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The best way to value shipping equities?

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What is the best way for investors to put a value on shipping stocks? At a time that the dynamics of listed companies are in a state of flux the question is an important one.

That dynamic is one where the big guns are getting bigger through M&A and there is a new school of minnows – penny stocks – swimming in the pond.

Analyst Amit Mehrotra, who covers shipping and a universe of surface transport names at Deutsche Bank, has just published a “Primer on valuing Shipping companies” which lays out what he believes to be the key parameters.  He suggests that: “The key to long term equity value creation in shipping is not embedded in net asset value (NAV), but rather sustainable cash flow attributable to equity holders.”

Mehrotra believes that in the world of shipping investing, lower risk can mean higher reward. He cites tanker stalwarts Euronav / Frontline (EURN/ FRO), along with Star Bulk (SBLK) on the dry side, “which offer the financial scale to represent true investment opportunities. Interestingly, these companies have business models that prioritise risk management and low debt”.

A slightly different take on these issues comes from Clarksons Securities,  in a recent tanker market presentation from analyst Frode Morkedal who suggested that the point where we are in the longer term cycle will impact exactly how investors look at “value”. In his slides, he suggested that during a longer-term upswing, which he suggests the tanker market is experiencing, investors will change their way of putting prices on shipping equities- moving from the NAV methodology towards a valuation framework built around cash flows and earnings with the peer group of large tanker stocks presently trading at somewhere around 3.6x earnings. For investors in tanker shares, this could bring back a return to the excitement of the mid 2003 to 2008, in Morkedal’s view, as P/E ratios begin to expand.

The differences in viewpoints are subtle. Mehrotra, stressing the importance of bigger players with clean balance sheets, at a time that emissions regulations have effectively created barriers to new entrants, suggests such considerations get ahead of pure cyclicality. He noted that EURN and SBLK have dramatically outperformed peer companies in their respective sectors.

Deep in the weeds of financial metrics, he explains an emphasis on NAV limits upside outcomes during cycles because cash flows are only valued at 1x- “…via the increase or decrease in net debt.” He says that valuations tied to the changes in cash flows can achieve higher multiples, similar to Morkedal’s view of investors’ valuation mechanics after they’ve decided that an upturn is real.

Mehrotra’s “Primer” emphasizes also points not-so-subtle differentials. He says that prudent risk management- certain the case with EURN and SBLK, will boost company valuations across the full spectrum of market conditions. He says that: “we see equity values of companies with low leverage remain relatively resilient in downturns vs. equity in companies with high leverage become impaired as market participants price in the potential need for new equity at the lowest point in the cycle.” Conversely, he says that: “Shipping companies with low leverage at all points in the cycle also have an ability to invest in a downturn, when asset values are lower, which secures low breakeven rates”.

Scorpio Tankers (STNG), a company not favored by Mehrotra, which, indeed, has been heavily leveraged, is mentioned is a potential beneficiary of the shift in trade flows with the Ukraine war at a time of a low tanker orderbook. He says: “There have been several periods over the last two decades where refined product tanker rates spiked for several weeks, followed by a quick rebound back to lower rates. Given the current favorable demand dynamics as well as expected low fleet growth in coming years, this time could be different and be the beginning of a sustained upcycle in rates as underlying supply and demand dynamics have never been so favorable.”