In my last article on Danaos Corporation (NYSE: DAC), I explained that after it fell from about $100 to less than $85 per share, DAC became a more opportunistic investment. Due to strong financial results in Q1 2022, the end of the COVID-19 lockdowns in China and new business developments, I’m bullish on DAC in the short and long term. In the short term, Danaos is well positioned to benefit from the market situation at the end of the COVID-19 related lockdowns in China. In the long term, DAC is well placed to take advantage of the global shortage of fuel-efficient container ships. My valuation shows the stock is worth $144 per share. In a nutshell, DAC is a solid buy.
Q1 2022 Highlights
In its first quarter 2022 financial results, DAC reported operating revenue of $230 million, compared to operating revenue of $132 million in the first quarter of 2021, up 74% year-over-year. The company’s net income increased to $331.5 million, or $16 per share, in 1Q 2022, from $296.8 million, or $14.47 per share, in 1Q 2021. DAC announced a Adjusted EBITDA of $369.5 million for 1Q 2022, compared to Adjusted EBITDA of $96.3 million, up 180%. Danaos declared a dividend of 75 cents per common share for Q1 2022. As of March 31, 2022, DAC’s total contractual operating revenue was $2.7 billion, with charters extending through 2028 and an average remaining contractual charter term of 3.8 years. “The first quarter of 2022 was again exceptional for Danaos”, commented the CEO. “This has enabled us to invest in the future by ordering six vessels in the 7000 – 8000 TEU range, to be delivered between March and September 2024, ready to be converted to run on green methanol when this fuel becomes widely available,” said he declared. continued. Additionally, DAC’s position in ZIM Integrated (ZIM) continues to generate strong returns for the company (including $110 million in net dividends declared in 1Q 2022). As of March 31, 2021, DAC owned 7,186,950 common shares of ZIM, with a fair value of $522.6 million. In April 2022, the company sold 1,500,000 of its ZIM shares, generating proceeds of $85.3 million. From May 2 to May 27, 2022, ZIM’s stock price rose more than 18% to $68 per share, implying that DAC’s position in ZIM common stock is worth $387 million.
In my last article on DAC, I said that the recent declines in freight rates and charter rates are normal. I explained that once China eases lockdowns, freight rates and charter rates will increase. Moreover, I said that when the unloading of containers in Chinese ports is completed, imports into the United States from China will increase. Now it looks like China’s COVID-19 lockdowns are about to end (see here and here). Figure 1 shows the Harper Petersen Charter Rate Index (HARPEX), reflecting the evolution of world prices in the container ship charter market. According to HARPEX, charter rates have fallen over the past two months. Nevertheless, HARPEX is still 120% higher than its level a year ago. Additionally, according to the World Container Freight Rate Index, container freight rates have declined over the past two months. However, it shows that container freight rates are still 30% above their levels a year ago. With the end of lockdowns in China and the resumption of economic activities, the demand for container ships will increase, driving up container freight rates. As a result, charter rates will increase. Thus, I expect charter rates to reach their all-time high in three months.
Figure 1 – Harper Petersen Charter Rate Index
Figure 2 – Global Container Freight Rate Index
Long term outlook
Besides the short-term prospects, Danaos can be a potential long-term investment. Geopolitical events, high energy prices, inflation and the outlook for interest rates, combined with supply chain disruptions, have slowed the pace of new ship deliveries. Figure 3 shows Maritime Safety Information’s (MSI) estimate of global container trade, global GDP growth, and containerized trade growth in 2022 and 2023. MSI expects the growth rate of the World GDP and world container growth rate are lower than in 2021. On the other hand, world container trade is expected to grow by 3.7% to reach 224 million TEUs in 2022 from 216 million TEUs in 2021. In addition, the global container trade is expected to increase to about 233 million TEUs in 2023. In this situation, DAC has entered into agreements to build six new fuel-efficient vessels in the 7000 – 8000 TEU range, which are expected to be delivered between March and September 2024. Figure 4 shows that between 2020 and 2021, DAC’s TEU capacity and number of vessels increased by 8% and 9%, respectively. In the first quarter of 2022, DAC’s TEU capacity and the number of its vessels remained unchanged. Assuming no more deals, by 2024 DAC’s TEU capacity and number of its ships will increase by 9.8% and 8.5%, respectively.
Figure 3 – Estimated world container trade
Figure 4 – DAC TEU capacity and number of vessels
Analysis of business cash conditions indicates that DAC’s cash flow increased significantly to $129 million in 2021 from just $66 million at the end of 2020, up 95%. This cash performance led to a sharp drop in the amount of the company’s net debt. DAC’s net debt stood at $787 million in 2021 compared to its previous level of $1,397 million at the end of 2020, down 43%. Additionally, DAC’s operating conditions show the economic recovery from the COVID-19 pandemic. The company’s operating cash flow increased to $428 million in 2021 from $266 million at the end of 2020. On the other hand, DAC’s capital expenditure increased by more than 100% to reach approximately $356 million in 2021. As a result, its free cash flow has decreased by 27%. to $72 million in 2021. In a nutshell, DAC’s cash flow and capital structure represents the company’s ability to make distributions and pay dividends in the future (see Figure 5).
Figure 5- DAC cash flow and capital structure (in millions)
Also, to analyze the company’s liquidity and performance conditions, I studied DAC’s operating cash flow and CFO/CA ratios. DAC’s operating cash flow ratio increased by 20% to 1.34 at the end of 2021 from its previous level of 1.11 in 2020. This ratio indicates how well the company can repay its current liabilities with the cash flows generated by its commercial activities. DAC’s CFO to sales ratio rose 453 basis points to 62.09% from 57.56% at the end of 2020. This is a sign of the company’s ability to turn sales into operating cash flow . Generally speaking, Danaos is profiting and growing steadily (see Figure 6).
Figure 6- DAC financial ratios
Using Comparable Company Analysis (CCA), I assessed DAC stock to be attractive and undervalued. By comparing Danaos Corporation with other competitors – SFL Corporation (SFL), Global Ship Lease (GSL), Costamare (CMRE) and COSCO SHIPPING Holdings (OTCPK:CICOY) – and using the CCA method, I believe that the fair share value is about $144. To choose the peer group, I considered container ship leaders in the shipping industry. Data was collected from the most recent quarterly and TTM data.
Table 1 – DAC financial data compared to its peers
Comparing DAC’s valuation ratios with other peers shows that DAC is basically one of the best investments in the shipping industry. The company’s P/E ratio is 1.59x, 63% below the group average of 4.31x. This is a sign of undervaluation and the fair value of the stock is higher than its market price. Additionally, the company’s EV/EBIT is 5.29x, 35% lower than the peer average of 8.14x. It should be noted that DAC’s EV/sales, EV/EBIT, P/E and EV/EBITDA are significantly lower than those of SFL. Danaos Corporation has an upside potential of around 71% (see Table 2).
Table 2 – Valuation of DAC actions
Danaos declared a dividend of 75 cents per common share for the first quarter of 2022. DAC’s cash flow and capital structure represent its ability to pay regular dividends to its shareholders. Furthermore, the analysis of the company’s liquidity and performance conditions shows that Danaos can pay its current liabilities with the cash flows generated by its commercial activities. With the end of lockdowns in China and the resumption of economic activities, I expect charter rates to reach their all-time high in three months. Thus, the company’s income will increase. Also, based on my market valuation, Danaos Corporation has about 71% upside potential to $144 per share.