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.

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1 See "Illustration of an interest rate swap" here as an example.^↩
2 This entry will be armortised away later if the swap is held until it ends.^↩
3 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....? ^↩
4 This is done in the press releases for their results, e.g.: see Section B "Normalised Net Earnings and Normalised Earnings per share" here. ^↩
5 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.^↩ 
6 Assuming dividends of 202m, based on 1H 2016 annualised dividend for both common and preference shares^↩
7 Assuming current charter rate of 10000 TEU vessel of USD 12K/day, and 97% utilization rate.^↩