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Is Seaspan Corporation a Buy?

By Matthew DiLallo - Oct 3, 2017 at 5:22PM

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Investors need an iron stomach before wading into these waters.

Seaspan Corporation's (ATCO -1.62%) stock is down a nauseating 47% this year and 66% over the past three. Driving the decline is a significant drop in the company's earnings due to challenges in the shipping industry, including the bankruptcy of one of its customers. That said, despite recently reporting another rough quarter, the tide in Seaspan's financial results appears to be turning.

That possibility of an improvement in its results, when combined with the company's dirt cheap valuation and compelling dividend yield, give investors several good reasons to buy Seaspan's stock. Though, while those factors suggest that investors who buy today could be well-rewarded, the risk is just as high that the stok could continue plunging, which is why they need to consider their ability to handle volatility before climbing aboard.

A ship in a port at sunset.

Image source: Getty Images.

The bull case for Seaspan

Seaspan Corporation is the largest independent containership charter company in the world. It currently manages 110 ships, which includes six scheduled for delivery over the next year. The shipper has leased the bulk of these vessels to customers under long-term time charters that have an average remaining length of four years and a total contracted revenue backlog of $4.8 billion. Those contracts should enable the company to generate relatively stable cash flow throughout the shipping cycle.

Last quarter, for example, the company produced $95 million in cash, which was down slightly from the $111.2 million it brought in during the year-ago quarter due to a customer bankruptcy and lower rates on some shorter-term leases. However, that cash flow still provided the company with more than enough money to cover the $6.4 million in dividends paid to shareholders and the $16.1 million paid out to preferred investors, which suggests that the current 7% dividend yield is on solid ground.

In fact, the company generated nearly $10 million in excess cash last quarter even after paying down debt and funding capital expenditures, which bolstered its cash position to $305.6 million. That continued a trend where the company has steadily shored up its balance sheet, having reduced its net debt to equity ratio from more than 2.0 times in early 2016 to less than 1.6 times last quarter, well below its sub-2.0 times target. That improvement certainly helps reduce risk, especially given the expectation that Seaspan's financial results will get better in the coming quarters due to the improving market conditions and the delivery of several newbuilds.

A container ship heading into a storm.

Image source: Getty Images.

Two caution flags to consider

That said, while Seaspan's balance sheet has strengthened, and is within the company's comfort zone, it's still not as strong as it could be. One evidence of this is the company's recently completed debt offering. While the shipper was able to raise $80 million in senior unsecured notes, which it plans to use to repay some existing debt, it paid a high price to do so since the 10-year notes bear an interest rate of 7.125%.

A few things are noteworthy about this offering. First, when shipping companies borrow money, they typically obtain secured bank financing and use their vessels as collateral. For example, Star Bulk Carriers (SBLK -3.43%) recently acquired a dry bulk carrier that it financed with secured debt from a financial institution. Meanwhile, GasLog Partners (NYSE: GLOP) recently bought a gas carrier and assumed its secured debt. One reason Star Bulk Carriers and other shippers use secured debt is that it's typically much cheaper than unsecured debt because the collateral lowers a creditor's risk. Another reason why shipping companies use secured debt is that they can borrow more money. In GasLog Partners' case, it paid $185.9 million for its latest ship, which includes the assumption of $117 million in existing debt, or 62% of the vessel's total cost. That higher leverage meant GasLog didn't have to issue as much equity to make this acquisition. Given this backdrop, Seaspan's decision to raise unsecured debt begs the question of whether it no longer has access to cheaper bank debt, which if that's the case, it could impact the company's ability to finance its future operations.

Another concern is that Seaspan's co-founder and longtime CEO Gerry Wang announced he would retire from the company at the end of the year. That announcement came after he and the company spent months engaged in contract talks to modify his employment agreement and overall compensation package. The unexpected departure and looming leadership transition have increased the uncertainty on the company's future direction.

Know your risk tolerance before diving in

One the one hand, Seaspan Corporation's stock is dirt cheap as a result of its plunge over the past few years, which when factoring in the improvements to its balance sheet and the shipping industry, make a compelling case that the stock is a buy. That said, investors need to have a high-risk tolerance before climbing aboard since concerns about its financial situation and future direction remain.

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