Friday, July 29, 2016

Seaspan (NYSE:SSW)

Seaspan is a REIT-like company that leases out container ships.  Its business model is simple: borrow money, use it to buy ships which are leased out, and pay the difference between the lease payments and the operating/finance costs as dividends.  The key story here is that long lease periods on the majority of their fleet should allow them to ride out the next few years downturn.

Income Statement and Dividend payments

A quick look at its 2015 income statement shows what we'd expect - the biggest costs are depreciation, ship operating costs, and interest payments:


Theres a catch here: the "Change in fair value of financial instruments" (outlined in green).  This is normal for companies that hedge their debt through interest rate swaps1.  Usually the hedged rate of interest will be included in the interest expense, and the "Change in the value of the swaps" is just an accounting entry to be ignored2.  But Seaspan has recorded them differently: The interest expense records the unhedged (variable) rate of interest, and the "Change in fair value of financial instruments" includes the difference between the hedged (fixed) rate and unhedged (variable) on the interest payments3.  We want to include this as part of operating expenses, and ignore the 'accounting entry' part4.  After adjusting for this (all figures in USD 000's):


For REITs we need to check how much of earnings are paid out as dividends:


In 2014 and after, they have paid out more than 100% of their earnings.  This means they are paying out of their depreciation.

Debt structure

The table below shows all debt, including preferred shares, and when it is due:


Can repayments be covered?  All required payments are shown below: the minimum interest repayments, plus rolling over the loans/notes on maturity, plus operating leases:


How much is of the variable rate debt is hedged at fixed rates?  Not much.  And not for long.  Out of approximately 3.4bn floating rate debt:


On the bright side, most of their swaps require payment of LIBOR at 5%, so when they expire, these repayments drop. The 2015 interest payments would be 92m lower if there were no swaps.  On the other hand, finding long term projects - 8 to 17 year leases on assets with a 20 to 30 year lifespan - is a risky business in the long term.  A spike in interest rates could cause problems.  More on this below.

Revenue

When their charter contracts expire?  They have some expirations in 2016/17, and more after 2020:


By 2018 they will have a number of ships with expired charters:
  • 25 panamax vessels (23 x 4250 TEUs and 2 x 4600 TEUs)
  • 2 X 8500 TEU ships
  • 2 x 1000 TEUS, expected delivery in 2017 which they have not charted out yet. May be deferred to 2018.
Assuming these are contracted out at today's market rates, I estimate 2018 'normalised' earnings to be 140m5, down 13% from 2015.  If dividends were maintained6, they'd be digging into 62m from depreciation - sustainable over a few years, since depreciation is around 220m.

Stress Test

3 ships are charted to Hanjin, at rates far above market.  Hanjin has requested a fee cut of 30%, Seaspan refused and said they'd rather take the ships back.  Unlikely, but what if it did happen? If they did take the ships back and re-lease them out at current market rates, I estimate revenue/earnings would drop by 33m7

What if the LIBOR rose to 5%? ...which last happened in 2007.  I estimate that 2015 interest and operating lease payments would raise by 56m if this happened:



If LIBOR rose to 2%, 2015 interest and operating lease payments would raise by about 15m.

Conclusion

Good way to play the container shipping cycle, while getting paid to wait out the downturn.

The main risks are:
  • The shipping cycle downturn may go on for more than 3-4 years, if demand decreases, or if more supply is bought onto the market.
  • Since 2014, Seaspan's dividends are greater than earnings.  Hopefully they are only doing this for a few years to ride out the cycle.  Management cannot lower dividends, as this would hammer the stock price, making equity raising difficult.  This is not a company that grows organically to build long term shareholder value. Think of it as a bond, paying out the difference between its lease rates and costs as a yield (with occasionally a bit of capital returned as well).
  • They are exposed to rising interest rates.
  • About 60% of their 2015 revenue came from China companies (YM, COSCO, CSCL, and COSCON).
Buying this stock is a bet that:
  • The container cycle will recover by 2020, when Seaspan has more vessels coming off fixed-rate charters, and,
  • Interest rates don't rise too much.
This is a cyclical stock.  But when the industry is under dark clouds, sell a few years later when the sun is shining.   Need to remember that it is not a 'buy-and-hold-forever' stock.


See "Illustration of an interest rate swap" here as an example.
This entry will be armortised away later if the swap is held to maturity.
Page 54 of the 2015 Annual report: "Although we have entered into fixed interest rate swaps for much of our variable rate debt, the difference between the variable interest rate and the swapped fixed-rate on operating debt is recorded in our change in fair value of financial instruments rather than in interest expense."  Why....? 
This is done in the press releases for their results, e.g.: see Section B "Normalised Net Earnings and Normalised Earnings per share" here.
Based on: a) 2018 minimum contracted revenue of 794m (2015 Annual Rpt footnote 14a), b) Revenue of USD 5.1K/day for a panamax and USD 10K/day for a 8500 TEU vessel, c) Utilization rate 97%, d) Operating cost for 10000 and 11000 TEU vessel of 15K/day, and for 14000 TEU vessel of 15k/day (from "Daily Operating Cost" graph, p23 here), and e) Excludes latest announcement of 2 11000 TEU craft bought from CGI. 

Assuming dividends of 202m, based on 1H 2016 annualised dividend for both common and preference shares
Assuming current charter rate of 10000 TEU vessel of USD 12K/day, and 97% utilization rate.

Bought Seaspan (NYSE:SSW)

Bought 1315 shares of Seaspan (NYSE:SSW) at USD 15.20 on 27th July 2016.  Total Cost is USD 19,987.09.

This is a cyclical play.  It pays almost a 10% dividend while we wait for the container shipping industry to recover.  I may be 1 or 2 years too early.

For Singapore residents, dividends are reduced by 30% due to withholding tax.


The Container Shipping Industry

Although markets in general are high, several industries are in cyclical downturns.  May be worthwhile to look for value in them.  Container shipping is one.

Container Shipping Cycles

This industry has many players, and all  are price takers. Its a typical cyclical industry.  This chart below is an index of charter rates for container ships:

Source: Harper peterson & Co

The above chart is for a combination of vessel types.  Current prices of for individual vessel types are here.

The usual cycle is that, when rates are high, everyone rushes to build ships.  New supply ends up pushing rates down, starting a downturn.  As it takes 1-3 years to build a vessel, new ships end up being added to an already depressed market.  We are in that phase now:

  • As of February 1, 2016, newbuilding containerships ... representing approximately 19.6% of the total worldwide containership fleet capacity ...were under construction. The size of the orderbook will result in the increase in the size of the world containership fleet over the next few years.  (Seaspan 2015 Annual Report, p11) 

There have been no orders in Q1:

  • With regards to new contracting activity, no orders have been agreed in 2016.  This is the first time since Q2-2009 that three months have passed without any orders signed. (Bimco)

Scrapping of vessels is required to bring the marked into balance, but it will take a long time:

  • Demolition of excess capacity lies at the centre of the road to recovery, also for container shipping.  Multiple years of negative fleet growth is needed to bring sustainable freight rates to the industry.  BIMCO's forecast of 2500,000 TEI to be broken up in r016 only cuts into the fleet by a fraction representing 1.26 of the current fleet size.  (Bimco)
  • Comparisons are being made to 2009 when approximately 1.3 million TEU was removed from a considerably smaller fleet. The mass scale lay ups were triggered by the fact that lines ran out of cash. The industry is not there yet as some lines are still making a profit and the very low fuel prices are propping them up. But a further two or three quarters of declining financial profitability may trigger a notable rise in the idle fleet as we enter the second half of 2016. (Drewry, Jan 2016)
  • The overcapacity build during from 2010 to 2015 assed 4.5million TEUs...at a time of slowing demand, and Drewry noted in its Container Insight Weekly that the 450,000 TEU of capacity it expected to be scrapped this year would account for just 2 percent of the global container fleet to 20 million TEUs.   (joc.com, Jul 2016)
I think the container ship market will take 2-4 more years to recover.  For companies to demolish, things need to remain bad a long time. 

Mega Ships

New larger ships are being delivered, with capacities of 10,000 to 19,000 TEU, compared to the older panamax ship previously (4,200-4,600 TEU).  The aim is to lower shipping costs, especially fuel, as larger ships are more efficient when full.

  • In 2015, 119 ships with 10,000+ TEU capacity accounted for 87% of the total new capacity being ordered.  The other 118 shipds ordered, ranging in size from 1,000 TEU to  5,300 TEU accounted for only 13%. (Bimco)

Two problems with this.  First, its no help when everyone orders them at the same time.  Second, with low fuel prices, the larges ships may not be much more cost effective:

  • The continued low crude oil prices exacerbate the vessel-oversupply. Two years ago, one of the advantages of the Megas was their fuel efficiency, but today's low bunker prices hurt the carriers more than help them as the 6,000-8,000 TEU ships are kept in service since they can still operate economically against the megas.  This serves to keep more capacity afloat and in service. (xeneta)

Panama Canal Widening

Previously, panamax class ships (4,200-4,600 TEU) were used to navigate the Panama canal.  With the widening of the canal this year, larger ships (e.g.: 10,000 TEUs) can run the canal instead.  This has led to a 'cascading' effect in the industry, as 7,000-12,000 TEU ships replace 4-6,000 TEU ships, and they in turn replace 2,000-4,000 TEU ships further down the hierarchy.


  • “The opening of the new Panama Canal in June has created a surplus of old Panamax ships of around 4,500 TEUs,” Drewry said. “This size and design of ship — previously one of the workhorses of the container ship industry — has essentially been made redundant. More Panamax vessels will surely head for the scrapyards of South Asia, as their owners or charterers replace them by newer and more efficient 8,000-plus TEU ships.” ....There are at least 23 Panamax ships anchored in Southeast Asian lay-up sites in Labuan, Davao and Batum and “with grim immediate prospects, more ships of this class will join the lay-up pool.” Twenty-two 4,000-TEU to 4,800-TEU ships, including some as young as 14 years, have already been sold for scrap this year. (joc.com, Jul 2016)
  • Furthermore, the opening of the new Panama Canal in June has created a surplus of old “Panamax” ships of around 4,500 teu. This size and design of ship – previously one of the workhorses of the containership industry – has essentially been made redundant. More Panamax vessels will surely head for the scrapyards of South Asia, as their owners or charterers replace them by newer and more efficient 8,000teu+ ships.  (drewry, 2016) 
  • There were 211 panamax vessels plying panama canal at early 2015.  (tradewindsnews, Feb 2015)

Other Things

The charter cost of the ship is a small proportion of the total running costs:

  • ...if you really look at the composition of the operating cost for the container operators, the charter cost or the ship cost accounts for anywhere between 10% to 20% depending on the vessel side [size?], so charter cost is not really a material consideration, whereas the fuel cost, loading cost, the box rates, IT, cargo canvassing and all the other cost are more relevant in aggregate.  (Seaspan 2016Q1 conference call)

Conclusion

Cyclical, not 'buy-and-hold'.  I think rates will take 2-4 years minimum to recover.  A recession may speed things up a bit - make the pain sharper, leading to more ships being scrapped.

Panamax ships may be redundant now.

Sunday, July 10, 2016

Sold Genel Energy

Sold on 29th June for SGD 4054.  Total loss was SGD 15,339.

Oil was above $50, close to the $50-60 price where shale producers can ramp up production again.  So use this chance to sell the losers.

The lesson here is not to buy stocks in a downtrend.  Especially for companies where: 1) you have little visibility into their business, 2) are small caps and 3) may go to zero.  The simplest lessons are the easiest to forget.

Saturday, June 18, 2016

Trend Following: Part 2

TLDR: I could not find a worthwhile systematic trend following fund to buy into, as I don't live in the US.

I don't have enough capital to do-it-myself and diversify among many markets, so I looked to buy into a fund.

    Past Performance

    What type of returns can you get?

    Use the SG Trend Index (previously the NewEdge Trend Index) to benchmark trend-following funds' performance.  It's a simple index, rebalanced and reconstituted at the start of each year, currently consisting of the ten largest managers (by AUM) that meet their criteria.  Before 2012, it had a wider range of constituents, with similar selection criteria.  

    I selected funds from Jezebel Liberty's Trend Following Wizards page (the ones I could get data for), and charted their performance against the SG Trend Index and S&P500.



    (Data source: IASG)

    The percentage increase and CAGR for those funds active the entire period:


    A few funds have astounding returns: 10 times your money!  Most give between 2 and 6 times.  The SG Trend index gives 2.7 times.  But before running off to buy, these funds were winners selected with hindsight, and are not now available to retail investors.  You can't buy the SG Trends Index either.

    So a lot depends on which fund you choose.  I couldn't find why the different funds performed so differently.  Perhaps different volatility targets.

    The general pattern is a short sharp peak, followed by several years of drawdowns.  You spend most of your time under the high-water mark.  So a lot also depends on when you enter.

    The correlation coefficient of each fund's monthly returns (log difference) to the SG Trends Index was 0.6 to 0.8.  So they are all doing the same thing.

    You might say that starting in 2000 just before the great Nasdaq crash puts trend following in a particularly good light.  Lets pick another date at the start of 2003,  which is one of the S&P's bottoms:



    The percentage increase and CAGR for those funds active the entire period:


    Even here, a worst case scenario for trend following, the SG Trends Index still gives 5% returns.

    Risks

    There are 2 main risks.

    First, drawdowns are long and large, even for funds with high returns.   Look at the table here - its from 2012, after which there was another year of drawdowns!  Can you live with this?  Easier said than done.

    Second, sometimes a fund's rules just stop working, as the market changes.  For example, the original rules used by the famous turtle traders gave a CAGR of 216% from 1970 to 1986, but were flat from 1986 to 2009.  From 2003 to 2006, the highly successful Dunn Capital (in the graphs above) had a drawdown of 50%, while other funds rose.

    Fees

    Fees are very high, most funds charge 2 & 20.  Or more.  High minimum investments mean they are not available for retail investors.

    Retail investors can find a lot of feeder funds which will allow you to invest in the Big Boy's funds. But they typically use swaps to gain exposure to the underlying fund's after-fee performance.  This means that the underlying funds' performance fees are hidden - often not disclosed.  On top of this the feeder fund has a management fee (typically 1-2%) plus a swap feee (typically 0.5%).  They're charging money for nothing!  And the swaps may be worthless if the banking system comes under extreme stress, like in 2008.

    Morningstar covers a couple of systematic trend following funds which charge low fees - around 2+% total.  They're available through Schwab with no front loading fee.  But can only be bought by US residents.

    Since most trend following funds do the same thing - there are only so many ways to 'follow a trend' - fees are an important criteria.  I think this space will become more commoditized in the future, though fees will never be as low as index funds.

    Other Factors

    Many large funds concentrate on bonds, which are more risky now in a zero interest rate environment.  See the last 7 slides by Andreas Clenow here.  Safer to buy into a smaller fund which can trade a larger range of commodity markets.

    Summary

    Its worthwhile buying into a diversified systematic trend following fund, not just for 'diversification' or 'non-correlation', but because the long term returns themselves are worthwhile.  Most years are down years - be prepared to suffer.  As always, there's a bit of luck in choosing a fund - hope that it dosen't suddenly stop performing after you buy it.

    I don't live in the US, so couldn't find anything to buy.  Shit!

    Checklist for buying into a Trend following CTA fund:


    • Fees. 2+ % all-in seems reasonable.  Avoid swaps.
    • Fund size.  Probably between 1bn and 20bn.  Large enough so it wont close.  Small enough that it can trade less liquid commodity markets, and is not forced to trade bonds in a ZIRP environment. 
    • Correlate its past monthly performance against the SG Trends Index to check its really doing trend following.

    Thursday, April 21, 2016

    Trend Following: Part One

    What is it?

    "The core idea of Trend Following is extremely simple...Wait for momentum to build in one direction and get on the bandwagon.  Expect to lose about two thirds of the time and so make sure your winners can pay for your losers and leave enough over to cover the rent." (Clenow)

    In other words, buy after prices start moving up, sell after they start moving down:


    The rules used are simple, for example:
    • moving average crossovers above, 
    • channel breakouts
    • "buy when the price has spent 5 days above the moving average", etc.  
    You may also have an overriding rule to decide "market direction" first, and only take the trades in that direction.  For example:
    • based on a 200 day MA.  
    • For the stock market - based on macro economic data.  
    • For a currency - based on its strength compared to all other key currencies.


    Key Components of Trend Following Systems

    Back Testing

    Rules are back tested against old data to be chosen for the system.  You must know computer programming.  The process is harder than it sounds - there are pitfalls like over-fitting. The book Systematic Trading by Robert Carver covers these.

    After testing, you start the system in real life and hope it keeps working.

    Suffering

    60-70% of trades fail.  These should be made up for by rare winners.  You must systematically take every trade, you can't start second guessing which ones will win.  

    Individual markets often have long periods, sometimes years long, where they are trendless, like soy from 2009 to 2011.  Even after bleeding for years, you need to take every trade.  After eight, nine, ten, eleven, twelve trades in a row lose, you still have to take the next one.  Hard to do, unless you enjoy pain.

    Position Sizing by Volatility

    Unlike investors, Trend Followers measure risk by price volatility.  Specifically, volatility from the recent past is assumed to be close to volatility in the near future.  Potential loss is measured based on this volatility and the stop loss level given by your rule.  This should be limited to between 1% and 1.7% of your capital per trade.

    Potential return is also measured by volatility (again with the potential profit given by your rule). More volatile instruments require a smaller position, less volatile ones require a larger one (or maybe leverage).

    You shouldn't trade instruments where past volatility is artificially constrained e.g.:
    • Pegged currencies, e.g.: trading CHF when the Swiss government removed the peg --> you get blown up.  Maybe your brokerage too.
    • Going long on bonds in an low interest rate environment: Upside is limited as interest rates can't fall much further.  Downside will explode once rates move up.

    Diversification

    Trend followers typically trade 30-40 futures markets at the same time, spanning commodities, currencies and bonds.  The large number of markets is required because most markets are usually trendless. Adding new markets decreases your risk and increases your returns at no cost.

    The problem with exchange traded futures is that one contract size is large.  Clenow suggests you need a minimum of USD 1m to start trading safely.

    Yeah...if I had a million, would I spend my time implementing a Trend Following System?


    May not work on stocks

    Trend following may not work on stocks, as they are more volatile than futures.  Stock markets are highly correlated, and become more so when the SHTF, like in 2008.  So a trend following system in different stock markets is not diversified.  Also, vicious short squeezes will kill a simple automated system.  A systematic trend following system dealing with stocks will probably be long-only.


    What Next?

    The main benefit of a futures-based Trend Following system is to provide diversification, in particular, they tend to do well when stock markets do badly.

    If I was to stick to equities-only, to avoid the high capital requirements for exchange-traded futures, a trend following system may be useful as a counterpoint to value investing. When the market is high - like now - and buying and holding is too risky, a growth/momentum strategy with a cut-loss could gain exposure to the market with limited risk.  So it gives me a way to trade when I'm no good at discretionary trading.

    Next, I'll look into whether I could build my own system, or buy into a fund.

             

    Books and Websites


    1. Trend Following by Michael Covel: The book that popularised it.  Well written and entertaining, but lacking information.  Read if you're bored.
    2. Following the Trend by Andreas Clenow.  Describes what its like to implement and follow a system through his experience as a fund manager.  Well written, clear and concise, it is non-technical and an easy read.  An excellent first book for building a system - also see his writings online (1) (2).  Anyone buying into a TF fund should also read this, to discover what TF funds do, how they work, and what you're in for.
    3. Systematic Trading by Robert Carver.  More technical that the previous book, it goes into more detail on why Trend Following works, and common pitfalls in building a system.   I usually skimmed each chapter several times, first to determine what he is trying to do, then how he is doing it.  Its still well written, clear and concise, with the occasional dash of humour.  I think Part One of the book ("Theory") will be useful to any investor/trader.
    4. Au.Tra.Sys blog: Still digging through all the stuff here; useful for anyone building a system or buying into a fund.

    Saturday, January 30, 2016

    Singtel

    A quick look at Singtel.  I like them because their revenues are recurring, and they are in a markets which are a natural oligopoly.  Was attracted by their high margins - in 2015 operating margins from Singapore and Australia (after tax) were 21% - high for any industry and surprising for a utility or "dump pipe".  

    The stock price has dropped recently.  Based on their earnings/cashflows, at what price would I buy?

    Segments

    Singtel is a holding company.  FY 2015 EBIDTA (ending March 2015) is broken down from:
    • 26% from Singapore.  Singtel is the market leader and incumbent.
    • 29% From Australia.  2nd largest operator.
    • 47% from regional associates and JVs, when broken down:
      • 9% AIS (Thailand)
      • 6% Globe (Phillipines)
      • 21% Telkomsel (Indonesia)
      • 10% Airtel (Africa, India and Bangladesh)
    Overall about 2/3rd of revenue and profits are from consumers, the remaining from commercial.

    Cashflows

    Their business model is to use cashflow spun off from existing businesses to buy new businesses.  They have to balance this with paying out dividends to shareholders, and capex requirements to maintain and expand their networks.

    CFO is mostly from Singapore/Australia:


    CFI (outflows) are comfortably below CFO:


    The largest part of CFI is buying Property, Plant and Equipment, which is quite steady over the years.  Acquisitions vary:


    The dividends have been generally covered by cashflows, but this may be a problem going forward:


    Risks

    The main risks are:

    Currency fluctuations

    Page 108 of Singtel's March 2015 Annual Report gives a Sensitivity Analysis:

    I'm not sure about this.  The Telkomsel number is just 10% of their profits.  And I can't make sense of the Optus number: Optus operating income was SGD 2853m in FY2015 (p2 of Appendix 1):


    How can a 10% weakening of the AUD result in a less than 10% weakening of results?  Furthermore, Optus' CEO Allen Lew has been quoted saying "Our suppliers bill us in US Dollars".  The Sensitivity Analysis probably understates the impact by including the effects of currency swaps.

    I'm expecting the AUD to drop another 20% vs the Sing Dollar from now (30% from the time of the 2015 results).  We are halfway through a decade long commodity decline.  By my calculations, assuming 30% of Optus' expenses are in USD, this would give in a 42% decline in Optus' SGD profit! (vs 2015 results)

    Competition

    Singtel's margins were stunning 10 years ago, but since then have consistently fallen to be similar with Optus:


    IDA has announced intentions to allow in a 4th Mobile operator.  I believe the market is too small to support one.  The previous time this happened, Virgin Mobile closed after 9 months.

    New Industries

    There's a risk from Singtel moving into different industries (e.g.: cloud hosting, security) which are different from their core industry.  These industries are usually a lot more fragmented and fast moving than rolling out telecoms infrastructure.  I don't think GLCs can compete in fast-moving, unstructured industries that rely on a first-mover advantage and network effects.  These are the guys you watch Netflix view Facebook over - they can never be Netflix or Facebook.  Better to be a dumb pipe.  For example, why did they buy HungryGoWhere?

    Conclusion

    I like them because they have recurring revenue/profits, in an oligopolistic industry with some barriers to entry.   Not cyclical: their revenues/profits did not fall in 08/09.  And with Netflix and Cloud computing, the long term trend is for more and more mobile, home and office data usage.

    The biggest risk is currency.  I'd wait for the AUD to drop further, or for the market to factor it in. People forget it was 20% below the SGD for several years in the 1990's and early 2000's - commodity cycles are long.  As a rough guess: factoring in a 40% decline in Optus' profits and 30% decline in Telkomsel's profits from FY15 levels, I get profit reduced by 38%, giving a share price of  $2.25 at 15X earnings or $1.80 at 12X earnings.