Do you own any shipping stocks? We’ve long been fans of certain shipping stocks due to their attractive yields, good dividend coverage, and long-term contracts. One of the granddaddies of the long-term contract business model is Seaspan Corp. (SSW), which has grown to be the largest independent containership owner/manager in the world. It has an average of seven years remaining on its long-term charters, which represent 90% of its revenue.
To say that SSW has had its ups and downs over the past few years would be an understatement. Take a look at these quarterly growth figures (you better hold onto the railing, though, you might get a wee bit seasick):
SSW’s price also has gone into the deep end, although it came back a bit in December 2017, rising from ~$5.75 to $7.15 in January, a 24% surge, but still very far below its mid to high teens prices in 2015-2016:
Now that we’ve made you a bit green about the gills, with SSW’s common shares’ tale of woe, let’s get to the brighter side of this story – its preferred shares.
Management has used a variety of different funding vehicles, including several preferred series over the past few years, and more recently, baby bonds, as it sought alternative funding sources to fuel its growth. As you can imagine, it takes a lot of capital to build container ships.
There are currently four preferred series on the market – SSW-H, SSW-G, SSW-D, and SSW-E.
They all yield over 8%, and we already own SSW-E, but it’s SSW-H that we found particularly attractive, since it’s trading 5.4% below its $25.00 call value.
We compared all four of these preferreds on a yield to call date basis to account for length of time to call date and current prices vs. their $25.00 call value. (SSW-D jumps out, with a whopping 47.51% annualized yield, but that’s just because its call date is at the end of this month, on 1/30/18.)
SSW-H has a call date of 8/11/2021, which gives you 15 quarterly dividends before it can possibly be called, for a total of $7.38. Plus, you’d realize a $1.35 price gain if and when it gets called.
The annualized yield to the call date is 10.30%:
Preferred Shares Profile:
All of these preferreds are cumulative shares, meaning that Seaspan must pay you any skipped dividends before it pays common shareholders. As it happens, we’ve held SSW’s preferreds through its downturn and it never skipped a quarterly payout.
In fact, when the going got rough in Q4 ’16, SSW’s management chopped the common dividend by 67%, from $.375 to $.125, but they kept those preferred payouts coming.
Note that these are perpetual shares, so there’s no maturity date. Seaspan has the right to call them in, starting on 8/11/2021, but it is not obligated to.
In addition, the preferred shares rank senior to the common shares in a liquidation scenario.
Preferred Shares Dividend Coverage:
SSW’s Q3 ’17 net earnings were $38.1M vs. its preferred dividend payouts of $16.1M, which = preferred dividend coverage of 2.37X:
(Source: SSW site)
We went back over the past four quarters to detail the preferred coverage for the preferred shares, using net income and earnings before depreciation and amortization – EBDA.
Other than in Q4 ’16, SSW has covered its preferred dividends amply. Even just using net income as a coverage metric, it has had a 1.83X cumulative coverage ratio for the past four quarters.
But net income includes huge amounts of non-cash depreciation and amortization due to all of those ships that Seaspan owns. Add those non-cash charges back to net income, (which is customary in the shipping industry and other capital intensive industries), and you get a much more robust coverage figure.
Even in that difficult Q4 of 2016, when it cut the common dividend by 67%, Seaspan still had EBDA/Preferred coverage of 4.2x. Its EBDA coverage was 7.1x in Q3 ’17 and averaged 5.93x over the past four quarters:
SSW’s dividends are reported on a 1099, not a K-1, and are treated as qualified dividend income.
However, if the dividend payments exceed SSW’s earnings, they are treated as a non-taxable return of capital. This is what happened in 2016, as SSW had a net loss of ~-$139M.
(Source: SSW site)
Common Shares Dividend Coverage:
One of the bright spots for SSW’s common shares is that their dividend coverage has improved dramatically in the past four quarters due to the reduced payout of $.125 vs. the prior $.375/quarter.
CAFD (cash available for distribution to common shareholders) was $65.1M in Q3 ’17, to be distributed to 121.83M shareholders, which gave them strong common dividend coverage of 4.27x.
Trailing coverage also was strong, at 5.2x, which was a huge improvement over the previous four quarters, when Seaspan’s dividend coverage was -.35X, due to a massive -$203M vessel impairment charge it took in Q3 ’16, relating to weak market conditions and the Hanjin (OTC:HNJSF) bankruptcy. (Hanjin returned all four vessels to Seaspan and management wrote off $19M).
At a price/book of .47x and a low EV/EBITDA of 7.07x, it looks like the SSW common shares are very undervalued. However, take a look at the dilution info in the risks section for more color on this.
Customer concentration: Partially due to mergers within the shipping industry, SSW has heavy 81% concentration in its major customers – 39% with COSCON, 17% with Yang Ming, 15% with MOL, and 10% with CSCL Asia.
(Source: SSW Q3 ’17 6K)
Market Rates – The downturn in market rates in the past caused a lot of pain for SSW common shareholders, sending SSW’s shares into a long decline. Even though it has mostly long-term contracts, SSW still has 10% of its vessels on short-term charters. However, those rates have improved markedly.
Dilution – You may be wondering why, if SSW’s common shares have vastly improved coverage, a low price/book, and, with market contract rates improving, why we just didn’t buy the common shares?
In addition to the rocky past performance and diminished earnings, there’s another overhang:
“Seaspan entered into a letter of intent in late December 2017 pursuant to which Fairfax Financial Holdings Limited (OTCPK:FRFHF), through certain subsidiaries, will make an investment of US$250 million in Seaspan, in exchange for the issuance by Seaspan of 5.5% interest bearing unsecured debentures, and Class A Common Share purchase warrants.”
“Seaspan agreed to issue 38,461,539 Warrants, each exercisable into one Class A Common Share in the capital of Seaspan and exercisable at US$6.50 per share. Each Warrant will be exercisable within seven years. Seaspan can also elect to require early exercise of the Warrants if the five-day volume weighted average closing price of its common shares reaches US$13.00 at any time after the fourth anniversary of the closing.” (Source: SSW site)
With a current float of ~59M shares, these warrants represent a big 65% dilution for common shareholders somewhere in the next seven years, if they’re all exercised. SSW is currently at $7.13, so the $6.50 warrants are 9% cheaper and may serve to put a damper on SSW’s common price.
Here’s an interesting juxtaposition from the Q3 earnings call: “We have 29 vessels on short term contracts expiring by the end of 2018 that represent approximately 10% of our forecast revenue. 24 Panamax vessels, three 10,000 TEU vessels and two 8,500 TEU vessels.”
“Most of these vessels are chartered below current market rates and provide (up)side as the current charters are renewed in a better rate environment. As an example, the 24 Panamax vessels on short-term charters are chartered at an average rate that is 2,000 a day to 2,500 per day below current market rates. And those current market rates are themselves at seasonally low levels.”
“And the current rates on our charters are approximately 3,500 to 44,000 per day below broker forecast for 2018. As well, rates under 8,500 TEU and 10,000 TEU vessels are well below current market rates with potential outside of 50% to 100% from where they are chartered today.”
(Source: SSW site)
New CEO – Former CEO Jerry Wang retired in 2017, but management has found a replacement – Bing Chen, who became CEO and was appointed to the Board of Directors in January 2018.
“Over his 25-year career, Mr. Chen has held executive positions in China, Europe, and the US. Most recently, Mr. Chen served as CEO of BNP Paribas (China) Ltd. where he led the bank’s growth strategy in China. From 2011 to 2014, Mr. Chen was the General Manager for Trafigura’s Chinese business operations, where he maintained full P&L responsibility for domestic and international commodities trading in the country. Between 2009 and 2011 Mr. Chen was responsible for building the greater China investment banking practice of Houlihan Lokey, Inc. as the Managing Director and Head of Asia Financial Advisory. Between 2001 and 2009 Mr. Chen held various leadership roles in Europe, including as CEO, CFO, and Managing Director of leasing and aircraft chartering businesses. Between 1999 and 2001 Mr. Chen worked as a Director, Business Strategy at Deutsche Bank in New York.”
“Mr. Chen received a B.S., Accountancy (Magna Cum Laude) (Honours) from Bernard Baruch College and an MBA (Honours) from Columbia Business School.” (Source: SSW site)
Q4 ’17 Guidance – Management guided to a $214-218M revenue range for Q4, which is just above Q3 ’17’s figure of $211M – not a big jump, but it continues the positive revenue trend we’ve seen in Q1-Q3 ’17. It also implies normalized net income of ~$36M to $44M, which would be in line with $38.14M Q3 ’17, and would represent 2.37x preferred dividend coverage.
(Source: SSW site)
Even with its struggles, SSW has a better ROA, ROE, and operating margin than broad industry averages. It has a higher debt/equity, but management is focused upon lowering the company’s leverage.
“We are hopeful that by next year at some point next year we will go below five times, (net debt to EBITDA). I think when you look out the more medium term which is around that 2020. I think an ideal goal for us would be to be around 3.5 to 4 times.” (Source: Q3 ’17 earnings call)
Debt and Liquidity:
“SSW currently has two credit facilities maturing in the next 20 months with an aggregate outstanding balance as of today of $57 million and which were secured by six vessels. Repayment of these facilities would increase our unencumbered assets to 25 vessels. We’re all comfortably within all our financial covenants.”
“In October, we issued 80 million of 10-year unsecured bonds and used the proceeds to repay secured bank debt. We currently have 19 unencumbered debt-free vessels ranging in size from 3,500 TEU to 9,600 TEU.” (Source: Q3 ’17 earnings call)
(Source: SSW site)
We rate SSW-H a buy, based upon its 5% discount to the $25.00 call price, the attractive 8.3% yield, and the strong preferred distribution coverage, which we feel will continue, as SSW benefits in its re-contracting efforts from improved market rates. In addition, the preferred shares rank senior to the common shares in a liquidation scenario.
All tables furnished by HiddenDividendStocks.com unless otherwise noted.
Disclaimer: This article was written for informational purposes only, and is not intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.
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Disclosure: I am/we are long SSW.
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.
Additional disclosure: CLARIFICATION: WE’RE LONG SSW-H & SSW-E, NOT SSW COMMON SHARES.