The global shipping industry remains sabotaged by headwinds and obstacles. At the end of the third quarter of 2017 daily rates for vessel owners were stuck at one-third of their historical average of the last quarter century. That's difficult to work with. Most shipping stocks have remained in disarray as a result. Textainer Group Holdings (NYSE:TGH) isn't one of them. The stock is up nearly 200% year to date.
How is that possible given the incredible loss of wealth among most other companies in the industry?
Well, Textainer Group Holdings boasts the world's second-largest fleet of storage and shipping containers -- leaving the disadvantaged task of renting out ships to others. That didn't save it from all of the recent ills facing the industry, but a sudden surge in shipping container pricing has lifted the company's fortunes.
Better yet, market conditions are improving just as a sizable chunk of its leases are set to expire. That means they'll be released under even more lucrative contracts in the year ahead. Knowing that, could 2018 be Textainer Group Holdings' best year yet?
All signs point to smooth sailing ahead
The virtually overnight recovery in shipping container prices has been nothing short of amazing.
It all started in early 2016 when new container prices reached a low point of $1,200 per cost equivalent unit (CEU). That also sapped the appetite for used containers, making it virtually impossible to sell them into various markets. Why is that a problem? Selling used shipping containers (usually for stationary storage uses) near the end of their useful life is a common practice deployed to maintain a fleet's age and viability -- and can comprise 30% of the expected return on a container. Swipe away that avenue to recover sunk costs and things can get ugly.
The market conditions forced Textainer Group Holdings to swallow a $65 million impairment charge in 2016. The timing couldn't have been worse, as the company was also confronted with the bankruptcy of Hanjin Shipping in South Korea. When it went down, it took almost 5% of the company's containers with it. In addition to the value of the physical assets, the insolvent shipper also skirted rental payments. The total impact for the shipping container leader in 2016: a $42 million reduction in net income and $13 million in lost lease revenue.
And yet, somehow, the supercharged recovery of 2017 makes all of that misery seem a distant memory.
By the end of the third quarter of 2017, new container prices had rebounded to $2,200 per CEU. The catalyst? China adopted new regulations for waterborne paints, such as those used to make shipping containers more aesthetically pleasing. However, the new paints take dramatically longer to dry than their predecessors, which has caused a sudden shortage of containers in Asia.
Higher prices for new containers have helped Textainer Group Holdings in more ways than one. The industry's business model has three moving parts: the initial lease of a container, lease extensions and releases, and disposition of containers for stationary storage applications. All three have seen their value increase in 2017 thanks to the shortage in Asia, and the trend could just be getting started.
That puts Textainer Group Holdings in a great position, especially after deftly managing its fleet through the recent downcycle and emerging with a utilization rate of 97.2% at the end of the most recent quarter. Consider that every $0.01 increase in per diem shipping rates has an estimated pre-tax income windfall of $8.5 million. A $100 increase in used container sales price provides an estimated $10 million pre-tax income boost.
It gets even better. Shipping containers leased during the low-priced market of 2015 and 2016 are in the process of expiring. That means they'll be released to decidedly more favorable contracts within the next several years, which creates significant upside potential in both the near and long-term.
Believe it or not, it could get even better still. China's new waterborne paint regulations are expected to continue to pressure the industry as the paints are difficult to apply in colder temperatures, which will add even more time to the manufacturing process this winter. Plus, new pollution regulation in China has forced the sudden closure of some steel production facilities in the country, which could cause steel prices to rise.
As Textainer Group Holdings president and CEO Philip Brewer recently told investors:
We do not expect new container prices to decline over the coming quarters... If current market conditions continue, as these leases reprice any increase in rental revenue will flow straight to our bottom line.
In other words, 2017 was just the beginning of what's shaping up to be a spectacular recovery for the shipping container industry.
Will 2018 be the best year yet?
To answer the question in the headline, it will be awfully difficult for Textainer Group Holdings to beat or match the nearly 200% stock gain achieved in 2017. It's also worth pointing out that an encore performance would put the company's market cap at nearly $3.8 billion -- an all-time high that would be difficult to justify.
That said, Textainer Group Holdings is entering 2018 with the wind at its back and favorable market conditions to exploit. All signs point to a continually improving business for years to come, which should easily reward shareholders. So although next year may not be the best ever for the stock, it's shaping up to be one with more outsized returns. Long-term investors should feel comfortable buying the stock at current prices.