Throughout my continuing coverage of the shipping sector, I have primarily focused on drybulk stocks including my recent analysis on Diana Shipping (DSX) with infrequent forays into the container ship market. Upon competition of my recent report on Diana Containerships (DCIX), I was referred to Costamare (CMRE) and eventually was able to secure an interview with their CFO, Mr. Gregory Zikos. I discussed the state of the market, including Greek/eurozone fears, inquired about Costamare's growth plans, and discussed Costamare's financial considerations (full transcript here). Through my personal analysis of the company, I have included pieces of our discussion where relevant. I suggest reading the entire interview for the best overall exposure.
Costamare has been active in the shipping industry since 1974 and has dealt exclusively with containerships since 1992. CMRE conducted their IPO in November 2010 and has since appreciated 17.5% in the equity markets while returning $1.56 in dividends, for a total return of 30.5% vs. a gain of 11.4% in the S&P 500. CMRE has a fully deliverable fleet of 56 vessels, including 10 newbuildings. Although I will cover most of the relevant information, I suggest also reading the Q1-12 earnings report as well as looking over the Q1-12 earnings presentation.
Costamare public debut was an initial public offering at $12/sh in November 2010. At the time, CMRE boasted a current fleet of 41 vessels, with contracts for 4 additional vessels, and 3 newbuildings.
In March 2012, CMRE conducted a secondary public offering at $14.10. CMRE had a current fleet of 46 vessels, with 10 additional contracted newbuildings.
Contracted Cash Flows
Costamare charters all of its vessels, and the majority of their revenues are locked-in for 2012-2016. The below exhibit from the 2011 Annual Report highlights the revenue backlog.
The contracted revenues offer safety in a turbulent market; however, they also limit CMRE's upside if spot markets improve quickly. In market-rates are still poor 2016-onward, CMRE's long-term earnings will obviously suffer.
Stable Leverage and Strong Balance Sheet
I discussed the financial picture of CMRE with Mr. Zikos:
Mintzmyer: With continuing payments for the vessel acquisition program, how much cash is needed by 2014?
Zikos: The remaining Capex equity commitment is under $150M. At the end of the previous quarter we have cash on hand of $320M. All ships in the water are currently profitable, including 4 vessels that are completely debt free. Leverage was approximately 55% at year-end 2011 and since then we have raised an additional $100M in a secondary offering.
Mintzmyer: How much cash is required to remain on hand to satisfy financial covenants?
Zikos: Restricted cash is required to be equal to 3% of outstanding debt. We amortize our debt substantially each year, repaying capital of north of $150M annually. Our company's leverage is well managed. We are not back-loading debt through grace periods combined with big balloons.
The below debt summary from the 2011 Annual report highlights the amortization profile that Zikos referred to. It's my best guess that 2017-2020 are similar. In Q1-12, Costamare had $44M of cash from operations and paid out $17M in dividends. This leaves $27M to use for debt amortization. If Q2-Q4 results are similar, Costamare might have to dip into their cash reserves to cover debt amortization. With current available cash of $126M, this should not be an issue in the near-term ($320M-$150M capex-$44M restricted).
Costamare has 10 vessels that remain to be delivered-- two in late 2012, seven throughout 2013, and one vessel due in early 2014. Each vessel is Large class, either 8,800 TEU or 9,000 TEU. All 10 vessels are chartered for 10-yr contracts with MSC and Evergreen for approximately $43,000. Full fleet information including current time-charter employment is available here.
Costamare appears poised to take advantage of the current market's weakness; however, investors should be aware that excessive growth requirements could lead to additional share offerings. If the charters are cash flow positive, this is not a bad thing, but in an uncertain environment, this is a question to consider.
Mintzmyer: Do you find the current environment attractive to acquire second-hand vessels?
Zikos: We have recently acquired two second-hand, charter-free 1998 built, 3,842TEU vessels for $12.45 million each, which we consider to be a low price. There are always opportunities and we are active in the markets.
Mintzmyer: What do you find more attractive at this time, second-hand purchases or expanding the newbuilding program, or waiting for a more stable market?
Zikos: We will look at everything as long as the calculated returns justify the decision; we are 100% returns oriented. We generally aim to buy at historical market lows either second hand vessels or newbuilds.
Mintzmyer: If Costamare wishes to expand their newbuilding program, will additional equity financing be required in the near-term?
Zikos: In the past 10 newbuildings, we were able to achieve 70%-80% leverage. The final equity commitment will depend on ship costs and debt availability. With a high degree of liquidity and a strong balance sheet,we are well positioned to pursue further growth whether in second hand vessels or newbuilds.
By my calculations, with cash on hand of $320M minus $150M in capex minus $44M in restricted cash requirements and assuming 70%-80 leverage on $100M newbuildings, Costamare can add 4-6 new vessels without dilution. If older vessels are purchased, such as with the recent $12.45M second-hand deal, CMRE can add up to twenty vessels assuming 50% leverage.
Cheap Access to Chinese Yards and Financing?
I recently encountered an interesting article from Bloomberg that mentioned efforts by the Chinese government to provide loans to Greek shipping companies in order to stimulate Chinese shipbuilding yards. I provided Mr. Zikos with the article and asked for his insights in relation to the Greek container ship industry.
Mintzmyer: Is it likely that Costamare can re-negotiate the terms of its current new building program? Is it likely that CMRE can increase the size of their newbuilding program at lower prices per vessel? Is the Chinese financing competitive?
Zikos: We have a strong relationship with our shipyards and have no intention to re-negotiate building rates, as we believe we have favorable terms. At 80% debt-financing of newbuilds, we have a projected equity yield of 18-19%. Some of our newbuilds are already financed by the China Import/Export Bank. Interest rates have been at around market levels.
It appears that Costamare is already taking advantage of some of the available loans. With banks in Europe tightening their portfolios, CMRE may need to rely on Chinese financing for additional newbuildings.
Costamare initialized their public dividend at 25c per quarter, with an increase in October 2011 to a payout of 27c.
With a dividend of 27c versus net income of 40c, CMRE is currently supporting a payout yield of 67.5%.
Mintzmyer: With a recently reported EPS of 40 cents and a dividend of 27 cents, the payout ratio is currently close to 70%. Do you expect the dividends to stay in the same historical 60-70% range?
Zikos: Our EPS will go up substantially from the end of 2012 due to newbuildings coming on line. Assuming the same payout ratio, the dividend should be expected to go up into 2013.
Mintzmyer: What will be the primary use of the remaining plow-back funds?
Zikos: After debt repayment and dividend payment, we use our remaining funds to target growth opportunities. Since 2010, we have done investments of $1.2B, expanding our fleet.
With new vessels expected to charter at $43,000/day for a 10-yr period, looking forward 1-yr, quarterly revenues will be boosted by approximately $3.9M for each vessel that comes online. Nine vessels will be delivered in 2012-2013. Assuming similar income margins (25%) and payout ratio (70%), the dividend has potential for an increase of up to 10c per share minus any losses from expiring charters. Thirteen vessels come off charter, six in 2012, and seven in 2013; however, six of these are chartered close to current-market rates, so the charter expiration will not likely be detrimental to earnings.
Current cash flows minus dividend payments (plow-back funds) do not appear to fully cover planning debt amortization, so although I expect a dividend increase of approximately 2-3c in early 2013, with the potential for an additional dividend bump in late 2013/early 2014, I also foresee additional equity offerings. CMRE would be best off in my opinion by delaying dividend hikes so that the majority of cash can be used for fleet growth.
In 2014, one newbuilding will go into charter, while six long-term charters will expire. If the current depressed market still exists in 2014, it's likely that the dividend will remain constant or even suffer a 1-2c decline. Of course, if the market improves, the charter expirations will serve as a positive measure for cash flows.
Insider Control Concerns?
Like most shipping companies, Costamare's founders, the Konstantakopoulos Family, owns 70% of the outstanding stock. With recent questionable actions by DryShips (DRYS), Paragon Shipping (PRGN), and Euroseas (ESEA) to include related-party transactions, non-competitive and high-commission management services, unfavorable debt financing, and insider dealing through Rights Issues, high insider ownership is obviously a concern. I brought both of these issues to Mr. Zikos in our interview.
Mintzmyer: What is the total current CMRE ownership interest of the Konstantakopoulos family and all related interests? What steps does management take to avoid ethical dilemmas and other issues with conflicts of interest?
Zikos: The Konstantakopoulos Family today owns 70% of shares outstanding after follow-on offerings in March. All shipping interests of the family are within Costamare, there are no other ships outside of Costamare and this eliminates potential conflicts. Throughout our public history we have had no public to private transactions. With a strong shareholding by the Konstantakopoulos family and no assets outside Costamare, we believe that all shareholder interests are aligned.
Mintzmyer: What are the terms of the current management contract? Is there open-market competition for the management contract? When is this contract renewed?
Zikos: The management agreement is for 5 years, and the contract includes $850/day per vessel + 75 basis points of revenues. There are no other commissions for any S&P or Chartering transactions.
Whether or not you choose to take Mr. Zikos at his word, the apparent facts back up what he has stated. The management contract is not out of line in comparison to all other publicly listed shipping companies. With a $43k charter, the management fee is approximately 2.7%, which is well below the industry average of 5% in management expenses. The downside is on smaller charters, such as the
If you are interested in the shipping industry, and specifically the container ship sector, I believe that Costamare offers a stable approach to the market. As Mr. Zikos pointed out, "Costamare has been in shipping since 1974, and since 1992, CMRE has been exclusively operating containerships… During our 37 year history we have never had any losses, and have never had to restructure debt."
This is a conservative investment. Downside is limited, but is present through annual expirations of various long-term charters. Upside is provided primarily through fleet expansion. Fleet expansion will likely require additional dilution of shares. If spot and second-vessel market stays low, expect rapid, but hopefully calculated, fleet expansion.
Dividends will provide a steady, mostly dependable, stream of income. If investing in CMRE, I recommend the use of a DRIP and a tax-free account such as an IRA. I suggest that all investors do their own due diligence and monitor the actions of the owning family for potential conflict of interest actions.
Additional disclosure: I may initiate a long position in CMRE within 72 hours.