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Excellent Risk/Reward Setup in 2022
A challenging 2020 turned into a phenomenal return for shipping in 2021. Although I expected a strong year as per last year’s intro article, and the average sector provided a +62% return, our Model Portfolios at Value Investor’s Edge achieved a 136.2% return with long only positioning including no leverage or options.
Let’s be clear upfront: I do not expect another 136% return in 2022. Such a return, essentially a decade of performance in one year, might never happen again in my lifetime. However, the risk/reward setup into 2022 looks to be the best on record and looks even better than in early-2021. This is because although the upside is likely a bit less, the downside risks have also been mostly mitigated. The financial strength of the average publicly-listed shipping company (i.e. balance sheet leverage, liquidity, cash flows) has never been stronger, corporate governance has never been better, and the majority of the firms we cover have adopted attractive shareholder return policies. For containership firms in particular, most of these firms have locked in strong contracts for 3-5 years, ensuring strong results for years to come, even if forward market rates fade. The dry bulk and tanker segments remain far more speculative, but again, the balance sheets are strong and the management teams are solid. This is arguably the best risk/reward setup we have ever seen in shipping.
Review of Markets in 2021
The shipping industry itself did very well in 2021, posting an average return of 62.4% YTD as calculated on Value Investor’s Edge (based on the average 50+ US and Oslo-listed shipping stocks since there is no cohesive industry ETF). Our models significantly outperformed, with a 2021 return of 190.8% in the Speculative Model and 81.7% in the Value Model (Best Risk/Reward).
This was a banner year for these investments and it marked the 6th consecutive year of industry outperformance. Our six-year track record is shown below, which includes 3 years of tracked trades (2016-2018) before a shift to easier to follow long-only model portfolios from 2019-2021.
The most interesting part of the comp chart is that the ‘shipping industry’ as an average (SEA ETF from 2016-2018; custom index from 2019-2021 after SEA was dissolved) has produced 0% returns in the past six years.
If you have heard, or believed “shipping is a bad place to invest,” that has indeed been correct for much of the past decade. A large part of this is because ‘shipping’ is actually numerous sub-segments, all of which have differing fundamentals and trade patterns. This is a sector where industry research and company-specific due diligence is incredibly important.
Although almost anyone could have made decent money in shipping in 2021, it remains clear that stock selection is very important as our models more than doubled the industry averages and outperformed the S&P 500 by 4.7x.
Top Picks for 2022
In today’s update, I will cover 3 of my top picks for 2022, which includes a popular trade favorite, a recovery play for 2022, and an overall top risk/reward setup. These 3 picks are included as part of the 12 stocks in our 2022 model portfolios at Value Investor’s Edge, which will be dynamically updated throughout the year.
Trade Favorite: ZIM Integrated Shipping (ZIM)
ZIM Integrated Shipping has been a favorite selection over the past year as I began buying immediately after their IPO in late-January 2021 from $11-$14/sh before sharing a research report on Seeking Alpha in early-February. Initially, I was looking for a $20-$30 range by mid-2021, but this was prior to the upward explosion of freight rates which occurred after May, as shown in the 1-year chart below:
Source: Freightos FBX Index, 1-Year Chart
ZIM is set to report of $30/sh in EPS for 2021 alone, and based on current rate levels, it looks likely that 2022 could exceed that performance. ZIM has already returned $4.50 in dividends and is set to pay an annual dividend of $10-$14 in the next couple of months (based on 30-50% of FY21 earnings).
The stock price has remained depressed due to a mixture of pre-IPO overhang from large sellers as well as a general misunderstanding or skepticism of the business. Naturally, many investors figured the container freight markets would be ‘boom and bust’ in short order, so ZIM rarely receives any credit for forward earnings potential. I estimate they currently have about $30-$35/sh in cash on the balance sheet, and are generating up to $1.50/sh in free cash flow per week at current rates. Additionally, ZIM has no traditional debt and its only major future obligations are ship leasing expenses.
I have provided a full-length update in early-December, which includes more details on the economics and expectations and I have included the snapshot which shows my near-term expectations for ZIM versus analyst expectations.
The above chart was my estimate as of 30 November. I now expect $13.00-$14.50 EPS for Q4-21 ($13.75 midpoint), $10.00-$14.00 for Q1-22 ($12.00 midpoint), and $7.00-$10.00 ($8.50 midpoint) for Q2-22.
My current ‘fair value estimate’ for ZIM is $77.50, for about 37% upside. This is an exceptionally conservative estimate, which only includes excess earnings expectations through Q2-2022. If freight markets remain strong throughout 2022, then ZIM could easily be a triple-digit stock by mid- to late-summer.
Recovery Play for 2022: International Seaways (INSW)
The top recovery play for 2022 is International Seaways, which is a crude and product tanker company with a fleet of 86 vessels. Although tankers suffered through dismal market conditions over most of the past two years as the result of COVID-19 oil demand disruptions, we are now close to a recovery scenario. Once global jet travel returns close to 2018-2019 levels and OPEC resumes full exports, we should turn the corner back to healthy rates as the global fleet is otherwise in a good balance. Although timelines can change, and Omicron likely pushed the recovery back by another few months, the current expectations is for a market recovery by Q3-2022.
INSW is especially attractive because it has a strong balance sheet and solid corporate governance, plus it trades at one of the largest discounts to net asset value (“NAV”) in the sector. INSW is also actively repurchasing shares, which builds value through exploiting the arbitrage between cheap shares and higher-value assets. Furthermore, INSW has a huge $100-$150M liquidity catalyst upcoming by mid-2022 as they are primed to either sell or refinance their FSO joint venture. Once this refinancing is complete, I expect INSW will supercharge their repurchases if these huge valuations remain.
Although we do not yet have a precise timing on the tanker market recovery, this is the sort of position that could double or more in a bullish market scenario, yet has minimal downside even if 2022 is a dismal year. In fact, there is a potential for INSW to still trade towards $20/sh or higher even if tankers have a bad overall year in 2022. That is the kind of risk/reward setup we enjoy and which has been our ‘secret’ to success all these years.
My current ‘fair value estimate’ is $26.00, for about 68% of expected upside.
Overall Risk/Reward Pick: Textainer Group (TGH)
My top overall risk/reward pick is Textainer Group, which is a box lessor firm, focused on providing financing for container lines to renew and expand their fleet of 20′ and 40′ boxes (as shown below).
Image Credit: Textainer Group
These boxes typically have a serviceable life of about 15 years and typical leasing terms were normally 4-7 years in duration. This would mean that firms like TGH would earn a decent return on the first contract, but they would have to accept mid-life returns and attempt to place these on new deals. The exceptional market strength from late-2020 throughout all of 2021 meant that the metal boxes were in very short supply and liners were willing to sign contracts of up to 12-14 years at all-time record rates.
This has completely transformed Textainer’s business model, both by increasing the expected ROE from all of its capital expenditures as well as by significantly reducing the contract tail risk from 2025-2030+. All of TGH’s recent growth will be fixed on these exceptional contracts well into the 2030s!
Despite this complete transformation of both TGH’s business model and their balance sheet over the past few years, the stock has not yet notably moved. I believe TGH should carry at a current ‘fair value estimate’ of $55.00, for about 47% upside. This firm earns the designation of our top risk/reward pick due to the exceptionally stable nature of the cash flows. Even if market rates correct lower in the coming year or two, a large portion of TGH’s highest margin cash flows are fixed until the 2030s.
Summary: Risk/Reward is Excellent in 2022
As covered in the summary notes and top picks, I believe 2022 offers the best risk/reward setup we have ever seen in shipping. Although I doubt we will see a repeat of the life-changing 136%+ type returns, there is arguably less risk this time around with the potential to still generate very high double-digit annual returns.
I have shared three of my top ideas for 2022: International Seaways, Textainer Group, and ZIM Integrated Shipping. Our own model portfolios include 12 top picks which will be dynamically updated and rebalanced on a regular basis throughout the year.
I hope these updates have been very helpful to readers. How was your experience in 2021? What are you looking for in 2022? I look forward to your views and inputs in the comments section!