2023-07-03 08:34:30 ET
Summary
- ZIM Integrated Shipping has experienced significant selling pressure following a net loss of $58 million in Q1, leading to a suspension of dividends.
- The negative sentiment is already reflected in the company's valuation and ZIM stock remains a good choice for those betting on the shipping industry's recovery.
- I downgrade the rating to a hold, but remain invested in anticipation of a cyclical profit recovery in 2024.
ZIM Integrated Shipping Services Ltd. ( ZIM ) has seen significant selling pressure following the company's first-quarter results, which included a net loss of $58 million. The immediate result of the net loss was that container freight company shareholders did not receive a dividend for the first quarter and are likely to see a complete suspension in the near future.
Having said that, I would argue that the dividend suspension for 1Q-23 has resulted in extremely negative investor sentiment, and I would advise investors to avoid selling into the weakness.
I have covered ZIM Integrated Shipping Services in March as a Strong Buy and I am changing my outlook on the stock as the shipping company recently halted its dividend and the stock price plunged to new lows in response.
Although I am downgrading my rating to hold, I continue to believe that ZIM Integrated Shipping Services is a good choice for investors who want to bet on the shipping industry's recovery.
D ividend Halt, Low Spot Rates Fully Priced Into ZIM’s Valuation
The stock price of ZIM Integrated Shipping Services fell after the company announced that it will not pay a variable dividend in the first quarter. Following earnings, ZIM dropped to new lows, reflecting extremely bearish investor sentiment.
Passive income investors who purchased the high-yield stock primarily for the dividend have most likely already closed their positions after the company announced that the dividend has been suspended.
In addition to the dividend suspension, the market, in my opinion, has already fully priced in the drop in spot rates that has occurred since 2021.
The Freightos Baltic Index tracks the daily movement of global freight rates for 40' containers (FEU) on twelve major global shipping routes. The price index has plummeted in the last year due to a slowdown in global container shipping growth and inflationary pressures. Shipping a 40' container currently costs around $1,300 on average, with a peak of more than $11,000 in September 2021.
The Freightos Baltic Price Index (Freightos Baltic Index)
I believe that the shipping market downturn has already been fully baked into ZIM Integrated Shipping's valuation multiple, and that the shipping company's stock is now primarily a bet on recovering spot rates.
ZIM Integrated Shipping Services experienced a significant decline in its key operating metrics as a result of declining shipping prices, with the full force of the deterioration hitting the company in the first quarter. The company's adjusted EBITDA fell 26% YoY, and short-term pricing pressure as well as capacity oversupply may hurt the spot market in the near term.
Q1-23 Financial Highlights (ZIM Integrated Shipping Services)
ZIM Integrated Shipping Services is not the only shipping company facing increased industry uncertainty. According to DHL, the average carrier's net profit fell 78% YoY in the first quarter.
Carrier's Average Net Profit (DHL)
When Can Investors Expect A Rebound In Spot Rates?
The stock of ZIM Integrated Shipping Services has a direct relationship with the recovery of spot rates and container volumes. The market currently expects ZIM Integrated Shipping Services to lose money in 2023 and 2024, with annual losses of $2.60 per share.
Earnings Estimate (Yahoo Finance)
The container and dry bulk markets are deeply cyclical with shipments typically accelerating during economic expansions and strong business and consumer spending.
Global economic growth is expected to remain resilient in 2024, supporting the odds for a shipping market recovery in 2024, and the much touted recession, which was expected to hit the U.S. economy in 2023, might not be happening at all this year .
Global Economic Growth (IMF)
Changing Investor Base For ZIM Integrated Shipping Services
Passive income investors were likely the primary investor cohort that purchased ZIM Integrated Shipping Services stock in the past, but I believe this is changing.
Though I don't expect the dividend to return in the near term, a new investor demographic may come across ZIM Integrated Shipping as a rebound play in the container shipping market.
Reaffirmed EBITDA Guidance
Despite a drop in EBITDA and ocean freight rates in the first quarter, ZIM Integrated Shipping Services maintained its EBITDA guidance of $1.8 billion to $2.2 billion for 2023.
Given that the container company experienced a 37% drop in sales and a 62% drop in adjusted EBITDA in 1Q-23, the reaffirmation of ZIM's EBITDA guidance gives investors hope that the shipping downturn will not be as severe as they fear.
Reaffirmed Guidance For 2023 (ZIM Integrated Shipping Services)
A Strong Balance Sheet Is The Best Recession Insurance
To understand why I am holding ZIM after the dividend suspension, we must look at the company’s balance sheet.
ZIM had $1.90 billion in cash and cash equivalents at the end of the first quarter, plus another $1.06 billion in 'other investments' on its balance sheet, bringing the total cash and investment value to approximately $2.95 billion.
ZIM has approximately 120 million shares outstanding and $24.58 in cash per share. ZIM is currently valued at less than half its cash and investment value, which, in my opinion, reflects a very high margin of safety.
Consolidated Balance Sheet (ZIM Integrated Shipping Services)
ZIM Integrated Shipping Services had net debt of only $381 million at the end of the first quarter, reflecting a net leverage ratio of 0.1x. While I judge the low leverage ratio to be beneficial for the company during a recession, I think the other factors mentioned in this article justify a more cautious stance and a hold rating.
Investors can also buy ZIM Integrated Shipping Services at a significant discount to book value, which means they get all of the company's operating systems, shipping assets, and customer pool for free.
ZIM Integrated Shipping Services is currently trading at 0.29x book value, well below the company's 2021 valuation of 2.22x book value. While the market may have been overly optimistic two years ago, valuing ZIM at 2.22x book value, I believe the market is now overly pessimistic.
Annual Valuation (Morningstar)
Why ZIM Could See A Higher/Lower Valuation
In my opinion, the risks associated with ZIM are concentrated on the macro front, particularly as they relate to spot rates. Cargo freight rates have fallen precipitously in 2022 and 2023, with ZIM's average ocean freight rate falling from $3,848/TEU to $1,390/TEU in the first quarter, and a recession could push rates in the spot market even lower in the short term.
Furthermore, there is a risk of market oversupply, which could keep spot rates low for a while longer. New container supplies, which are expected to enter the market in 2023 and 2024, are expected to keep the container market under pressure in the near term.
Container Fleet Development (S&P Global)
My Conclusion
True, ZIM saw a drop in key performance indicators such as average freight rates, EBITDA, and cash flow in the first quarter, but I believe the dividend suspension will benefit ZIM Integrated Shipping Services in the long run.
For one thing, in my opinion, the dividend suspension has been fully reflected in the company's valuation. Two, a completely new type of investor may come across ZIM Integrated Shipping as a potential rebound play in the distressed cargo freight market. While passive income investors have historically dominated the trade, I believe that the majority of investors who previously purchased ZIM have already sold following the 1Q-23 dividend halt, limiting selling pressure.
While the dividend is no longer a compelling reason to purchase the shipping company's stock, the prospect of a cyclical profit recovery in 2024 is compelling enough for me to remain invested, though I am downgrading my rating to hold.
For further details see:
ZIM Integrated Shipping Services: Time To Be Cautious (Rating Downgrade)