Description

ZIM Integrated Shipping Services Ltd (ZIM)

ZIM is trading at a EV/EBITDA of 0.8x versus peers trading at 3.1x while achieving a higher ROA. The shipping industry doesn’t have enough ships due to years of underinvestment and is now poised for several years of much higher freight rates. ZIM is an asset-light shipping company with flexibility to manage through the business cycle and is currently benefiting from significant operating leverage. ZIM is underfollowed due to its recent IPO and residing in the hated shipping space. ZIM will end 2022 with more cash on the balance sheet than the current market cap. ZIM’s trading multiple should expand as they establish a positive track record and improve methods of returning value to shareholders. I estimate stock is worth $185 per share for an upside of +176% from current price of $57.44 on 4/6/22.

Company Overview

ZIM, based in Israel, is the 10th largest global shipping company operating around 2% of global TEU (Twenty-foot Equivalent Unit standard container) capacity through the most popular trade routes. They mostly ship dry van containers (general cargo, cartons, boxes, furniture, etc…) by operating 118 vessels in an asset-light business model where they charter almost all of these ships through mostly 1-5 year leases. Around 40% of their routes are Transpacific, 27% Intra-Asia, 18% Atlantic, 10% Cross Suez, and some Latin America. They are using around 570k containers and own 37% of them while leasing the remaining 63%. ZIM has an efficient digital sales and customer service platform that is better than most of its peers. They have strategic collaborations with the 2M Alliance which is a cooperation agreement with Maersk and MSC and allows ZIM more efficiency through vessel sharing and slot charter agreements in certain routes.

History

Established in 1945 and built up over the next 40 years to 77 ships at one point even including passenger ships before air travel became popular. The company was formerly completely owned by the Israel Corporation (which was founded by Israeli government and then majority owned by Idan Ofer and Ofer Brothers Group). In 2008, ZIM almost went public on Hong Kong exchange but the GFC forced them to call it off. They tried to IPO again in 2011 but a significant drop in shipping rates forced them to call it off. In 2014, ZIM was facing going concern issues similar to a lot of shipping companies and completed a restructuring where Israel Corp ownership was reduced down to 32% and $1.4B of debt was exchanged for 68% equity. Of the $2B remaining debt, $0.6B was tied to ship financing and these holders elected to retake ownership of the ships and lease them back to ZIM. In 2015, the Israel Corp spun-off its ownership in ZIM into Kenon Holdings (NYSE: KEN). In Jan 2021, ZIM listed shares on NYSE through a very poorly executed IPO which didn’t matter much because they only raised $204mm (only around 7% of 12/31/20 total assets) for about 14% dilution. This IPO was more about establishing a market value for ZIM and access public markets as they were already very close to a net cash position on the balance sheet.

Industry and Competition

Ninety percent of global trade takes place by sea so shipping isn’t going anywhere. Bulk shipping of raw materials is a very commoditized business with very little barriers to entry and wildly fluctuation prices (see Baltic Dry Index). The containership business is different with higher barriers to entry due to requiring more extensive carrier infrastructure. If you are familiar with the US trucking industry, then these differences are very similar to LT vs LTL trucking and containerships more like LTL where they book a lot of partial space and carry more expensive cargo. The containership business also benefits from more port flexibility as containers are easily transported by rail or truck and can be offloaded away from the port (bypassing very strong unionized labor). Increasing M&A in the containership industry has reduced the “top 20” to the “top 12” with the top 3 (MSC, Maersk, CMA CGM) handling almost 50% of global capacity. ZIM is around 2% market share at number 10. The bigger companies have an advantage and, similar to LTL trucking, can increase competitiveness through service differentiation (like various distribution centers), capacity utilization (alliances have improved this for everyone), and technological efficiency improvements. This should continue to drive the M&A trend in the industry. ZIM will likely never be acquired due to Israel’s “golden share” (discussed more in Ownership section).

The containership business is still a cyclical and commoditized business with volatile freight rates, however, dry bulk or tanker industries are even more cyclical and commoditized with much higher volatility in freight rates. The rapid increase in globalization in the early 2000s led to consistently rising freight rates and golden years for shipping companies. As a result, shippers started ordering way more ships. Ships take around 3 years to build but add in planning/financing/contracting and it can take up to 7 years. The GFC in 08-09 crushed the global economy and slow economic growth the following decade meant all these ships were being delivered into an enormously oversupplied shipping market. Freight rates peaked in late 2007 and consistently declined until mid-2019. Containership rates went down around 65% during that period, and tankers and dry bulk both went down around 85%. Obviously, a lot of shipping companies went out of business and the existing ship fleets are getting aged. To better manage the fluctuations of the business cycle, many shippers have become more asset-light and charter ships through 1-5 years charters (many shippers were forced to do this after facing BK risks like ZIM). Now, the reverse industry dynamics are taking place where COVID sparked huge demand for goods (because people couldn’t spend money on services) and freight rates have skyrocketed. Port congestion and geopolitical issues have only added fuel to the fire and containership rates have gone up almost 500% the past two years. The rate for chartering ships followed a similar pattern and increased astronomically the past two years. New containership orders doubled in 2021 vs 2020 but are still well below peak ship orders in 2008. Global containership capacity increased by 4.7% in 2021 while demand for shipping services rose 6.7%.

New order deliveries of containerships are expected to rise in 2023 and 2024 by around 2.2mm TEUs each year which would normally add a lot more capacity to shipping and bring down freight rates. However, a new regulatory initiative comes into effect January 1, 2023 that will force the early retirement of a lot of TEU capacity and force other ships to operate at slower speeds. The Carbon Intenstiy Indicator (CII) and Energy Efficiency Existing Ship Index (EEXI) are estimate to reduce available TEU capacity in containerships by around 17% in 2023 (retired ships estimated to be around 11% and lower speeds will reduce capacity by 5-6%). These initiatives actually increase restrictions annually which may reduce capacity further. In summary, the 4.5mm TEUs of capacity coming from new containerships in 2023-2024 should roughly offset capacity forced offline due to environmental regulations.

ZIM Expense and Revenue Drivers

Zim increased their ships from 87 to 118 in 2021 and charters almost all of them through 1-5 year charters. As of 12/31/21, 19% of ZIM’s 114 chartered ships have a year or less remaining on lease terms, with the remaining 81% of ships locked in leases longer than one year. Four percent of ship leases are for periods exceeding 5 years. The average remaining charter length is now around 26 months. Charter rates have spiked so much, that ZIM instead has recently shifted to buying secondhand vessels to add capacity and has the financial flexibility to do more of this if they choose. As charter rates go higher, expect this expense to rise a lot going forward each year as leases renew. However, chartering ships was only 5.5% of containership revenue in 2021 so this is not a major expense driver which is poorly understood by investors. In fact, higher freight rates, which drive higher charter rates, significantly outweigh costs of higher charter rates. For example, containership charter rates went up 300% in 2021 from 2020, yet ZIM’s charter expenses went down from 14.3% of containership revenues to 5.5%. Bigger expense factors are cargo handling (19.4% of containership revenue) and bunker/fuel costs (7.6%). The main component of cargo handling expense is stevedoring at ports which is heavily unionized. While stevedoring and other port expenses are rising, there is a lot of leverage on the income statement. For example, in 2021 containership revenue rose 178% but cargo handling expense only rose 31%, by comparison, from 2020. Rising oil prices obviously increase fuel costs but containership companies can pass some of this along. Company doesn’t disclose how much was received in fuel surcharges but includes it in freight revenue.

ZIM’s revenue is heavily dependent on volatile freight rates but they are not completely reliant on the spot market. Instead, the vast majority of ZIM’s fleet operates on 12-month contracts. In 2021, ZIM’s average rate per TEU increased by 127% compared to general world container spot freight rates that increased over 400% on average from 2020 to 2021. In 2020, ZIM’s average rate per TEU increased by 22% compared to general world container spot freight rates that increased around 50%. Port congestion is a major driver of higher freight rates as the more ships that are stuck at ports significantly reduces the available capacity to transport new goods. So, freight rates should eventually come down a little as port congestion issues work themselves out and geopolitical issues hopefully subside. However, strict environmental regulations will significantly reduce capacity and keep freight rates higher for longer.

Valuation

ZIM generated EBITDA of $6.6B in 2021 and expects to generate $7.1-$7.5B in 2022. Net cash as of 12/31/21 was $3.6B, however, they paid out just over $2B of this in the March 22 dividend. Adjusting for the large dividend, TEV is currently right at $5.26B which is 0.8x trailing EBITDA and 0.73x 2022 EBITDA forecast. Many containership transportation companies are private but the publicly traded peers are trading at 1.9x to 4.5x EV/EBITDA with an average of 3.1x. Dry bulk transportation companies are trading at 3.6x to 5.2x with an average of 4.2x. Containership leasing companies are trading at 5.4x to 7.7x with an average of 6.3x and benefit from more predictable cash flows through longer term leasing contracts.

Other asset-light logistics companies trade at 10-15x EV/EBITDA such as C.H. Robinson currently at 12.4x. While ZIM is also an asset-light logistics company, I do not believe it will ever trade at these multiple levels due to its heavy sensitivity to volatile freight rates. However, ZIM should trade at least in line with its containership transportation peers at 3.1x which would value ZIM currently at $185 per share, or +766% upside from current levels. Even if ZIM could trade inline with the cheapest of the peers, Maersk, at 1.9x, it would put ZIM stock at $117 per share, or +75% upside. Maersk is likely discounted due to trading on the Nasdaq Copenhagen stock exchange. Hapag Lloyd is a dominant player in the space and achieves a similar ROA as ZIM. MATX, however, is a weaker player in the space and ZIM had a 2021 ROA of 47% vs MATX of 25% and they both trade on US stock exchanges. A strong case can be made that ZIM should trade at or equal to MATX, which would put ZIM at $178 per share.

DCF using 15% discount rate

Ownership

Kenon Holdings, Ltd (KEN) owns 26% of ZIM. Kenon was the new company spun off from Israel Corporation and is controlled by Idan Ofer. Since KEN owns more than 20% of the shares/voting rights and no other entity owns more than 50%, KEN is deemed a “controlling shareholder” by ZIM. Daenos Corporation (NYSE: DAC) owns 6%. The State of Israel holds a Special State Share in ZIM which basically gives Israel veto power over M&A and has an anti-takover effect. Israel also requires ZIM to own at least 11 ships (currently waived) and Israel can use these ships in national emergency situations.

Capital Allocation

ZIM currently has a dividend policy to distribute around 20% of net income quarterly the first 3 quarters and then a catch-up dividend in Q4 bringing total distributions to 30-50% of net income. Inline with this policy, ZIM declared a $2.00 dividend in Aug 2021, a $2.50 dividend in Dec 2021 and a massive $17 dividend in Mar 2022. Cash paid out as dividends was $536mm in 2021 and just over $2B for the Mar 2022 dividend. Israel withholds 25% foreign taxes on dividends. ZIM also used $434mm of excess cash to pay down debt in 2021.

While ZIM has basically copied Maersk in their dividend policy to distribute 30-50% of net income, we believe shareholders would be better served if ZIM would establish a consistent dividend at a maintainable level, keep enough cash for growth needs and maintaining dividend in a downcycle, and using excess cash for buybacks. Buybacks look very compelling when the stock is trading at less than the current year’s expected EBITDA and at a significant discount to peers. We think it is very likely buybacks will enter the capital allocation equation this year as ZIM debates how to manage its large pile of cash.

Catalysts

-          Each quarterly earnings provide an opportunity for management to demonstrate execution and establish a track record. ZIM currently trades at a steep discount partly due to lack of track record and this discount should be reduced over time.

-          We expect management to re-evaluate its dividend policy in the near future as the company continues to generate massive cash flow. Any announced stock buybacks should boost the share price. Any shift toward a consistent, reliable dividend would significantly widen the shareholder base to income investors and boost the share price.

-          The shipping industry as a whole is entering a new phase of higher freight rates due to undersupply of ships. This growing awareness should boost share prices across the industry.

-          ZIM only went public a year ago and is underfollowed by investors. Expanding awareness and coverage of ZIM should boost the share price.

Risks

-          A global decline in consumer spending would lower freight rates accordingly across the industry. Global recessionary risks are rising.

-          Israel is a risky place to HQ a business from a geopolitical perspective and any geopolitical escalations could have a negative impact on ZIM.

-          Israel exercising its right to use ZIM ships for national emergency measures could have a materially negative impact on the share price.

-          It is possible that the Russia-Ukraine conflict has permanently shifted the trend of globalization to protectionism and global trade may continually decline going forward. We believe this is a longer-term possibility but not a short-term likelihood.

Catalyst

Catalysts

-          Each quarterly earnings provide an opportunity for management to demonstrate execution and establish a track record. ZIM currently trades at a steep discount partly due to lack of track record and this discount should be reduced over time.

-          We expect management to re-evaluate its dividend policy in the near future as the company continues to generate massive cash flow. Any announced stock buybacks should boost the share price. Any shift toward a consistent, reliable dividend would significantly widen the shareholder base to income investors and boost the share price.

-          The shipping industry as a whole is entering a new phase of higher freight rates due to undersupply of ships. This growing awareness should boost share prices across the industry.

-          ZIM only went public a year ago and is underfollowed by investors. Expanding awareness and coverage of ZIM should boost the share price.