2023-10-20 17:41:54 ET
Summary
- ZIM Integrated Shipping Services Ltd.'s dividend cut came sooner and deeper than expected due to strong profitability headwinds.
- Looking ahead, I don't expect positive profit or dividend payout in the next 1-2 years due to low shipping rates and volume.
- Despite the gloomy outlook, there are positives afoot.
- At the same time, the stock's current compressed valuation has largely priced in all the negatives.
ZIM's dividend lesson
The thesis of this article is twofold and both are relatively straightforward. First, I want to summarize the lessons I've learned from ZIM Integrated Shipping Services Ltd. ( ZIM ) as a dividend investor. Second, I want to upgrade the stock from my previous rating of SELL to HOLD because I believe the negatives have been priced in at this time.
In the early part of 2023, I wrote several bearish articles to caution readers against ZIM. During that time, the overall sentiment on ZIM was bullish and my view was considered contrarian. One of the key reasons for the bullish view was the dividend yield (more than 100% at that time). Of course, even the bulls won't expect such dividends to last. Therefore, the gist of the bullish argument was that the dividend can last long enough to compensate for the risks.
My view was simply that it wouldn't be because of the strong headwinds in shipping rates and volume. Indeed, the company kept bleeding cash. The dividend cut came sooner and deeper than expected. ZIM investors suffered large total losses (see the chart below).
Looking forward, the picture is still gloomy. I do not expect the company to earn a profit in the next 1~2 years either in terms of accounting EPS or free cash flow. As such, I do not think there will be dividends either in the next 1~2 years (and ZIM's dividend guidance is/was to pay out 30~50% of its net income annually). Global shipping rates and volume are still near a cyclical bottom (see the next two charts), and I anticipate the situation to persist longer given the ongoing macroeconomic uncertainties (e.g., high inflation and the possibility of a recession) and geopolitical conflicts (e.g., the Russian/Ukraine war and the Israel/Hamas conflict).
However, as to be elaborated on next, I do see a few positive signs in development. At the same time, I believe the stock's current valuation (about 0.22x of its tangible book value) has also priced in all the negatives.
The positive developments
As seen from the chart below, inventory level has recovered strongly in the recent six months across all major shipping categories (manufacturing, retail trade, and wholesalers). In the meantime, the global shipping volume this year (the orange line in the right panel) has also recovered substantially from the bottom level compared to 2020 (the dark red line). By eyeballing the data, in the first half of 2023, the global volume has recovered to be about the average in the past five years between 2019 and 2023.
A full recovery could take longer due to the macroeconomic and geopolitical risks I just mentioned. However, if the shipping market does recover, I see ZIM as well-positioned to benefit because of several differentiating features in its business model. The top differentiators in my view are its focus on a global niche strategy, its relatively young and agile fleet, and its use of digital technologies.
ZIM operates in several selected trade routes, in which it has a sizable market share. I expect such focusing on a niche to enable ZIM to offer more competitive rates and services to its customers once the overall climate changes. ZIM also has a relatively young and flexible fleet, which allows it to adapt quickly to changing market conditions such as routes and operation schedules as needed. Finally, in this mature sector, ZIM is a player that emphasizes the role of new technologies more than the average in the way I see things. It uses digital solutions to improve its efficiency and customer service (such as booking and tracking).
Risks and final thoughts
The picture is not all rosy and ZIM is not out of the wood entirely. There are a few key risks associated with ZIM. Some of these risks are common to the shipping sector and some of them are more unique to ZIM. The common risks include the macroeconomic and geopolitical risks mentioned above. Other key common risks include environmental regulations and government policies. Shipping companies who operate a global fleet have to navigate (apologies for the pun) a web of environmental regulations and government policies from different regions/countries. A change in these regulations (for example, new regulations on emissions or export control) could increase their costs or disrupt their operations.
In terms of risks that are more unique to ZIM, three top ones come to my mind. First, ZIM has a higher exposure to the spot market than some of its larger competitors, making it more sensitive to fluctuations in the spot market. Second, its niche strategy mentioned above could be a double-edged sword. It helps to specialize but at the same time could also make it more vulnerable to economic downturns in specific markets. For example, if there is a recession in the U.S., ZIM could be disproportionately impacted, as the US is one of its largest markets. Finally, also due to its niche strategy, it's more reliant on several key customers, which causes concentration risks.
However, my view is that these negatives have already been fully priced in at the current price levels. The next chart shows ZIM's price-to-tangible book value (P/TBV) ratio in recent years. As seen, its current P/TBV ratio as of July 2023 is only 0.221x. This is a level that is far lower than its historical averages as seen in the chart and also the average ratio for the shipping sector (whose average P/BV ratio is about 2.3x as of this writing). Also, it is important to note that TBV only includes the assets that are more liquid assets and can be more accurately priced than those included in BV (such as goodwill and intellectual properties). In the meantime, ZIM is taking steps to mitigate some of the risks mentioned above in my view. For example, ZIM is reducing its exposure to the spot market by entering into longer-term contracts. It has also been investing in new technologies and fuels to reduce its environmental impact.
All told, I am still seeing strong headwinds for ZIM Integrated Shipping Services Ltd. in the next 1~2 years due to both shipping rates and shipping volume for its key routes. I do not expect positive earnings, free cash flow, or dividends in the next 1~2 years. However, I now begin to see some positive signs afoot. Furthermore, I view ZIM as well-positioned to benefit once the tide turns thanks to a few differentiating factors in its business model. Finally, the stock's current valuation is so compressed that the negatives have been factored in the way I see it. These considerations led to my upgraded rating of HOLD from my earlier rating of SELL.
For further details see:
ZIM Integrated: The Dividend Lesson (Rating Upgrade)