The world's seventh-largest container shipping company, Hanjin Shipping, filed for bankruptcy in September. This much you know. What you may not know is that the big problem afflicting Hanjin affects not just Hanjin -- but U.S.-listed container shipping companies Costamare (NYSE: CMRE), Danaos (NYSE: DAC), and Seaspan (NYSE: SSW), foreign operators such as Nippon Yusen and Maersk -- indeed, every container shipping company on the globe.
The problem with shipping
This problem, in a word, is "oversupply", and the low prices container shipping companies must charge as a result of it. Simply put, there's currently too much container ship supply, competing for too little demand for containers to ship. According to The Wall Street Journal, container shipping companies need to be able to charge at least $1,400 per month that a container is in transit to break even on the cost of shipping it.
But in fact, rates for this service currently average "less than $700 a container a month." That's barely enough to cover the cost of the fuel needed to run the container ships, much less the cost of building, maintaining, and manning the ships themselves. But since these ships have been built already, and must be paid for, operators are forced to run them simply for the cash flow.
Result: The top 20 container ship operators are expected to report combined losses up to $10 billion this year.
Good news and bad news
The situation is not without hope. As American economist Herbert Stein once wrote, "if something cannot go on forever, it will stop."
Obviously, if container shipping companies as a group continue to lose $10 billion a year, then eventually, the weaker ones will go out of business. The supply of container shipping services will then decrease, oversupply will vanish, and the companies that do not go bankrupt will again be able to charge rates that permit them to earn a profit -- for themselves and for their shareholders.
In fact, the Journal reports that this process is already under way -- but it will not wrap up in a day. Bankrupt companies such as Hanjin will sell off part or all of their fleets to other operators, slowing the rate at which container ships vanish from the seas, and delaying the recovery. But over time, the process will play out. It's a logical necessity. Our task as investors is to try to figure out which companies will survive to see the end of the process and invest in them.
Babies and bathwater
So who will survive the inevitable shakeout in the container shipping industry? That's probably going to be a function of the companies' current debt levels, and the cash they can generate to service that debt. Unsurprisingly in a capital intensive business like container shipping, each of the three U.S.-listed container shipping stocks named above has some debt -- $1.5 billion at Costamare, $2.6 billion for Danaos, and $3.1 billion for Seaspan.
As for the cash needed to pay down that debt, Danaos is in the best shape, with $278 million in trailing free cash flow and a history of generating cash profits since 2013. Costamare is likewise FCF-positive, and has been so since 2014. Seaspan, however, hasn't generated positive free cash flow since 2013, and was running a $165 million annual FCF deficit at last report according to data from S&P Global Market Intelligence. It's also the only one of the three firms to report negative GAAP earnings for the past 12 months.
Valuing the prospects
With an enterprise value-to-free cash flow ratio of approximately 7.9, a 6.4% dividend yield, and a 5% projected growth rate, Costamare appears to have a good chance of weathering the storm in container shipping, and producing good profits for investors on the other side. Danaos is more expensive with an EV/FCF ratio of 10.2, and it pays no dividend.
But it's Seaspan that worries me most. Analysts give Seaspan stock the advantage on growth rates (projecting 14% annualized profits growth over the next five years), while investors love Seaspan's beefy 14.7% dividend yield. Still, the company's expensive enterprise value -- $3.6 billion -- combined with its lack of free cash flow, make it the least likely value candidate of the bunch.
In full knowledge that I'm going against the consensus here, torpedo to my head, I have to say that Seaspan looks the most likely ship to sink. Costamare seems the best prospect to make it back to port. And Danaos? Meh. With no dividend and no published growth rate expectations to rely on, I just doubt it's worth the risk.