Given the turbulence in the shipping business brought by Hanjin Shipping's recently declared bankruptcy, it's natural that investors in Textainer Group Holdings Ltd. (NYSE:TGH) would worry about the risk in the container company's shares.
The shipper does, indeed, do business with Hanjin. After filling in some overall context around Textainer, I'll analyze its exposure to Hanjin, as we try to determine just how precarious the container lessor's shares are at present.
State of the industry, and recent Textainer earnings
It's important to understand at the outset that an investment in the container shipping sub-sector carries earnings risk for the very near future. A report by Moody's Investors Service in June extended a negative outlook on the global shipping industry for another 12 to 18 months. According to the report, container shipping companies are especially at risk of posting lower EBITDA (earnings before interest, taxes, depreciation, and amortization) due to the conflict between ample new container supply and lower demand.
Since owning and leasing shipping containers is Textainer's primary line of business, it's not surprising that lower lease rates for new containers drove an 8% decline in revenue in the second quarter of 2016, revealed when the company released earnings on Aug. 9. Yet shareholders were taken aback by a net loss of $1.5 million, versus net income of $40.3 million in Q2 2015.
A sizable chunk of the profit decline between comparable quarters arose from a $19.5 million impairment charge on used container inventory held for sale and disposal. Management pointed to weak rates for used containers as its motivation to be proactive and write down the inventory, in part to maintain a reasonable utilization of existing containers.
Even before the second-quarter report, Textainer's immediate prospects weren't very robust. I had the chance recently to crunch a few vital Textainer metrics in an analysis comparing the company to fellow shipping industry corporation Frontline. My opinion at the time was that Frontline constituted the better buy, due to a balance sheet encumbered with less debt, which offered a "better margin of safety" to the investor. You can see that head-to-head comparison here.
The metrics I used will serve decently to illustrate Textainer's position two quarters into 2016, after we add another updated column. The July 21 calculations pull from Textainer's first-quarter data, while today's article uses information from the second quarter:
|TTM operating income||$174||$138|
|TTM operating income Margin||32.70%||26.50%|
|Operating cash flow||$351||$342|
|Times interest earned||2.00||1.43|
|TTM payout ratio||118.50%||60.00%|
|Forward PE ratio||9.8||10.21|
The poor second quarter negatively impacted many of the metrics above, highlighting increased risk in the company's operations, and by extension, its stock. In particular, pay attention to the deterioration in the current ratio (tracking a company's ability to cover current obligations with current assets), from 2.75 to a much lower, though admittedly still-healthy reading of 1.75. In addition, times interest earned, which measures the degree to which a company can cover its debt service, declined significantly during the quarter.
These two metrics point to a slight bit of liquidity and solvency pressure, and explain why management slashed Textainer's quarterly dividend payment to $0.03 per share, winnowing a more-than-generous 8% yield all the way down to 1.5%. This may not be a happy circumstance for shareholders, but on the other hand, it's a pragmatic decision, given decelerating revenue and a high proportion of debt to equity on the balance sheet.
Hanjin Shipping filed for protection from creditors in its home country of South Korea on Aug. 31, and in the U.S. on Sept. 2. On Sept. 9, Textainer released a one-page update for investors on the bankruptcy.
As of Sept. 2, roughly 5% of Textainer's owned fleet in 20-foot-equivalent units (TEU) was leased to Hanjin. Textainer disclosed that it may incur "significant costs" from the Hanjin bankruptcy, even if the troubled company resumes shipping.
Specifically, Textainer cited that a portion or all if its Hanjin receivables may be deemed uncollectible. In addition, significant costs may be incurred in "recovering, repairing, repositioning, and releasing those containers leased to Hanjin, and the rates achieved for released containers may be substantially below the lease rates paid by Hanjin."
Surprisingly, though it can quantify the percentage of its container fleet affected by Hanjin, Textainer ended its press release with the following simple statement: "At this time Textainer is unable to quantify the financial impact related to Hanjin's recent filings."
This, my friends, is a projection of more than mild uncertainty, and with heightened uncertainty comes increased risk. If Textainer can quantify the amount of its fleet leased out to Hanjin, why can't it go ahead and calculate and disclose at least a wide range of potential financial impact?
I suspect that the situation is a bit more complex than writing off receivables, guessing at lost lease revenue, and projecting container releasing costs.
This is because Textainer's revolving credit facilities and secured debt facilities are collateralized by its owned containers. Removing some or all of the Hanjin containers from eligible collateral schedules held by creditors could impact the company's financing cost, debt covenants, or both. Until more clarity emerges from Hanjin's receivership proceeding, it may be difficult to assess impacts on Textainer's borrowing base.
Let me put this another way: It would be constructive for management to address as soon as possible whether the containers leased to Hanjin affect the company's position vis-a-vis its secured creditors.
Until then, it's prudent to exercise caution around shares. Textainer already exhibits some strain on its balance sheet in the form of significant debt. Hanjin's receivership crisis, and a lack of clarity on how this might effect Textainer's credit, has pushed the stock's risk -- for now at least -- beyond the zone of the comfortable.