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Market observer with legal background and interest in financial services, physical commodities trading, shipping and irrational exuberance. Values entrepreneurship and good governance, may also use some behavioral investment/contrarian criteria.
  • Depreciation Policies Part III: The U.S.-listed Containership Universe And Why Maersk Is Different 3 comments
    Jun 24, 2012 10:11 AM | about stocks: AMKAF, GSL, DAC, DCIX, CMRE

    About a year ago I started looking at depreciation policies of U.S.-listed drybulk (http://seekingalpha.com/instablog/927562-adjusted-return/186005-depreciation-policies-for-some-us-listed-drybulk-companies) and tanker companies (http://seekingalpha.com/instablog/927562-adjusted-return/190576-depreciation-policies-for-some-listed-tanker-companies-euronav-an-outlier). It started more as a small exercise while going through the annual filings: after all, straight-line depreciation is not very appropriate for a cyclical industry where asset values are subject to often violent fluctuations.

    However, a thesis emerged in my mind that conservative depreciation policies (with a corresponding heavy charge on earnings) would mean that during prolonged lean times, book values would not be very far from actual market values, that the relevant company had still gas in the tank and that it would be less likely to dilute shareholders in order to plug a covenant violation, "invest in the downturn" or simply pay back debt. Such policies also indicated companies that paid less attention to the market's reaction to earnings and more to long-term value preservation and creation.

    That exercise gave me confidence to invest in Euronav, a Brussels-listed tanker company, at very low prices in the late summer and autumn of last year. Even if the tanker sector is nowhere near out of the woods yet, Euronav is one of the few companies that has gone through the terrible 2011 without a huge dilution or restructuring exercise and seems able to cope with future challenges without having one.

    In the drybulk sector, while not included in the original post, I found that Euronav's older sister Compagnie Maritime Belge (CMB) also has a very conservative depreciation policy which masks tremendous underlying cashflows - one of the factors that led me to invest in the company in the beginning of 2012 despite some expensive charter-in commitments.

    I am happy with this thesis and thought I would repeat the small exercise for some listed containership companies. I recall that the two assumptions affecting the depreciation rate are a) the estimated useful life of a vessel, expressed in years and b) the residual or salvage value based on scrap iron price per lightweight ton (lwt or ldt). (The constants for each company are each vessel's acquisition cost, built year, acquisition date and lightweight tonnage. Method is straightline.) Longer useful life periods or higher residual value assumptions both reduce depreciation and increase reported income. Conversely, shorter useful life assumptions or low residual values both increase depreciation costs and reduce reported income.

    Useful life/Salvage value

    Global Ship Lease - 30 years

    Costamare - 30 years/$150-250 per ldt

    Diana Containerships - 30 years/$200-350 per ldt

    Danaos Corp.- 30 years/300 per ldt

    Pretty much a standard policy across the board. But take a look at the depreciation policy of Maersk Line, the largest containership owner and operator in the world: 20 years useful life to an estimated residual value of 10% of the cost.

    Maersk Line is the largest segment of Copenhagen-listed A.P. Moller Maersk Group, which has interests in various industry sectors, including an extremely profitable even if declining oil E&P business (currently trying to increase reserves), a very profitable and expanding drilling business, a top port terminal operator and a very large tanker business. A few SA articles have featured some of the varied aspects of Maersk Group (http://seekingalpha.com/symbol/amkaf.pk?source=search_general&s=amkaf.pk).

    Up until 2005, Maersk used to employ a 15-year useful life estimate for its vessels. The change in depreciation policy from 2006 onwards - to 20 years - resulted in a $600 million annual benefit to the P&L account (albeit including the benefit from the accompanying change in depreciation policy for the company's containers (boxes)).

    Under its current policy Maersk Line's depreciation charge for 2011 was $1.6 billion on $18.5 billion of assets - the segment's net loss from operations was $600 million (finance expenses at Maersk are incurred centrally at group level).

    Couldn't Maersk Line further modify its depreciation policy to increase the estimated useful life of its vessels to 25 or even 30 years as the U.S.-listed owners do and reduce its depreciation charge by 25% or 50% percent annually (a very hypothetical $400m or $800 increase in annual profit)?

    Of course they could but they don't seem to care very much. They don't have to impress the U.S. markets with headline profits, nor do they want to raise equity. Similarly conservative policies are employed across the group.

    As in drybulk and tankers, conservative accounting policies do not mean that the company always makes good operational decisions. Too much cash burns a whole in the pocket sometimes. Maersk does have high commitments in its liner business, contracted in previous, headier days. But as a result of the conservative financial planning and accounting policies, the current book equity is much closer to market reality even after expensive acquisitions or investments.

    Currently Maersk has a market cap of some $28 billion and trades at a 25% discount to its equity, with profit guidance of above $3 billion for 2012.

    One could argue that the real comps of Maersk are other global liners listed in non-U.S. exchanges, such as the Japanese lines (MOL, NYK), Hanjin, Cosco or OOCL (and they directly compete for debt capital with non-listed CMA CGM and MSC). However, Maersk also has segments that are directly comparable to individual companies listed in the U.S. (containership, oil and gas, oil drilling, tanker and terminal operators), and some of the latter ones currently enjoy very favorable valuations and prospects.

    A comparison of the Maersk Drilling business with the likes of Transocean, Seadrill and Pacific Drilling would show a huge value in the making, and the oil business is being transformed from a huge cash-cow to a top independent E&P company.

    The comparison with the small U.S.-listed containership providers above is a reminder to investors that what they take for granted in the gung-ho U.S. markets is not the global standard and that opportunities for much safer long-term investments exist elsewhere.

    Stocks: AMKAF, GSL, DAC, DCIX, CMRE
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