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.^↩

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.  A chart 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 2016 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 large 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 charter 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.

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.