Costamare: Deeply Undervalued

| About: Costamare Inc. (CMRE)

Summary

Maritime transportation stocks are suffering from the general economic slowdown and bear markets in commodities.

Costamare has a lot of downside protection given by its already contracted revenue, strategic moves and fixed assets.

The stock offers the possibility to go long with a very favorable risk/reward ratio.

Costamare Inc (NYSE:CMRE) is an owner of containerships, and its business mainly consists in chartering its vessels to other companies. The Company's main customers are A.P. Moller-Maersk, MSC, Evergreen, Hapag-Lloyd and COSCO.

Costamare is one of my favorite stocks. I have analyzed the company after seeing the massive downturn in the stock price, despite the good profitability and the very high dividend (when I first bought the stock the dividend yield was more than 13%). Given the sector in which it operates, the stock has very large capital requirements , mainly needed to buy containerships. I was very surprised in seeing that the stock was trading at a P/B ratio of just about 0.7. The current P/B ratio is a bit more than 0.80. The current dividend yield is 11.2%.

How is the company doing?

When I see a capital-intensive businesses that despite being profitable trades at P/B levels under 1, I have to analyze it to understand whether there is some opportunity to place a good bet with asymmetric risk/reward.

First I checked the company's historical performance. Since 2008, the year the company was incorporated, Costamare has had two years of negative revenue growth (2009 and 2010) and 5 years of positive revenue growth.

The second thing I have analyzed is the structure of operating cash flow and capital spending. We can easily see that the company's capital spending is volatile, and there is no reason why it shouldn't be. The sector is highly cyclical, the better the general economic environment, the higher the trade, the higher the number of containerships built, sold, rent and leased. At first sight, people would think this is a risky business, because, first, it suffers a lot from general economic downturns and secondly, it suffers from low maritime transportation costs, a condition that is clearly related to the first one, but somehow amplifies it, because it underlines that in many cases, this kind of service (maritime transportation) is just a commodity. Marine transportation is highly commoditized, but this doesn't mean there is no value or moat in maritime transportation companies.

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Indexes that track maritime transportation costs give a good idea of the impact of the economic cycles in this business. Shanghai Containership Index is a good benchmark to use in Costamare's case.

What's happening in the maritime transportation business?

Well, I don't think many people need me to tell them what's going on in the world, but I will do a summary. The Chinese slowdown triggered a bear market in practically all the commodities and together with slow economic growth in Europe, contributed to the fear of a global recession. Stocks in the maritime transportation industry have been beaten down as a consequence.

Should we be concerned? I can't be sure, but I don't think we should. Economic theory suggest that when supply exceeds demand in a way that creates a strong imbalance, prices fall, many businesses go bankrupt, supply shrinks to create a new equilibrium. I don't see why this time should be different. In a way or another, the extreme supply of commodities (not only oil) will go back to normal levels, the maritime transportation capacity will fall (or rise less than the overall economy) and prices for maritime transportation will rise again.

Costamare is playing well

Costamare can be hurt by low maritime transportation costs, there is no doubt about it. But is the current valuation appropriate? The company is quite good in managing its business, they have never had a losing year. The current P/B value is 0.83, the P/E is 6.2 and the company is expected to have the same earnings in 2016. I wouldn't use the P/FCF, since it's much more volatile than P/E, due to the cyclicality of the company's purchase of assets.

Reading the company's 4th quarter results, I saw that a high percentage of the company's revenue is locked in long term contracts. For 2016 and 2017, almost the full capacity of Costamare's containerships is already booked at an established price. Contracted revenue is more than $450 million for 2016 and more than $420 million for 2017. For years from 2018 onwards, a significant portion of revenue is already contracted, more than $250 million for both 2018 and 2019. This means that we are already covered from price reductions for both 2016 and 2017, and for more than half of the revenue for 2018 and 2019.

Costamare has at least 2 more years to wait for maritime transportation costs to rise again, since the low costs would have no effect on the revenue for 2017 and 2018. What someone could argue is that the low costs could have an effect on future revenue. That is true, but here comes the recent moves of the management, another reason that makes me confident in the company's future.

In the fourth quarter, the company entered in several agreements:

- Agreed to charter the 8,531 TEU containership Navarino for a period of minimum of 11 months and a maximum of 13 months.

- Agreed to charter the 2,474 TEU containership Aeropolis for a period of minimum 2 months and maximum 6 months.

I won't list every agreement, I will just underline that the maximum period was 13 months.

I think this is a strategic choice. The company is chartering its containerships for short terms so that it doesn't get hurt by the current low prices, if they rebound in the near future. It's not how the company usually operates. Usually the containerships are chartered for more than 7 years. It's the best way to operate, contracting for the long term when prices are high, contracting for the short term when prices are low.

Costamare is a good bet

The market fears that the global economic downturn will keep costs of marine transportation low, hurting Costamare's profitability. We have to take into account that we have 2 years to wait for prices to rebound, without big consequences if they don't. First, If they don't rebound in two years, the company will still have contracted more than 50% of its revenue for 2018 and 2019. Secondly, in the remote possibility that maritime transportation costs remain low, the company is not at risk. It's true that the company has a significant amount of debt, $1,912 billion against $802 million equity but so far the company has never had problems repaying the debt, with interest coverage constantly above 2.00 and recently above 3.50. In the remote but possible case the company's earnings starts to go south, threatening its ability to repay debts, it still has a lot of protection given by the typology of its fixed assets. The company has 72 containerships that are active or that will delivered between 2016 and 2018. The company's fixed assets are fungible, and can be sold in the case eventual losses make it hard to repay debt.

So we have three sources of protection:

- the company has contracted almost all the revenue for 2016 and 2017, and more than 50% of the revenue for 2018 and 2019.

- the company is not contracting for the long term, given the current low prices.

- the company's assets are fungible and can be sold to buy time in the case costs of transport don't rise.

Conclusion

The recent economic slowdown, the bear markets in practically all commodities and the low maritime transportation prices are all factors that contributed to beat down maritime transportation stocks. I would suggest a long on Costamare, that I consider one of the stocks with a highly asymmetric risk/reward. Personally I will enjoy the dividend and wait for the price to reach a reasonable level. The stock should trade at a P/B near 2 and a P/E near 13, ideally in less than 2 years. This would mean a percent increase of 100-110% from the current levels.

Article by Federico Mezzero

Disclosure: I am/we are long CMRE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.