Horizon Kinetics LLC is a value investing shop lead by Murray Stahl (Trades, Portfolio) and Steven Bregman. The firm employs a true long-term and contrarian investment philosophy. They put out some of the most original and interesting research I’ve come across. In their second-quarter commentary, they highlighted a pocket within this overvalued market they find highly compelling: the shipping industry. As true contrarians they like because it sucks:
"Ocean shipping has its own business cycle, which is not coincident with the U.S. business cycle. In a depression since 2008, it is the only industry in the world that has yet to emerge from the economic crisis of ten years ago."
With AP Moller-Maersk as an example, they illustrate why these companies are, almost as a group, undervalued and out of favor:
"Apart from their fundamental investment merit, if any, many of these companies lack sufficient market capitalization or trading liquidity to qualify for inclusion in equity indexes, so they have no utility to mainstream investors. Even as the world’s largest shipping company, with a $25 billion market value (though over half the shares are family controlled), AP Moller-Maersk is held in just one ETF, the iShares MSCI Denmark ETF. Before you say, “Ahah!”, that ETF has a grand total of $43 million in it. If that ETF only held AP Moller-Maersk, if it were a 100% weighting, that would amount to less than 1/10th of 1% of the company’s shares. The company is not even in the top 10 of this ETF. AP Moller-Maersk trades at 0.8x book value."
They included the table below which shows the price-book book value (a traditional value metric that’s highly informative when applied to asset intensive industries):
One thing to be somewhat mindful of is the amount of debt carried by these companies. A low price-book ratio is great but as the equity-debt ratio becomes skewed towards debt, a company like that can quickly get killed. Alsom buying at a low price-book ratio won’t help you in such situations. I checked the above list on enterprise value to revenue levels and debt-equity ratios.
Frontline and Navigator Holdings have noticeably higher enterprise value-revenue ratios. Stolt-Nielsen, Frontline and Bonheur also have higher debt-equity ratios. My data source doesn’t have the data for Torm, Team Tankers and Concordia. I’ve owned Maersk on and off for the past couple of years. Currently I own it, and it shows up as conservatively financed compared to this peer group when looking at the above metrics.
But there are important risks too:
"As to geopolitical risks, there are two recent changes. The first was the reimposition of sanctions on Iran. In early May, the U.S. announced it would no longer participate in the international plan of sanctions relief for Iran. Among the actions triggered by the U.S. withdrawal, the shipping insurance industry is banned from providing insurance to ships involved in transport to and from Iran. This ban will go into effect on August 6th. This will create idle tanker capacity. Among holdings in our portfolios, many shipping related companies have dropped considerably in price since this news, such as AP Moller Maersk and Clarkson’s, the shipping broker. Others, such as Navigator Holdings, Stolt-Nielsen and Braemar Shipping Services, another shipping broker, have not."
It’s not so much oil prices but miles travelled that matter to the shipping industry. Higher oil prices tend to enable profitability on longer routes. If the oil market’s forward prices are higher compared to current prices, that can also draw capacity away from the industry. In such circumstances vessels can be used as a means of speculative storage. Then there are trade war concerns, which are quite threatening to the shipping industry (especially container) as shipped volumes may decline.
Then there are the trade war concerns:
"Second, investors have become concerned about the impact changes to U.S. trade policy will have on shipping. Prior administrations of both political parties have promulgated trade policies that increased the volume of cross-border trade and were relatively unconcerned about the consistent growth of U.S. trade deficits. The current administration pursues an entirely different approach. Once the consensus investment view reflects the belief that the world trading and tariff regimes are being compromised, the shipping company shares can decline further, although AP Moller-Maersk is already down over 25% from early May. The concern is that trade disputes will further delay the recovery in this industry. Yet, recalling the valuations we just saw, these firms already reflect the conditions of a trade war."
At Horizon Kinetics, they believe valuations already reflect a full-fledged trade war. I’m not sure that’s the case, but currently the primary frontier is still the U.S. and China. Under circumstances like that trading volume should simply shift.
"The unifying theme is that they have been operating in a depression for about a decade. Most have adapted to an environment of low shipping rates. Costs have been dramatically reduced, and many operate at levels that are more or less breakeven. Their valuations reflect that there appears to be little possibility of improvement in the foreseeable future. The attractive aspect of this, if one may use that term here, is that these companies trade well below their book or, really, salvage value. If some diversification away from systemic equity risk was desired, this would be a good choice, since no other sector in the realm of equities has comparable upside optionality. Obviously, if these companies were to trade at even a modest premium to book value, all else equal, they could easily double. But all else would not be equal, because for that to happen, shipping lease rates would first have to rise, and when that happens rates can double and triple in a matter of weeks. That would translate into higher earnings and then into higher book value. That circumstance can unfold very fast."
I’ve not been able to isolate companies that really trade at salvage value, which I’m taking to mean the result if you would sell the fleet for scrap value. Especially when fleets are younger in average age per vessel, scrapping them tends to hurt a lot. If you take salvage value to mean to sell all vessels at prevailing market prices, it sounds right. It is all together a very interesting industry to take a closer look at for the enterprising investor who seeks companies facing tough times.
Disclosure: Author is long Maersk.
