Seeking Alpha

An 8% Baby Bond Yield From Global Ship Lease With Smooth Sailing Ahead

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About: Global Ship Lease, Inc. (GSL), GSL.PB, GSLD, Includes: CMRE, CMRE.PD, DLNG, RILY, RILYH, SSW, SSW.PD, SSWA
by: Richard Lejeune
Richard Lejeune
Deep Value, dividend investing, micro-cap, newsletter provider
Summary

GSL is a far stronger company than it was a couple of years ago.

GSL is now solidly profitable, and profitability has been locked in through 2020 with favorable long-term leases.

The balance sheet has been strengthened by a merger, equity capital raise, and very favorable containership leasing rates.

Refinancing high-cost legacy debt will further increase profitability and enable a common stock dividend to be reinstated shortly.

The baby bonds, preferred stock, and common stock all appear to be bargains at current prices.

Global Ship Lease Inc. (GSL) has become a much stronger company during the last couple of years. No common stock dividend has been paid since 11/12/2015, but the reintroduction of a common stock dividend finally appears on track for 2020. GSL is focused on long-term leases for its fleet of containerships with an average remaining lease term of 2.6 years. Even if favorable containership rates ended tomorrow, profitability already is locked in for 2020. The GSL balance sheet has been further strengthened by a merger, an equity capital raise, and bond buybacks. The expected near-term refinancing of high interest rate debt will further increase profitability in 2020.

This article looks at the top 10 reasons to consider the GSLD baby bonds and also highlights the major risks. GSL and GSL.PB also are worthy of consideration and are covered here briefly.

What is GSLD?

Global Ship Lease 2024 bonds (GSLD) is a par $25 baby bond with an 8% coupon maturing on 12/31/2024. Many investors may not be familiar with GSLD since it's a new issue that has been trading for less than three months. Quarterly interest payments of 50 cents are paid on the last day of February, May, August, and November. Note that the first interest payment being paid on 2/29/2020 has a 2/13/2020 x-dividend date and will be for 55.56 cents. The first interest payment is larger than normal since it covers a period of longer than one quarter. See the prospectus for additional details.

At a recent price of $25.20, GSLD is actually trading below par if the accrued interest is deducted from the trading price. Good quality baby bonds trading below par with an 8% coupon have become rather hard to find lately. GSLD appears to be a bargain and might not last for long at this price. GSLD is a smaller issue with only 1.3 million shares outstanding. It typically trades about 25K shares daily. Use limit orders and patience when trading.

What is GSL.PB?

Global Ship Lease Inc DEP SH Ser B (GSL.PB) is a par $25 perpetual cumulative preferred issue with an 8.75% coupon. Interest is paid quarterly and GSL.PB now yields 8.8% at a recent price of $24.83. Dividends are qualified for tax purposes. GSL is structured as a corporation so that a K-1 is NOT issued to holders of either GSL or GSL.PB. See the prospectus for additional details.

What about GSL?

While this article is focused on GSLD, the rapidly-improving balance sheet also is relevant to common stockholders. Leading shipping author J Mintzmyer wrote a 10/3/2019 Seeking Alpha Top Idea article that made a strong case for GSL to restore the common stock dividend in 2020. GSL had made significant progress since that article was published including reporting a profitable Q3, completion of a significant equity offering, the successful GSLD offering and reducing its secured 2022 bond debt by $57 million.

Despite all this progress, GSL sold off recently with the rest of the shipping sector on coronavirus fears. After hitting a 52-week high of $9.25 on 12/26/2019, GSL has pulled back to a recent price of $7.38. This appears to be an excellent entry point to bet on the restoration of the common stock dividend in the next few months. I believe that GSL has significant support at $7.25 where the last equity offering took place and this limits the downside risk. As noted in the J Mintzmyer article, GSL is permitted to resume a common stock dividend in 2020 under the terms of the 2022 secured notes provided that they are profitable in 2019.

Refinancing the 2022 Bonds?

The GSL 9.875% Secured Notes maturing on 11/15/2022 (CUSIP Y27183AA3 and CUSIP 37953TAB1) were issued on 10/23/2017 when GSL was a struggling company. The distressed condition of GSL at that time is reflected by the high 9.875% coupon for this secured bond issue. The GSL bonds were issued as a 144A issue such that trading was restricted to institutional investors only. Some of the restricted 144A issue was later swapped for a substantially identical unrestricted issue. This is why two CUSIP numbers are listed above.

Unfortunately, the 2022 bonds are extremely difficult for most retail investors to trade. Most brokerages refuse to trade them at all. Those who do allow trading typically require that a round lot of $100,000 par value of the bonds be traded. Despite the high coupon and trading difficulty, the 2022 bonds are no longer a great value at a recent price near $104.75. $340 million of the bonds were outstanding as of the end of Q3 2019. Subsequently, $17.3 million of the bonds were repurchased in a 12/9/2019 tender offer and an additional $47 million of the bonds were redeemed in a 1/31/2020 partial call. The remaining $276 million of secured bonds are now much better secured as a result of those substantial recent buybacks. By reducing the leverage of the secured bond, GSL has set itself up to refinance them at a much lower rate.

1. Lower interest costs ahead

Dynagas LNG Partners LNG (DLNG) recently refinanced its secured bonds and bank credit line with a new bank credit line at three-month LIBOR plus 3% which now totals about 4.75%. Let's assume that GSL can refinance the remaining $276 million of 2022 bonds at 5%. This would generate annual interest cost savings of about $13.5 million and further improve profitability in 2020.

2. Profitable in 2019 and beyond

GSL has become a solidly profitable company. Q3 2019 earnings were $9.9 million and $28.8 million for the nine months ended on Sept. 30, 2019. Any changes to charter revenues will be very gradual given that their average ship charter has 2.6 years remaining. As noted above in item No. 1, a refinancing of the remaining 2022 bonds is expected shortly and will add to earnings. Two additional vessels with long-term charters attached were acquired on 11/25/2019. That transaction is expected to be accretive to earnings. Altogether, GSL appears on track to earn about $50 million in 2020.

3. Improving credit quality

The GSL 2022 bonds were upgraded from B to B+ by S&P on 11/8/2019. The bonds may be due for another upgrade since GSL subsequently reported profitable Q3 results, retired $57 million of secured debt and demonstrated access to the credit market with the successful GSLD offering.

4. Strong Liquidity

Strong liquidity always is an important consideration for high-yield investors considering buying a debt or preferred stock issue. GSL should report Q4 cash of approximately $85 million, taking into account the recent GSLD offering and recent buybacks of the 2022 bonds.

5. The Poseidon merger made GSL a larger and stronger company

GSL completed its merger with privately held Poseidon Containers on 11/15/2018. The merger doubled the size of the GSL fleet and made it less dependent on French parent company CGA CGM by diversifying its charters and ownership structure. The merger also increased the net asset value per share by 52% and strengthened the balance sheet.

6. The equity offering helped enabled debt reduction

GSL raised $55.2 million in a 10/1/2019 equity offering at $7.25 per share. This cash was used along with some recent cash flow to repay a portion of the 2022 secured bonds. A unit of B. Riley Financial Inc. (RILY) acted as the underwriter. RILY also retained a 6.8% equity stake (assuming conversion of the private preferred stock) for itself. It's always quite an endorsement to see an underwriter choosing to retain such a large block of shares for its own account.

7. Containership rates remain favorable

Despite all the negative sentiment in the shipping sector, containership rates as measured by the Harpex Index are still fairly close to their five-year highs.

8. GSL is less vulnerable to trade wars than most peers

GSL is focused on smaller containerships. Their average ship size is much smaller than the ships owned by peers Seaspan Corporation (SSW) and Costamare Inc. (CMRE). Smaller containerships are typically used on secondary trade routes rather than the U.S. to China trade route. While Phase II trade negotiations with China appear to be progressing well, GSL would be less impacted than peers if they should unexpectedly break down.

9. GSL is less vulnerable to coronavirus than most peers

The coronavirus has hit the shipping tanker and dry bulk sectors especially hard. People are traveling less (especially in China) which reduces the need for tanker ships to ship oil, gasoline and jet fuel. An industrial slowdown in China also reduces the need for dry bulk cargos such as coal and iron ore. The impact on the containership sector is much less severe. Consumers are still likely to keep buying the same amount of goods that are shipped by containerships such as clothing, produce, and appliances. Perhaps people will stay home more and shop online rather than going to the mall if the virus outbreak worsens. This won't change the demand to ship consumer goods.

10. Moderate balance sheet leverage

Balance sheet leverage is an important consideration for debt holders and is shown on page No. 4 of the December 2019 Investor Presentation. As shown, GSL has a pro forma market capitalization of about $266 million. This includes the conversion of private preferred stock issued in the Poseidon merger to common stock. Including the recent issuance of GSLD and the recent partial call of the secured bonds, GSL should now have about $542 million in bank debt, $276 million of secured bonds, $33 million of GSLD debt, $35 million of GSL.PB and $837%5 million in cash. Therefore, the enterprise value is approximately:

542 + 266 +276 + 33 + 35 - 85 = $1067 million

The pro forma (assuming conversion of private preferred shares issued to Poseidon holders) GSL equity accounts for about 266 / 1067 = 25% of the total enterprise value. That's a fairly modest level of balance sheet leverage for a profitable company like GSL with hard assets (ships) and stable revenue from long-term leasing contracts.

Let's do the same calculation for containership shipping peers CMRE and SSW. CMRE has an equity market cap of $875 million with $166 million in cash and restricted cash, $1,308 million of debt and $365 million of preferred stock. Therefore:

equity market cap / enterprise value = 875/(875+1308+365-166)= 37%

SSW has an equity market cap of $2.7 billion with $3.4 billion of debt, $0.26 billion of cash and $0.83 billion in preferred stock. Therefore:

equity market cap / enterprise value = 2.7/6.67 = 40%

A higher equity market capitalization/enterprise value indicates less balance sheet leverage. So, using this metric, GSL is somewhat more leveraged than CMRE and SSW. Note however that CMRE and SSW have become market favorites lately. GSL is more leveraged than peers currently based on market cap/enterprise value, but this could be because GSL doesn't currently pay a common stock dividend. The 8.75% yield for GSL.PB is higher than the 8.61% yield for Costamare Inc. PFD SER D (CMRE.PD) and the 7.78% yield for Seaspan Corporation PFD SER D (SSW.PD). GSLD offers an 8.0% yield as compared to a lower 6.9% yield for the less risky Seaspan Corporation baby bond (SSWA).

What are the major risks?

See pages S-18 to S-21 of the GSLD prospectus for a detailed listing of risk factors. I have briefly highlighted some of the major risk factors here. Even with an average remaining lease term of 2.6 years, GSL would eventually be vulnerable to a severe and extended downturn in the containership market. This could happen if for example there was a severe recession. Counterparty risk would be an issue if former parent company CGA CGM faltered. GSL has 23 of 45 ships leased to this global shipping leader. Moody's downgraded the debt of CGA CGM from B2 to B1 in September 2019. In the unlikely event that CGA CGM did default on any of its leases, ships could be rechartered to other parties at market rates that are currently very favorable.

Conclusions

Solid baby bonds with an 8% yield are very hard to find in the current market environment. GSLD has become quite popular with my Panick High Yield Report members. Many high-yield investors may not be aware of GSLD because it's a smaller issue and has only been trading for a few months. GSL has improving credit quality as outlined above. GSL and GSL.PB also appear very attractive at current prices.

Disclosure: I am/we are long GSL, GSLD, GSL.PB, DLNG, SSW.PD, CMRE.PD. 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.