Description

Seaspan

Introduction:

Seaspan Corp. (NYSE: SSW) is the world’s largest independent charter owner and manager of containerships. The company focuses primarily to long-term, fixed-rate time charters with major container liner companies. SSW is registered in the Marshall Islands and the board is led by a previous Berkshire Hathaway Management executive David Sokol. The industry that Seaspan operates in has been through a tough time over the past 10 years with industry growth rates well below an acceptable rate, however key metrics lead me to be far more optimistic into the next few years. With recent stock price volatility related to global trade uncertainties, I believe that entering an investment in the sub $10 range is ideal in maximizing shareholder returns.

Background:

The Seaspan business model is relatively simple to understand, the company has two core activities; buying vessels at favourable economics and then subsequently leasing out these vessels to the world’s top container-liners. The company is paid a set charter rate for their services which include leasing the vessel, containers and additional services (crew). As of March 1st 2019, Seaspan is supported by 112 vessels after adding close to 25 vessels in the past 2 years.

Seaspan focuses on building a strong partnership with liners and locking in long-term contracts to ensure consistent and stable cash flows. Within the container-shipping industry, liners are responsible for: sourcing & aggregating cargo, managing logistics, fuel costs, cargo operating expenses and finally paying the daily charter rate. On the other hand, the lessor is responsible for the vessel, crew, technical operations, design, maintenance, insurance and providing an optimal contract structure.

Overall liners prefer to lease rather than outright purchase for a few reasons outside of the short-term cash benefits; addresses constantly changing fleet and capacity needs, allows liners to target new routes and opportunities and finally outsourcing provides the opportunity diversify fleet concentrations and manage residual values. In the past few years a lot of negative sentiment has surfaced around the concentration of Seaspan’s customer base with just four customers contributing to 80% of the total revenue. The two potential risks are either the liners switch lessors to one of Seaspan’s competitors or downsize (decreasing demand) and don’t contribute as much revenue to the company. I think this negative sentiment is slightly overstated given the magnitude and position of these four liners. Each of these liners rank among the top players in the industry and at this scale are likely to remain with Seaspan’s consistently reliable service paired with low cost structure. The relationships developed between the two parties should result in a continued partnership as long as the economics serve both parties, which I believe they will. To address the second issue, I think that there are a few key operating metrics that suggest the market is improving and demand will remain consistently high.

Industry Overview:

Container shipping is often overlooked, however according to the International Chamber of Shipping, about 90% of the global goods are transferred by sea, and thus the container ship is a very critical element of our day-to-day lives. Over the past 10 years we have seen the industry go through many up and downs with the changes in demand. One of the biggest contributing factors for volatility in charter prices is the government intervention in the industry. Given the size of the industry, the government is motivated to subsidize the cost of vessels to help protect jobs and keep profits within their country. This intervention has often led to excess capacity in down times and thus decreasing charter rates.

The industry is heavily correlated with GDP growth given that global trade spikes with an increase in economic activity. A lot of talk has been circulating the potential for an eventual recession sometime in the near future but what sets Seaspan apart from competitors concerned about the same issue is their diversified growth in many different regions. With their diversified revenue base, I see shifts in the US economy having minimal effects given the likelihood of increased charter rates (which we’ll get to in a little bit).

Internal Capabilities:

During the volatile times since 2008, the containership industry had made many adjustments to the traditional pricing structure. Previously, prices were typically fixed and volume was adjusted to account for changes in demand and supply. However, over the past ten years we have seen the volume of vessels on sale continuously increase with constantly changing values. For the most part, the value of a vessel had been very low over the past decade and thus lessors can take advantage of this. Seaspan’s business model has been very similar to another big value play over the past few years, Aercap. One key strategic direction that both companies took was to build up their asset base when they were cheap and take advantage of the market rates during an eventual market uptick.

The biggest risk with this strategy is the need for capital in these types of industries. With Seaspan in specific acquiring 112 vessels has led to a boat-load of debt on their balance sheet, putting their liquidity at risk. The recent $1,000,000,000 investment by Fairfax (50% debt,50% equity) helped reduce the effects of their more expensive debt, however this is still a concern for the company that has held many investors back over the past few years.

(Company Reports)

Theses:

I.                     Unfair valuation driven by high debt and overstated risks to global trade threats

With the recent uncertainty of global trade, and the conflicts between North America and China a lot of negative sentiment has plagued the company’s stock price with the perception of decreased TEU. In my opinion, the company’s current business is best positioned to avoid the situation entirely and watch as competitors struggle. Given the structure of the company’s business model they have been able to lock into long term lease  structures with the average agreement currently standing at 5 years. With this five year lock in the company has stability that competitors with shorter term contracts don’t but also have the flexibility to take advantage of favourable economics ­– which competitors with longer term contracts or out-right selling vessels don’t. With their strategy of building up their asset base coming to fruition in the next few years, the global trade uncertainty will have little effects on them in the long run.

When we compare SSW’s multiples to those of their competitors we see that they are trading at a steep discount which I believe is mainly due to their market position. Being the largest company in the business, industry trends tend to cause a larger affect on them than their competitors, sometimes it is justified, but in this case it is definitely an overreaction. In comparison to their competitors, Seaspan’s contracts are better, their asset base is stronger and have a much more experienced management team led by a former Berkshire executive.

The other main concern that many investors currently have is the large and potentially hurtful debt balance on the company’s books. Based on management’s estimates and the potential increase in charter rates I think there is a very minimal risk that a company of this magnitude will face constraints when paying off debt. To date, cash has been used to expand their fleet but now as vessel prices rise, Seaspan will use the cash they generate to pay off their debt. I believe this is actually a strategy that investors should be ecstatic about rather than worried given it’s success rates for many asset heavy businesses in the past.

Overall, I think the cheap valuation is driven by an overreaction to political uncertainty that has directly correlated Seaspan’s business success to the potential of increased protectionism. This is slightly unfair given Seaspan’s current locked in contracts and overall operational excellence. I do agree that the political uncertainty has an affect on Seaspan’s potential future profitability, but I do not believe that it is any less than their competitors and thus should be trading in line.

II.                  Optimism from industry metrics suggest that supply is going down and we should expect a spike in prices.

The first key indicator that suggests charter rates are rising is the fact that demand growth figures are now higher than supply growth. When you pair this metric with the fact that industry supply rationalization and demand improvement driving idle fleet reduction, the likelihood of a charter rate increase grows substantially. Idle containership fleet of vessels over 500 TEU less than 180, or 2.3% of the global fleet in 2018 despite the volatility in trade. I see this trend continuing to at least 2021 when there may even be a shortage of vessels to meet global demand.

The recently decrease in supply has come from consolidation of the liners and increased discipline among the biggest ones. The orderbook-to-fleet ratio is currently sitting around 12-13% which is the lowest it has been since 1999. Given the consolidation in the industry and Seaspan’s current market position I think they are best positioned to take advantage of the dynamics at this time and start raising charter prices.

Finally, the most promising metric is the company’s asset values. The initial strategy of acquiring vessels while they are cheap was risky because it came with the presumption that eventually these vessels would grow in price. For a long time, it seemed unlikely that they would shift by a significant amount but over the last twelve months, asset value has been on the constant upswing and is trending to go even higher. This helps solidify that levering the company to this point was actually beneficial and we shouldn’t be concerned about the debt as it seems management is excellent at allocating capital.

Valuation

Overall, the valuation represents that Seaspan’s assets itself are trading at a steep discount in comparison to their earning capabilities and fair market value.

I mentioned Seaspan’s competitors to be trading at a premium earlier, but specifically the one competitor that stands out is Costamare who is closest in size but offers half the value added services that Seaspan does while their contracts are structured in an imperfect manner. They are currently trading at EV/EBITDA of 9.4x in comparison to Seaspan’s 7.4x.

Risks & Catalysts

Risks:

In terms of the industry the only major macro trend that could go against the company is if there is further escalation between tensions in US and China, however based on recent proceedings it seems that both parties have decided to layoff on any further tariffs and put their issues aside. I think the potential for a trade war is incredibly unlikely and should not stop us from investing. Furthermore I don’t see how the trade war could affect the company given that upwards of 80% of their revenues are under locked in contracts to 2020, the year for re-election.

Any sort of downturn in the company’s cash flows can drastically hinder their ability to meet their obligations moving forward. If for any reason the charter rates were to drop, or idle rates were to increase again the remaining debt on their books will become a major point of concern given how tight their schedule is right now.

Catalysts:

Further consolidation in the liner industry should lead to further opportunity to grow the company’s bottom line. Given that SSW’s biggest customers are the biggest liners in the world, they are the most likely companies to be acquiring the smaller players. Since Seaspan has already built relationships and provided reliable service to them, any further acquisitions or additional routes they acquire will go to Seaspan in the future.

Overall, the current multiple of 7.4x is extremely cheap for a business of this quality and I think the risk-reward level is optimal for a business that is a market leader in an industry that is on the upswing.

Catalyst

See Above