Global Ship Lease: No Dividend Yet Spells More Upside

| About: Global Ship (GSL)
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Global Ship Lease (NYSE:GSL) is a container ship leasing company whose stock has had quite a run in the last year and a half. But I think the GSL story is not over and there is still some nice upside potential.

GSL was formed to buy 17 ships from parent company CMA CGM, the third largest container shipping company in the world, and then charter them back to CMA. GSL went public through a SPAC acquisition in August of 2008 and is currently leasing the 17 ships to CMA under long term charters with an average remaining life of 8 years.

Bad Times

GSL ran into trouble in 2009 as container shipping rates crashed in the wake of the global economic downturn. GSL had all of its ships leased out on fixed rate long term charters so it was not directly exposed to the drop in shipping rates. But it encountered two other major problems:

  1. CMA was and is the sole leasing counterparty of GSL. Highly leveraged CMA watched its cash flows plummet and it came under serious financial distress. The bankruptcy of CMA would almost surely have meant the end of GSL.
  2. The drop in shipping rates also caused ship asset values to decline. GSL’s debt is secured by its ships and GSL was in danger of violating the loan to value covenants on its debt.

I got into the stock at the end of 2009 and by then GSL had managed to receive a waiver on the loan to value covenant (at a price of course!) although CMA was still under fire. The short story from there is that CMA majority owner Jacques Saade twisted and turned long enough for container rates to recover and CMA was able to recapitalize in an orderly fashion earlier this year.

Good Times

The fog over GSL was slowly lifted and the stock ran up, and up, and up. It hit a high of $7.75 in recent months after dropping to $1.03 at the end of 09. The intrinsic value of GSL is probably around $6 a share on a discounted cash flow basis (although sensitive to assumptions as to rates when the ships are rechartered), and many GSL faithful were surprised at how far the stock ran.

Did Someone Say Dividend?

When GSL delivered Q1 earnings on May 16 (see conference call transcript here), the driver of the run up was revealed: it was all about the potential dividend. While GSL had maintained steady cash flows, the terms of its credit amendment had prevented it from paying out a dividend since early 2009. If GSL could meet the 75% loan to value test on April 30th then it would be clear to reinstate the dividend. GSL would still have a $40 million annual debt repayment obligation so the dividend would not be the .23 cents a quarter it had paid out back in the good old days. Investors were probably expecting about .15 cents a quarter.

Investors love dividends, especially in the shipping sector. But they seem to hate not getting their anticipated dividend even more. GSL reported that it had cleared the April 30th loan to value test and had the ability to reissue a dividend, but it was not going to do so. The stock promptly dropped from over $7 all the way down to $4.97 the next day. In the Q1 earnings conference call, things got heated as one investor accused GSL CEO Ian Webber of lying on the previous conference call that GSL was certainly going to reinstate the dividend if it cleared the loan to value test.

Whether Webber ever implied the dividend was imminent is open to debate, but he could have done a better job of explaining why it was not being reinstated now. The most logical explanation seems to be that GSL wants to preserve its cash position due to its option to buy two new ships at the end of this year for $122.5 million. (These ships come with pre-arranged charters to Zim Shipping at above market rates.) Assuming GSL contributes 30-40% equity for the new ships, it will have to come up with between $37 and $49 million. Additionally, GSL has the $40 million a year mandatory debt amortization. GSL’s current cash flow from operations is somewhere between $70 and $75 million and it has $28 million in cash on the balance sheet. So it would be cutting it somewhat close with a dividend if it wants to avoid raising equity capital for the new ships.

(The sharpest move might have been to reinstate the dividend, watch the stock run to $9 or $10, and then raise equity for the ships at a price almost certainly above net asset value. Don’t tell your finance professor.)

The dividend that never was led to the odd situation of the stock dropping almost 30% because the company wanted to save cash for the ship purchase, which could easily add 15% to the company’s intrinsic value. The new Zim ship charters should contribute about $5 million, or 11 cents a share, in cash flow to equity per year. Even if those 11 cents are capitalized at 10% that is another $1.10 of value for what was a $7 stock.

Where Is This Ship Headed?

If we assume the market will value GSL based on the dividend, as seems to be apparent from the market action, then what is GSL worth? GSL cash flows are mostly fixed so it is fairly safe to say annual cash from operations with the Zim ships will be around $77 million. It will probably hold some back for unexpected ship repairs. So let’s call that conservatively $2 million. Then there is the $40 million debt repayment. That leaves $35 million a year for dividends. Yahoo Finance will tell you that GSL has 54.5 million shares outstanding, but 7.4 million of those are subordinated B shares that will not be receiving a dividend for the foreseeable future. That leaves 47.4 million (fully diluted) A shares receiving the dividend for a dividend of .74 cents a year.

Now here is where it gets interesting. Costamare (NYSE:CMRE), which is a pretty good comp for GSL, has a dividend yield of about 6% and has a 48% payout ratio of cash from operations. If GSL were to be given the same yield on a .74 cent dividend (which assumes a 45% payout ratio) it would trade at $12.33 a share, while the stock is currently around $5.80. Even if we assume a .60 cent dividend at an 8% yield that would equate to a $7.50 stock price, or about 30% upside.

On top of all of this, GSL filed a $500 million shelf offering in February, raising speculation that it will try to refinance its bank loan with high yield debt (its current debt level is $519 million). That would almost certainly reduce the mandatory loan amortization and free up even more cash for a dividend.

I don’t know when exactly the dividend will be reinstated (my best guess is late this year) or how much it will be (I’ll guess it starts with .60 cents), but I think the stock will reward those with patience if comp yields stay around 6%. GSL has been a wild ride, but I think there are more positive developments to come.

Disclosure: I am long GSL.