inflation could ease and hence end the interest rate hikes, leading to an expansion of the economy and hence higher demand for ZIM’s shipping vessels.
To conclude, after the exploration of ZIM’s dividend trap, the stock now trades on heavily discounted valuation multiples on the surface. However, I believe that such multiples are not as attractive as on the surface. My view is that its EPS will remain negative in the next ~2 years or so due to the normalization of shipping rates and weakened demand ahead, especially for its transpacific routes. And its current TTM P/B ratio risks misleading investors, due to the combination of decreased cash flow, debt service obligations, and CAPEX expenditures.
For further details see:
ZIM Integrated: Dividend Trap Turned Value Trap