2023-09-24 22:46:50 ET
Summary
- ZIM Integrated Shipping Services' shares may have already hit bottom after a brutal valuation decline of 57% in FY 2023.
- The odds of a recession by August 2024 are decreasing, indicating a potential avoidance of a severe earnings contraction.
- A rebound in shipping rates in August and the company's strong balance sheet contribute to the upgrade of ZIM Integrated Shipping Services to a hold rating.
- A complete dividend suspension could help ZIM improve its liquidity situation.
ZIM Integrated Shipping Services ( ZIM ) has suffered a brutal valuation decline in the last twelve months with shares down 57%. While I was previously cautious with regard to the container company, I now believe that ZIM Integrated Shipping’s shares may have already bottomed. Container shipping rates recovered, indicating surprise earnings potential for ZIM's third fiscal quarter. The odds of a recession by August 2024, although high, are decreasing, indicating that fewer analysts believe that the U.S. economy is going to suffer a recession. As a result, a severe earnings contraction may be avoided. Considering that ZIM Integrated Shipping Services has a very strong balance sheet and liquidity position, I am upgrading the shipping company to hold!
Previous rating
I have issued a number of sell ratings for ZIM Integrated Shipping Services, largely due to the devastating decline of shipping rates following the COVID-19 pandemic which in turn resulted in huge declines in the company’s free cash flow and adjusted EBITDA. Additionally, the shipping company reported very negative results for the second quarter and lowered its adjusted EBITDA guidance for FY 2023 by a massive 30%: Getting A Reality Check After Updated Outlook. However, given the rebound in shipping rates lately as well as ZIM Integrated Shipping Services’ solid liquidity, I believe shares may have already bottomed and an earnings contraction may not be as significant as some investors fear. As a result, I am upgrading ZIM from sell to hold.
Diminished odds of a severe cyclical earnings contraction, earnings surprise potential for Q3
The single biggest catalyst for ZIM Integrated Shipping Services' revenue growth and free cash flow is shipping rates. Shipping rates have fallen precipitously after the pandemic but have seen a bit of a recovery lately. Shipping rates for a 40-foot container rose from ~$1,500 per container in July to $1,800 per container in August, according to the Drewry Container Index which measures shipping costs. The uptick in rates is likely to have a positive impact on ZIM Integrated Shipping Services' Q3 earnings potential and for this reason, I would expect a number of upward EPS revisions, not only for Q3 but also for FY 2023.
Although shipping rates in recent weeks have fallen back to $1,500 per container, shipping rates are still 20% above pre-pandemic levels. The drop in shipping rates, of course, affects the entire industry and not just ZIM Integrated Shipping Services.
According to the OECD Economic Outlook from September 2023, the organization expects global growth to moderate from 3.0% in FY 2023 to 2.7% in FY 2024, but export-focused countries like China are expected to grow significantly faster. Moderating inflation is also a big reason why I believe the economic reality going forward could look much more resilient than investors think.
Investors are slightly more optimistic today than they were last month about the possibility of a recession hitting the global economy next year. To be clear, analysts still expect a recession to manifest by August 2024 and according to Statista the odds of such a recession are currently 60.83%. But they are also down from 66.01% in August, which is likely a reflection of moderating inflation.
Dividend suspension should lead to improved liquidity position
Besides freight rates in the spot market, the most important figure to watch going forward will be ZIM Integrated Shipping's free cash flow. While the company lowered its adjusted EBITDA outlook for FY 2023 (to $1.2-1.6B), the shipping firm still managed to pull in $321M in positive free cash flow in the second quarter, despite a depressed pricing environment. In the past, ZIM has paid a generous dividend to shareholders which was the main appeal for investors to buy the stock. However, I expect ZIM to completely suspend its dividend in FY 2023 which would fundamentally improve the firm's free cash flow/liquidity position. At the end of the second quarter, ZIM had more than $1.0B cash in the bank plus $863M in other investments.
ZIM Integrated Shipping Services’ valuation
ZIM Integrated Shipping Services is projected to lose $4.35 per share but estimates for FY 2024 show that analysts don't expect the situation to get much worse. FY 2023, however, is not going to be a great year as consumer demand remains weak and the global economy is still under the influence of high interest rates, a post-pandemic slowdown in shipment volumes, and materially lower shipping rates.
ZIM Integrated Shipping Services' key metrics like revenues, free cash flow, and net income have already fallen back to pre-pandemic levels and the firm may be able to avoid a more severe earnings contraction altogether.
ZIM is currently valued at 0.25X FY 2024 revenues which is about 38% below the 1-year average P/S ratio. Since the shipping company is expected to lose money this year, a P/E ratio cannot be applied. However, ZIM is now much cheaper than shipping company Maersk ( OTCPK:AMKBF ). Assuming ZIM could earn $2 per share in FY 2025, and applying a 10X P/E ratio, the shipping company could trade at $20 in the longer term.
Risks with ZIM Integrated Shipping Services
The biggest risk for ZIM Integrated Shipping Services, obviously, is a drop in container freight rates which would immediately limit the company’s free cash flow recovery potential and worsen its liquidity situation. Another risk is the growth trajectory of China, an export country, which is suffering a weaker-than-expected post-pandemic recovery in its economy. Slowing growth in China, potentially driven by falling consumer spending and exports, could be a catalyst for shares of ZIM Integrated Shipping Services to achieve new lows.
Final thoughts
While I have been bearish about ZIM Integrated Shipping Services due to the possibility of a severe earnings contraction, I believe that the market situation as well as risk profile have recently improved, in part due to some recent upside momentum in shipping rates. With decreasing odds of a global recession and an August rebound in freight rates, I believe there is a good chance that ZIM Integrated Shipping Services’ shares have bottomed out... and that ZIM has surprise potential for Q3. While the company still needs upside impulses to lift shares into a new up-leg, there is a good chance that moderate growth in the global economy next year could prevent a severe earnings contraction.
For further details see:
ZIM Integrated: The Bottom Is In (Rating Upgrade)