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.
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.
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.
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.
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