- TGH has released its 2nd-quarter results, and I feel ambivalent about it. Revenue and utilization increased, but net income dropped.
- In the past 10 quarters, the interest coverage ratio has declined from over 4x to under 3x, based on the most recent earnings release for Q2 2014.
- Estimated earnings projections for the next 5 years are around 5%-6% per annum.
- The lack of a recent dividend increase seems to suggest management is also slightly conservative about future cash flows.
- Geopolitical tensions around the world and trade sanctions between Russia and the rest of the world could impact business operations. Considering the current valuation, it's a hold for me.
Last year in August, I initiated a position in Textainer Group Holdings (NYSE:TGH) in my DGI portfolio, at around $34 per share. Currently, the share price is at the same level, while yielding 5%. The Dow Jones Industrial Average Total Return index (DJITR) gained around 8% during the same period. This so-called underperformance has not changed my outlook about TGH, but I am still closely monitoring the progress of the company. This article is meant to give an update about the company's fundamentals and what the future might look like as a shareholder.
A small introduction for those of you who don't know about TGH and what it does (Source: Earnings Report Q2 2014):
Textainer Group Holdings Limited and its subsidiaries ("Textainer") is the world's largest lessor of intermodal containers based on fleet size. Textainer has more than 2 million containers, representing more than 3 million TEU, in its owned and managed fleet. Textainer leases dry freight, dry freight specialized, and refrigerated containers. Textainer is one of the largest purchasers of new containers as well as one of the largest sellers of used containers. Textainer leases containers to approximately 400 shipping lines and other lessees, sells containers to more than 1,200 customers and provides services worldwide via a network of regional and area offices, as well as independent depots.
Revenue and earnings growth
Since 2006, total revenue has grown at 13% CAGR. In the first 6 months of 2014, revenue has grown 6% compared to the first 6 months of 2013, which suggests that TGH isn't growing revenues as fast as it used to. Earnings Before Interest Tax Depreciation Amortization (EBITDA) has grown 18% per annum since 2006. As a percentage of revenues, the EBITDA margin increased to over 80% in the past few years. Apparently, TGH is able to convert sales into earnings more efficiently.
(Source: Created by author)
But do higher sales and earnings automatically lead to higher cash flows? In general, cash flow is used to finance organic growth, pay dividends and/or to buy back shares. In the past years, TGH spent a lot of money in capital expenditures (MUTF:CAPEX) to increase its fleet size. Even though cash flow from operations doubled in the last 4 years to $370 million, it was hardly enough to cover CAPEX, not to even mention dividends or a buyback program. TGH issued debt to finance the investments in new containers.
(Source: TGH Investor Presentation, August 2014)
As mentioned, TGH issued almost $2 billion in debt to finance growth opportunities. The ratio of debt-to-equity has increased in recent years to 2.3, although this ratio has been quite stable over the last 10 quarters. According to the Investor Relations presentation, TGH uses "low leverage relative to public peers" like TAL and CAI. Even though the debt is used to increase assets (containers), and is not used to fund regular operations. I monitor these debt levels closely by means of the interest coverage ratio. According to Investopedia, the interest coverage ratio:
... is a financial ratio that provides a quick picture of a company's ability to pay the interest charges on its debt. The ratio indicates how many times the interest could be paid from available earnings, thereby providing a sense of the safety margin a company has for paying its interest for any period.
(Source: Created by author)
In the past 10 quarters, the interest coverage ratio has declined from over 4x to under 3x, based on the most recent earnings release for Q2 2014. The higher interest expense in Q2 2014 is partly due to the $6.4 million write-off of unamortized debt issuance costs related to the refinancing of debt. As a result of the recent refinancing, TGH reduced its funding costs by 39 basis points year-over-year. If management is right, we should expect an increase in the interest coverage ratio in the next quarters.
TGH has paid stable dividends for 24 consecutive years, and has increased it on an annual basis for 7 straight years. It's a dividend challenger on David Fish's CCC-list. The stock currently yields 5.5%. Its 5-year DGR is 15%, which is obviously quite high, although the payout ratio (based on EPS) has hovered around the 50% mark in the last 3-4 years. Estimated earnings projections for the next 5 years are lower at around 5%-6% per annum, so we should expect a lower dividend growth which more or less matches earnings growth. The lack of a recent dividend increase seems to suggest management is also slightly conservative about future cash flows.
The number of outstanding shares has increased from 49M in 2011 to 57M in 2014. I am not overly fond of this development, since it dilutes my ownership of the company.
During the second quarter, TGH saw a strong increase in container demand, which is expected to continue through the third quarter. However, rental prices remain low, and return on new container investments have declined. From the 3rd quarter onwards, TGH expects to show improved results because of continued increase in utilization and lower funding costs.
Price/sales-ratio: In the last 10 quarters, the price-to-sales ratio has moved between an average range of 3.4x-4.1x revenue per share. With the latest quarterly earnings release, revenue per share during the last twelve months is $9.5. This puts the valuation of the company between $33 and $39 per share.
Price/earnings-ratio: In the last 10 quarters the price-to-earnings ratio has moved between an average range of 8.7x-10.3x earnings per share. With the latest quarterly earnings release, earnings per share of $3.1 puts the valuation of the company between $27 and $32 per share. The PE ratio has steadily increased in the last quarters, so compared to the end of 2011, the current stock price is relatively high.
Dividend yield: In the last 10 quarters, the dividend yield has moved between an average range of 4.6%-5.6%. With its current quarterly dividend of $0.47, this puts the valuation of the company between $34 and $41 per share.
Dividend Discount Cash Flow-analysis: Using an earnings growth rate of 6% for the next 5 years (according to analysts' estimates) and half of that as perpetual growth thereafter, using a 5-year dividend growth rate of 7% and 3% as perpetual dividend growth rate, the estimated fair value of the stock is around $32 (considering a holding period of 30 years).
In terms of valuation, TGH appears to be fairly to slightly overvalued. There's hardly any margin of safety, should there be any deterioration in business fundamentals.
Textainer is growing revenues and earnings on a consistent basis. The properties of this dividend stock are great, with high current yield and high dividend growth rate. However, debt levels and the increase in outstanding shares need to be monitored. The lack of a recent dividend increase seems to suggest management is also slightly conservative about future cash flows. All in all, TGH is a somewhat risky bet on increased global trade. Geopolitical tensions around the world and trade sanctions between Russia and the rest of the world could disrupt business operations. For now, TGH is a hold for me, and I am monitoring the progress of the company closely.