Danaos: Too Cheap And Profitable To Ignore
Summary
- Danaos' Q2 FY2023 results showed a decline in earnings due to the exclusion of the previous year's ZIM dividend, but debt was reduced and liquidity remained strong.
- Danaos invested in the dry bulk market at an attractive valuation. This diversification effort looks awesome.
- Despite the anticipated annual EPS decline, the stock maintains too cheap valuation multiples, offering investors a solid margin of safety.
- Danaos stock is a clear Buy, in my view, despite all the risks.
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My Summary Thesis
You are reading my 11th article on Danaos Corp. (NYSE:DAC) stock here on Seeking Alpha, and it is also Buy-rated like the other 10.
That's because unlike ZIM Integrated Shipping (ZIM), which I also write about quite often, Danaos' revenues are much more predictable. Moreover, shrewd cost management and generous shareholder policy are bearing fruit - the stock has finally begun to recover after a long sell-off last year. And unlike technology stocks, whose growth is primarily due to multiple expansions, Danaos stock is still one of the cheapest in its sub-industry.
My Reasoning
Let me first take a brief look at the company's recent financial and corporate results to paint you a general picture.
Danaos reported Q2 FY2023 about a week ago [August 7, 2023] showing $7.14 per share in earnings [-5.9% YoY]. The decline was primarily due to the exclusion of the $13.9 million ZIM dividend from the prior year, Evangelos Chatzis [DAC's CFO] said during the earnings call.
DAC's total revenue decreased by 3.7% YoY in Q2. Vessel operating expenses rose to $41.9 million, primarily due to inflationary pressures affecting repairs, maintenance costs, and insurance premiums. General and administrative expenses remained stable at $7.2 million while interest expenses saw a decrease of $7.6 million, attributed to reduced indebtedness and the capitalization of interest on vessels under construction. As a result, the adjusted EBITDA decreased by 7.7% YoY to $177.3 million, largely due to the absence of the $13.9 million ZIM dividend recognized in the previous year [as noted above].
DAC's press release
The company secured ~$0.47 billion in new charter contracts during the quarter, increasing the total charter backlog to $2.5 billion. Now the operating day's contract coverage stands at ~99% for FY2023 and ~86% for FY2024, limiting downside risk and providing a solid contracted income base.
DAC's IR presentation, August 2023
What I particularly liked about the Q2 results is that the company brought down its debt to just $131 million, and maintained a favorable net debt to adjusted EBITDA ratio of 0.2x. In terms of liquidity, Danaos had $293 million in cash reserves by the end of Q2, and its overall liquidity, which includes access to the Revolving Credit Facility, amounted to $653 million. That's >47% of DAC's market capitalization, which is solid.
DAC's IR presentation, August 2023
Danaos invested opportunistically in the dry bulk market, purchasing a stake in Eagle Bulk Shipping (EGLE) [currently at ~16.7%] and acquiring 5 Capesize bulkers. When analysts asked the management about the entrance into dry bulking, the executives said that interesting opportunities in the container market were limited, and for the time being, they see potential in the dry bulk market. And I agree with them - take a look at my June article on Golden Ocean Group (GOGL) where I state that the imbalance between supply and demand in the dry bulk shipping sub-industry will remain for years to come.
In the past quarter, Danaos continued its share repurchase program, using $65.5 million of the $100 million allocated for this purpose. Additionally, they announced a dividend of $0.75 per share, in line with previous ones.
DAC's dividend yield appears to be more than stable at a payout of only 10%, assuming stable contractual revenues, continued deleveraging, and potential growth from EGLE investments.
Seeking Alpha, author's notes
Therefore, from the standpoint of corporate governance, financial stability, and potential total shareholder return, I do not think investors should be concerned.
Also, what makes DAC an even more interesting investment today is its discounted valuation.
On August 12, I published an article about DAC's direct competitor - Global Ship Lease (GSL) - in which I talked about GSL's underestimation. But if GSL is undervalued with its next-year EV/EBITDA of ~3.4x, how can you call DAC with its 1.9x?
As you can see, DAC is almost half as expensive as GSL, while its EBITDA should fall much less than GSL's in 2 years:
The narrowing of the existing spread alone would give DAC stock a huge boost in the medium term, not to mention the potential business growth from the development of the dry bulk shipping sub-industry.
Your Takeaway
Certainly, there are noteworthy risks to consider.
First, fluctuations in charter rates, shipping demand, or the potential cancellation of charters by customers could negatively affect the company's financial performance, given its dependence on charter agreements.
Second, a decline in the HARPEX index could further amplify this risk in 2024-2025. Moreover, the shipping industry at large is susceptible to shifts in global economic conditions, supply-demand imbalances, and geopolitical factors.
However, Danaos benefits from reliable revenue streams and effective cost management, leading to stable EPS figures and a long-awaited stock price recovery from last year's decline:
Seeking Alpha
Also, Danaos' stock remains undervalued within its sub-industry. Even with a projected annual decline in EPS for the next 2.5 years, the stock continues to be valued at <4 times the price-to-earnings ratio by FY2025, which I believe provides investors with some sort of margin of safety.
Seeking Alpha
As I wrote in my last article, DAC is a very cheap cash machine not only in absolute terms but also compared to other direct peers. The company's recent Q2 FY2023 financial results make me, as an investor, more confident about the future and expect the FCF generation potential to last longer than currently priced in by the market. So that's why I reiterate my previous "Buy" rating today.
Good luck with your investments!
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This article was written by
Oakoff Investments is a personal portfolio manager and a quantitative research analyst with 5 years helping readers find a reasonable balance between growth and value by sharing proprietary Wall Street information.
He leads the investing group Beyond the Wall Investing with features that include: a fundamentals-based portfolio, weekly analysis on insights from institutional investors, regular alerts for short-term trade ideas based on technical signals, ticker feedback by request from readers, and community chat. Learn more.Analyst’s Disclosure: I/we have a beneficial long position in the shares of DAC either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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