2023-12-19 00:34:39 ET
Summary
- ZIM Integrated stock price has been declining due to poor Q3 results and depressed freight rates.
- Recent events in the Red Sea, such as missile strikes on cargo vessels, have sparked a short squeeze and potential increase in freight prices.
- Despite the current challenges, ZIM's aggressive fleet updates and low valuation make it an attractive long-term investment.
Thesis Summary
ZIM Integrated ( ZIM ) has seen its share price continue to slide in the last three months, with the stock selling off after a dismal Q3. The company faced impairment losses, and freight rates continued to be depressed.
However, we saw a short squeeze last week, as the issues in the Suez Canal could help lift freight rates in the short term.
Overall, it is clear following the last quarter that it may take some time for ZIM to recover. Nonetheless, it's hard not to be bullish with the valuation so low.
I maintain my buy rating on ZIM, even though the stock could still take some time to really turn around.
Last Rating
In my last article on ZIM , I rated the stock a buy, as the stock was cheaply valued, and I believed freight rates could begin to turn around.
That, of course, has not been the case.
WCI (Drewry)
The Drewry World Container Index has continued to slide in 2023, though we have seen a significant reversal in 2023. More on that later.
The last quarterly results were also worse than expected for ZIM, sending the stock to new lows.
Q3 Results
While volumes have marginally increased, revenues are down 61% YoY, pretty much in line with the 66% drop in freight rates.
Financial Metrics (Investor slides)
The silver lining is the large cash cushion the company has, with over $3 billion on the balance sheet.
For the full year, management expects continued weakness, with the company projecting up to $600 million in losses.
2023 Full Year Guidance (Investor Slides)
Clearly, the outlook isn't great, and the stock will likely not pay a dividend in the near future.
As we can see in the graphs below, ZIM's revenues and profits have decreased substantially in the last few years:
Financial metrics (Alphaspread )
During the height of the COVID pandemic, shipping companies were doing very well, with freight rates much higher than today. However, this quickly changed as supply constraints abated.
We can see that ZIM also had a handsome profitability rate but actually posted an EBIT loss in the last quarter.
The real question is if the company will be able to regain its previous profitability, which in itself depends on how the pricing of the freight market evolves.
Interestingly, we have seen some very sharp moves in freight rates in the last month, which brought about a 17% rally on Friday. What exactly is going on?
Why the short squeeze?
ZIM is, in fact, up 30% in the last 5 days. What's going on exactly?
This could likely be the result of a short squeeze sparked by the recent events in the Red Sea. As we can see, over 24% of the float is shorted.
According to AP News , last week, Yemen's Houthi fired missiles that struck numerous cargo vessels in the Red Sea.
Approximately 30% of container volumes transit the Suez Canal and make up about half the traffic through the canal by weight,"
Source: Stifel analyst Ben Nolan
With the increased risks in the Suez Canal, freight ships are being forced to diver through the Cape of Good Hope. This will add numerous days to these routes, leading to a possible supply constraint and an increase in freight prices.
The more container ships that divert around the Cape of Good Hope, the better the prospects for both spot and contract rates in the Asia-Europe market - as well as the trans-Pacific market, courtesy of Panama's travails.
Source: Freightwaves
We have already seen a substantial increase in rates for certain routes, such as Shanghai to Genoa.
DWI Shanghai Genoa (Freight Waves)
As we can see from ZIM's geographical volume distribution, the company has significant exposure to Asia and the Pacific.
Volume Breakdown (Investor slides)
Future Outlook
The current short squeeze could certainly provide investors with a good point to exit or take a profit if they bought the recent lows.
ZIM price analysis (Tradingview)
From a short-term perspective, the RSI is overbought, and we are approaching the 200-day MA on the 4h chart, which could provide some resistance.
However, it's hard to know at this point how the geopolitical situation will progress. If the current situation persists, then ZIM's next quarter could be a lot better than anticipated as freight rates climb.
Overall, though, I would point out a few reasons why investors might want to hold on for the long term.
Firstly, the company has aggressively invested in updating its fleet.
ZIM deliveries (Investor slides)
Though this will come at a cost, it should significantly improve the efficiency of the company.
To give an indication, I think I already used this illustration on a couple of occasions, but the 15,000 TEU LNG ships that we are now gradually deploying on our Asia to the U.S. East Coast trade lane, around -- it will cost the same to operate the 10,000 TEU ship that they come and replace. So we get a 50% additional intake at the same -- more or less the same cost of a given voyage. So that illustrates the magnitude of the benefit that we expect to get from those vessels that come in in terms of charter at competitive price. But on top of it, we expect to get additional savings by running them on LNG, which today is a source of fuel, which is more cost-effective than even a heavy fuel."
Source: Earnings Call
A 50% increase in intake while also saving money on fuel as the fleet transitions to LNG.
On the other hand, even though the company might have to burn some cash, the balance sheet is still robust enough to support a few unprofitable quarters.
Zim Assets (Alphaspread) Zim Liabilities (Alphaspread)
The company's assets well exceed its liabilities, and ZIM has close to $2 billion in cash.
Valuation
On top of that, the company is trading as cheaply as it ever has. That is understandable, given the current environment.
Still, even with a conservative forecast, the stock seems undervalued based on an FCF analysis.
Based on the outlook for the sector, revenue growth will likely be small. In the following DCF model, we have assumed a growth rate of around 4%, with a terminal rate of 2%. This is in line with estimates from Mordor Intelligence, which estimate a CAGR for the freight industry of 4.02% from 2023-2029
DCF Model (Alphaspread) DCF Model (Alphaspread)
If the company can recover modest profitability by 2025, then the stock could appreciate close to 37%. The valuation assumes the company can achieve an operating margin of 5%, with a discount rate of 8.4%, and revenues reaching $6.8 billion over the next five years.
This seems very reasonable, given the upcoming improvements in the fleet and the fact that operating margins were above 20% two years ago.
If we look at the current valuation metrics, the company is also very cheap.
ZIM valuation metrics (Seeking Alpha)
Both based on an absolute level and compared to the industry average, ZIM trades at a heavy discount.
Risks
Of course, investing in ZIM is still a risky play. The freight market will still take time to recover. Furthermore, while there are short-term tailwinds, the larger trend of de-globalization could negatively impact the whole shipping industry.
For ZIM investors, if the situation doesn't improve in the next two years, the company could be forced to seek further financing or even dilute investors.
Takeaway
In conclusion, while the current outlook for the shipping industry is bleak, the current escalation in the Red Sea has provided fuel for a short squeeze. While these gains could be short-lived, I do think ZIM offers reasonably good value. The combination of an improved fleet and higher freight rates moving forward could help lift the stock. But investors might have to be patient on this one.
For further details see:
ZIM Integrated: War Fueled Short Squeeze; Will It Continue?