Rising Star Buy: Seaspan

This article is part of our Rising Star Portfolios series.

My Special Situations portfolio is focused on transactional events that create advantageous stock mispricings. Often, special situations create value through their structural complexity or through a lag in financial reporting that typically follows any change. One of those transactional events is a company starting to pay a once-slashed dividend. For my latest buy recommendation, that company is Seaspan (NYSE: SSW  ) .

The company is poised to massively increase its dividend as it finishes building out its container ship fleet, and it's already shown signs of the dividend increases, with a recent promise to hike the payout by 50% for the year, to $0.75 per share, following last year's climb of 25%. Moreover, the company has promised a "progressive dividend policy," indicating that it will substantially raise its dividend as earnings ramp. That's a policy that BP (NYSE: BP  ) has undertaken as it brings its dividend back up after a few quarters of no payout.

For companies like BP and Seaspan that are held for their income potential, it's the progressive policy and the promise of above-market dividend increases that make these stocks a special situation. So this isn't just your humdrum play on annual dividend increases. An increase in Seaspan's dividend should create corresponding rises in its share price.

The business
Seaspan owns and operates containerships engaged in international trade, in Asia -- but China in particular. Containerships transport those standard-size containers that house and carry most (some 90%, in fact) of the world's dry cargo. After these ships reach port, the containers are loaded onto trains or trucks and further distributed.

Seaspan has 58 containerships in operation and has orders for 11 more scheduled for delivery by March 2012. The company contracts these ships out on long-term, fixed-rate contracts, providing some security against short-term fluctuations. In fact, it's already got the upcoming 11 ships under charter. The company's current 58-ship fleet is a relatively young five years old on average, and the average remaining charter sits at seven years, ensuring some revenue visibility.

As part of its charters, the company provides the ship and crew, but additional operating expenses such as fuel are up to the charter customer. So the company doesn't have direct exposure to energy costs.

Why I'm buying
As you might imagine, the business of buying massive containerships is capital intensive. The company has taken on $2.4 billion in debt (against a market cap of $1.2 billion) and issued Series C Preferred shares at 9.5% in January to help fund acquisitions. But its acquisition pace will slow next year, as it acquires its full fleet, and the ships last for decades.

Once that fleet is in place, the company expects cash available for distribution to run around $300 million per year. And before the financial crisis hit, the company had been paying out better than 80% of its available cash. A comparable payout would have the stock yielding 20% at today's prices. Even if things don't get that rosy, there's still the potential for solid upside here.

Also of interest is the company's joint venture with Carlyle. The JV gives Seaspan the right of first refusal on acquisitions and divestitures of the JV, so Seaspan gets the pick of the litter in future deals.

Risks
The recently issued Series C Preferreds could appear to be issued for the purpose of paying dividends instead of funding acquisitions. While management specifically addressed this concern on the conference call after the recent earnings announcement, it bears watching nonetheless. In addition, a yield of 9.5% on those preferreds looks pricey. If you believe that management is competent, then that hurdle rate implies that the gains for future investments is quite high. And of course, I'll be keeping an eye on that $2.4 billion in long-term debt.

The company is clearly reliant on rising world trade, especially from China. Major disruptions in the heretofore common trade pattern could put pressure on the company. The company's long-term contracts help mitigate these dangers though.

Summary
Seaspan offers a different and longer-term catalyst that what I'm usually looking for as part of my Special Situations portfolio. But the potential value with a rapidly increasing dividend simply looks too good to ignore. So I'm adding $750 in Seaspan to my portfolio tomorrow.

Interested in Seaspan or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here.

Jim Royal, Ph.D., does not own shares of any company mentioned here. Motley Fool Options has recommended a write covered strangle position on Seaspan. The Fool owns shares of Seaspan. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (26)

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  • Report this Comment On March 31, 2011, at 1:45 PM, gwhitebeard wrote:

    You tell me that you are buying a whole 40 shares??? $750??? Are you kidding me?

  • Report this Comment On March 31, 2011, at 2:07 PM, TMFRoyal wrote:

    Hi, gwhitebeard,

    That's about 4.5% of the total capital that we're allotted. Given the relative size of the portfolio, some would consider an immediate 4.5% allocation to be pretty aggressive. Especially if there might be the possibility of a decline and the subsequent desire to add more without being overweight.

    Fool on

    Jim

  • Report this Comment On April 02, 2011, at 1:44 PM, Khizhim wrote:

    Jim:

    SSW promises a "progressive dividend policy" but won't it only be able to keep its dividend promise if its business conditions remain favorable? You reported that SSW said it'll increase its dividends if its earnings "ramp up." WILL its earnings "ramp up"?

    How about the PRC central government's stated intention of decreasing its reliance on exports and of increasing its reliance on domestic demand? Won't that result in a reduction of containerized exports of consumer goods which have been manufactured in the PRC?

    The announcement of an alleged "progressive dividend policy" seems to me to be a highly-questionable basis on which to evaluate a stock. The company's business outlook seems to me to be a more appropriate consideration. In this case, yes, containerized exports from the PRC have boomed until now, but have you chosen this company at its peak?

    This company's prospects may look good, but I assume any assessment of those prospects would need to consider details such as the economic outlook in nations which import PRC products and such as the prospects for consumer spending in those economies. How do you assess those variables?

    An announcement of a "progressive dividend policy" may be an important statement of management's respect for shareholders, but doesn't it almost "beg the question" of how well the company will do in the future? Granted, many companies won't pay dividends at all if they become more profitable. Many companies which do pay dividends won't increase their dividends if they become more profitable. This announcement may be important, but will this company be able to keep this promise?

  • Report this Comment On April 02, 2011, at 1:56 PM, Khizhim wrote:

    PS:

    World container shipments may decline if importing economies' demand fewer imports and if the PRC exports less, but SSW might do well if it can dominate its industry. How about that?

  • Report this Comment On April 06, 2011, at 5:55 AM, blaueskobalt wrote:

    Hi Jim,

    I've enjoyed following your Special Situations portfolio. I'm curious about this one, though. There are a lot of competitors in this industry, and many of them already have dividend yields well above the level of SSW.

    SBLK is above 8% (though their ships are old and charter rates not too attractive), but SB has quite new ships, and their yield is above 6%...there are a variety of other examples. What makes SSW more attractive than SB?

    -Sean

  • Report this Comment On April 07, 2011, at 8:52 AM, TMFRoyal wrote:

    Hi, Sean,

    Although I'm not so familiar with SBLK or SB, the appeal of Seaspan is that earnings can ramp very fast as the economic climate normalizes, but the share price (I think) does not yet reflect that potential dividend (and the company should be valued on its dividend). The massive fleet build-out and decent rates should give SSW a boost. So the "special" in special situations here (and how I can justify it for this portfolio) is that you have a clear catalyst in the company's progressive dividend policy, which promises accelerated and well above normal dividend growth. I'm less interested in the dividend per se than I am in the increasing payout leading to capital gains.

    Jim

  • Report this Comment On August 10, 2011, at 4:02 PM, AtticusTheFish wrote:

    Soi Jim,

    That was a good theory. How do you feel it stacks up today.

    Things have changed quite dramatically, for sure, and the economic outlook (today) seems less certain, although I'm feeling it will continue to muddle along with some form of slow growth.

    Are you inclined to be adding to this SSW position at these levels? Or does the economic shift to more sobering views lead you to believe SSW may be in jeopardy?

    Cheers,

    Drummond

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