A firm placed in a growing and healthy industry, guaranteed future cash flows, and 0.52x NAV ratio, all providing significant downside protection and opportunity for growth, the Danaos Corporation
THESIS (SECTION 1)
At the time of writing, $DAC trades at a price of $64.40.
My thesis on DAC is based on 3 main points:
It is trading at an industry lows in terms of quantifiable metrics (P/B, EV/EBITDA, Debt/Equity, etc.) with negligible debt. The 0.52x NAV multiple also provides significant downside protection.
It has secured a large amount of non cancelable contracts (made at all time high rates) during COVID which will account for 2/3 of future revenue regardless of future freight charter rates.
The high stable source of contracted revenue differentiates it from competitors by providing it with a large influx of guaranteed future cash flows - in what is generally a volatile industry. This acts as a significant competitive advantage.
Due to these points, I believe that DAC is undervalued, as it is treated similar to risky charter firms which are open to speculation of changes in container shipping rates - in spite of its significant lack of exposure to such volatility due to guaranteed future revenues (see section 7).
INTRODUCTION (SECTION 2)
The Danaos Corporation ($DAC) is a Greek freight charter company. It is heavily undervalued by numerous metrics - trading at a EV/EBITDA of 1.89, 0.52 P/B, a 3.52x P/E, and a 0.18x Debt/Equity multiple. As a freight charter company which owns the majority of its vessels, it is not directly subject to changing freight rates in the short term, although it is exposed to changing supply and demand as well as high capital dependance. Companies in the shipping industry are often viewed as a risky investment due to low ROCs and heavy competition. However, this company is currently at a massive discount, and its exposure to risk is limited as 2/3 of the current revenue is contracted until 2025 at the (high) COVID-19 spot rates. Furthermore, these contracts are with liners that are in great financial health, due to the previous few years of high cash flows in the shipping industry. As of June 13, 2023, the average contract for their fleet has 20 months until expiration. $100 million in share buybacks were announced in 2022, of which $40 million have already been purchased. Currently, there is a 4.73% annual dividend yield with a payout ratio of approximately 11.9%.
GENERAL RISKS (SECTION 3)
The firm is at its highest ever point in free cash flow - contracted EBITDA locked in contracts over the next 2 years are more than its current Enterprise Value. With the high amount of earnings that are already locked in contracts, the are around 2 valid foreseeable risks I have identified:
The decrease of spot rates is a real possibility - for this evaluation I will assume that rates revert to lower 2019 spot rates (about 40% of what they are currently) as each vessel comes out of contract. (Danaos provides vessel-by-vessel rates and contract terms so this is easily projected.) This assumption will only apply to about 1/3rd of the revenue in the next three years with the balance still on current contract rates.
The risk of a recession reducing demand may harm the company in the short term, but is somewhat balanced by the shipping industry implementing environmental regulations that will force many vessels to sail more slowly to reduce emissions. This naturally limits supply in the industry, albeit that new vessels are being brought into the market in 2023 to 2025
MANAGEMENT (SECTION 4)
Dr. John Coustas is the current CEO and President of the company. He assumed management of the company from his father (who founded the company in 1982) in 1987. He holds degrees in Marine Engineering, Computer Science, and Computer Controls. With a 44% stake, CEO John Coustas is the largest shareholder. In comparison, the second and third largest shareholders hold about 2.4% and 2.3% of the stock. His stake likely means he is largely in charge of decisions made at the company. Given he has over 30 years in shipping experience with the firm, he may place his main incentive on steady growth instead of attempting to maximize shareholder returns, although this might be balanced by other incentives due to sizable large stake in the company. The company was under extensive strain after the GCF until COVID due to a high level of debt and low charter rates - this prior history may impact the actions which the management of the company undertake with their current cash.
CHARTER FLEET (SECTION 5)
The average age of a vessel on the Danaos fleet is 11 years - for reference, depreciation of these vessels starts at ages ranging from 25-30 years. It is possible that current older vessels may be used for additional periods due to the obscenely high recent spot rates (this may be reduced after the intiation of environmental regulation. In any case, Danaos does not have a fleet for which aging is a current risk. Around $530 million was committed in 2021 to building 6 new vessels, which will be delivered in 2024. Prior to this, another 6 second hand vessels were purchased for $270 million in 2021- these second hand vessels have currently yielded around 8% in adjusted earnings. These worn vessels bought at attractive prices shows how Danaos management has a commitment to stable, sustainable growth.
Vessel orders have been placed with anticipated deliveries between 2023-2025, and the increase in Danaos' net shipping capacity is ~12.8%.
CONTRACT CUSTOMER BASE AND INDUSTRY CONSOLIDATION (SECTION 6)
Due to the recent increase in cash flows which shipping companies experienced during COVID, large numbers of shipping companies are in extremely (historically) healthy financial positions. Furthermore, the majority of Danaos' contracts are Industry Standard Charter Contracts - this means that they are not cancellable and are not subject to renegotiation or change unless in the case of a restructuring or bankruptcy.
In past years (during which the shipping industry was under far greater strain than it is now), Danaos received full compensation from ZIM when it restructured in 2014 in addition to when HMM restructured in 2016 in the form of equity. However, in the case of Hanjin's bankruptcy, no vessel owners received compensation which contributed to Danaos recording a net loss of $366 million in 2016, down from a net profit of $117 Million in 2015 (it is worth noting that the period was also of a general industry turndown).
DAC Customer Base
CMA GM (22%), M SC (15%), and HMM (15%) were the 3 biggest charter contract companies for Danaos in 2022. In the Q3 earning call for GSL (a Danaos competitor with a customer base which partly overlaps with the firm), Ian Webber (CEO) said - “Further, we have industry standard charter contracts, they're noncancelable. We only deal with the really good names. We've never had a bad debt in GSL. It kind of doesn't happen in our industry by and large, anyway. Liner companies are desperate for these ships. They need the charter fleet to run their scheduled services. Without the ships, they don't have services. So it's in their own interest to behave properly. And as George said, they're in the best financial shape they've probably ever been in..” - this summarizes my conviction on the matter. The already low risks of customer bankruptcy are also somewhat mitigated by the firms diverse customer base (their largest customer accounts for 25% of their revenue, followed by the second largest customer at approximately 16%). This risk is already low because of the fact that liner companies have recently come out of a cash flow windfall.
The market share is currently concentrated amongst a smaller number of larger liner companies due to many smaller firms having faced bankruptcy in recent years - this consolidation and increase in supply side power could allow the maintenance of higher freight and therefore charter rates, which could have an adverse effect on the aforementioned supply shifters, benefiting Danaos.
FUTURE DEGREES OF CERTAINTY ON ALREADY CONTRACTED REVENUES (SECTION 7)
As mentioned, Danaos has done an excellent job locking in its revenue at the high recent rates seen in the market. Despite this, the stock seems to be treated similarly to other companies in the sector where the market is watching the precipitous fall in daily container rates and selling shipping stocks accordingly. In the case of Danaos this does seem like a baby-and-bathwater situation.
For context, the following graph shows the container shipping rates (those charged by the liner companies which indirectly then impact charterers at contract renewal) over the last few years. Due to the short supply of container vessels partly created by the port congestion during COVID, liner companies were scrambling for supply and willing to lock in to charters for long periods despite the high rates. The COVID period truly was an outlier for the industry:
Freightos Baltic Index - door to door rates for 40 rate containers
BRIEF INTRODUCTION TO LISTED COMPETITORS (SECTION 8)
The corporation's main listed competitor is Costamare Shipping ($CMRE). It's market cap is $1.159B, about $250 million less than DAC. It's Debt/Equity ratio is 1.15, compared to DAC's 0.18. It also trades at a higher P/B value (0.54 compared to DAC's 0.52) and EV/EBITDA (4.36 compared to DAC's 1.89).
The only other listed competitor is Global Ship Lease Inc. ($GSL). It is also valued at a discount, but to a lesser extent than Danaos Shipping. It trades at a higher P/B of 0.72, a higher EV/EBITDA of 3.17, and Debt/Equity of 0.87.
CATALYST
I believe sheer value can act as a catalyst for the stock as it shows consistent earnings due to the contracted future cash flows. More media coverage as the stock increases and shows consistent earnings could also have a similar effect. In the case of a decrease in container shipping rates, consistent profits produced by Danaos could help it maintain its value relative to competitors. In recent times, the media coverage has been low due to the fact that the firm was unestablished and not immensely profitable until after COVID.
Financials (Cash Flow Statements, Balance Sheets, etc.) are available at: https://app.tikr.com/stock/financials?cid=28245722&tid=29447871&ref=3d3vgg