Seaspan Preferreds - Thoughts On Valuation

| About: Seaspan Corporation (SSW)

Summary

Seaspan's preferred stock has gotten hammered along with the common, lately on dividend fears.

The preferred has been oversold and there is a dividend cushion.

My top pick for the complex and thoughts versus Costamare.

On February 1, 2017, Morgan Stanley (MS) initiated coverage of Seaspan (NYSE:SSW) with an underweight rating and a $4.50 price target. At the same time, the firm assigned Costamare (NYSE:CMRE) an overweight rating and gave it a $7 price target.

Regarding Seaspan, they noted:

"We see growing pressures on SSW's stock due to a) weak global trade and prolonged oversupply of containerships, b) declining earnings from legacy charters rolling over at lower levels and the impact of the Hanjin Shipping bankruptcy filing, and c) deteriorating balance sheet and liquidity position as current dividend creates annual cash burn that exceeds ~$200m. We see increasing risk of a steep dividend cut in 2017, shifting SSW's valuation away from its yield premium.

Further, Morgan Stanley is not alone:

A number of other equities research analysts also recently issued reports on SSW. Seaport Global Securities restated a "neutral" rating on shares of Seaspan Corporation in a research note on Thursday, January 19th. Zacks Investment Research downgraded Seaspan Corporation from a "hold" rating to a "sell" rating in a research note on Wednesday, December 28th. Janney Montgomery Scott started coverage on Seaspan Corporation in a research note on Thursday, December 1st. They issued a "neutral" rating and a $10.00 price objective on the stock. Citigroup Inc. downgraded Seaspan Corporation from a "neutral" rating to a "sell" rating and reduced their price objective for the stock from $12.00 to $7.00 in a research note on Thursday, November 3rd. Finally, TheStreet downgraded Seaspan Corporation from a "hold" rating to a "sell" rating in a research report on Monday, October 31st. Five investment analysts have rated the stock with a sell rating, four have issued a hold rating and one has assigned a buy rating to the company's stock. The company presently has a consensus rating of "Hold" and an average price target of $12.79.

What made me think of this was my most recent weekly shipping preferred note (here), where I noted:

Preferreds have been weaker than equities over the last week as Seaspan has gotten hammered.

I know, very eloquent. I then went on to say:

The biggest casualty has been Seaspan, so I will have to begin taking a look at the name.

Why? Because charts like this make me curious:

SSW Total Return Price Chart

SSW Total Return Price data by YCharts

The thing is, SSW's preferred stock has gotten hammered over the last few weeks, dropping double-digit percentage points. Morgan Stanley and others are rightfully concerned over the state of the containership industry and containership rates. Both continue to be stressed and are having a negative impact on earnings and the financial condition of the participants.

Should the concern over the company's dividend take such a toll on the preferred? Typically, you get a "baby with the bathwater" knock-on effect. Today, a look at the preferred stock.

The first thing I did was put together some key statement of cash flow data, because, in my humble opinion, this is where the rubber meets the road.

Some folks tend to disagree with my calculation of free cash flow as I take cash from operations, subtract vessel expenditures and then subtract common dividends. As the table above shows, there is no free cash flow when calculated this way, so any metrics utilizing it are gibberish. Costamare continues to generate free cash flow, which is one of the key differences (you can find my references to CMRE's FCF here and here) between the two firms. That said cash from operations covers preferred dividends by over 5x. Common dividends are cut before preferred dividends (preferred are cumulative as well) and the company generates sufficient cash from operations to comfortably cover their preferred. Does this mean that the preferred dividend won't get cut? No. What it does mean is that the company has $500 million on their balance sheet, a slowing newbuild book (as well as the ability to put mortgages on the vessels) and the ability to generate sufficient cash to pay the preferred dividend. Nothing is guaranteed, but some things are still feasible under a stressed scenario - this is one of them.

Seaspan has four series of preferred stock outstanding (the Series D, E, G and H) and one baby bond (SSWN). The following table shows Seaspan instruments versus other containership lessors outstanding preferred stock:

CMRE's and SSW's preferreds trade in the same zip code of 9.5% or so. The outlier is the smaller Global Ship Lease (NYSE:GSL) which trades north of 11% due to its smaller size and fleet composition.

The following chart compares the stripped yield of the SSW preferreds and the yield-to-maturity of the baby bond:

From the chart above, I "cage matched" the stripped yields of the preferred in order to determine which was most attractive and what the relationships were historically:

From the chart above, we can see that the Series E has historically "out yielded" the Series D - admittedly, the yield gap has narrowed.

The chart above shows that the Series E has historically yielded more than the Series G - but no longer (again, in from the wide gap). The Series G moves on.

The chart above shows that the Series G has almost always yielded more than the series E, and still does. From the various Series, the G is the yield pick. As well, it has the second longest lock-out period.

Versus the risk free rate (risk premium), the Series G is near the wides (which we might expect given the sell-off):

I recently wrote about Costamare preferreds and the fact that I am long the Series C. As these are the two leaders in the containership lessor space, let's take a look at the companies.

Over five years, the equity of SSW has outperformed CMRE's:

SSW Total Return Price Chart

SSW Total Return Price data by YCharts

Over the last year, the roles have been reversed as CMRE's financial position and free cash flow have differentiated it from SSW:

SSW Total Return Price Chart

SSW Total Return Price data by YCharts

The question (to me at least) is - what is the relationship between the Seaspan preferred and the Costamare preferred? The problem is that the Series G doesn't have much of a history. Given the yield proximity of the Series G and Series E, I used the Series E as a proxy to determine the relationship.

As the chart above shows, historically the Costamare preferred trades at a higher yield than the Seaspan preferred. With the recent sell-off in the Seaspan complex, the Seaspan preferred are now trading on top of Costamare. Normally, I would, at this point, recommend swapping out of the CMRE preferred and into the SSW preferred to take advantage of this relationship reversal. Given the financial profile difference between the two, however, I am more inclined to diversify the position by owning both.

Series G prospectus here.

Series H prospectus here.

All Series re-offering prospectus here.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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