ZIM Integrated: Caution Left The Building, But The Risks Remain

seekingalpha08-20

ZIM Integrated Shipping unveiled a huge bump to full-year guidance, leading to a big jump in the stock price.Freight rates have surged due to disruptions from the Red Sea crisis.While many investors ...

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Suphanat Khumsap ZIM Integrated Shipping (NYSE:ZIM) was soaring on Monday after releasing strong earnings results and an even stronger bump to full-year guidance. The disruptions in the Red Sea have led to a surge in freight rates, which in turn have sparked a dramatic turnaround in ZIM’s fundamental results. Management has declared a large bump to the quarterly dividend, and the earnings yield over the coming quarters looks significant. However, I urge caution as investors mustn’t forget that this remains a highly cyclical business facing long-term headwinds from oversupply. I expect the stock valuation to compress meaningfully as the dust settles, more than offsetting any dividends paid along the way. I reiterate my sell rating. ZIM Stock Price I last covered ZIM in March, where I rated the stock a sell on account of the rapidly rising leverage ratio. The stock has more than doubled since then. Data by YCharts I clearly got this one wrong, but my long-term view of the business and stock remains unchanged. It may be tempting to jump back on the bull wagon, but I expect the near term boom to eventually fade. ZIM Integrated Stock Key Metrics ZIM is a shipping company which, due to leasing much of its fleet, has direct exposure to market fluctuations in freight rates. With the Red Sea crisis proving stubborn and expansive, the company has benefitted from the resulting surge in freight rates.   2024 Q2 Presentation In the second quarter, ZIM saw revenues jump 48% YoY, with adjusted EBITDA jumping an astounding 179% to $766 million. The company’s strong showing on the net income front allowed management to declare a $0.93 per share dividend, equivalent to 30% of net income.   2024 Q2 Presentation While the company saw a double-digit uplift in carried volume due to its ongoing investments, it was clearly the surge in freight rate that drove the bulk of the growth, with freight rates jumping 40% YoY. The company ended the quarter with $5.6 billion in total debt versus $2.3 billion in cash, for a net debt position of $3.2 billion. I note that some analyst reports may be omitting the operating lease liabilities in the calculation of the balance sheet position, but I find such an exclusion to be imprudent, especially given that management themselves are not making that same adjustment.   2024 Q2 Presentation In addition to the strong financial results, management also increased full-year expectations, now expecting 2024 to see $2.6 billion to $3 billion in adjusted EBITDA and $1.45 billion to $1.85 billion in adjusted EBIT, up from the prior expectation of adjusted EBITDA between $1.15 billion and $1.55 billion and adjusted EBIT between zero and $400 million. That is a huge jump.   2024 Q2 Presentation Assuming similar margins, that guidance suggests roughly $700 million in net income generation for the rest of the year. It is worth noting that there is not necessarily any reason to believe that management’s guidance is conservative, as they do not have the best track record of surprising against consensus estimates.   Seeking Alpha On the conference call, management, of course, credited their strong results to the Red Sea crisis though noted that “market dynamics still point to supply growth significantly outpacing demand, setting up for a reversion following recent peak rates.” That sense of caution is refreshing to hear, but when asked about priorities for capital allocation on the call, management still emphasized a preference for capEx over other items such as returning cash to shareholders or reducing the net debt position. Is ZIM Stock A Buy, Sell, or Hold? Management’s discussion of capital allocation is very important in predicting future stock returns. Consensus estimates call for a swift return to unprofitability next year, likely due to expectations of a resolution to the Red Sea crisis.   Seeking Alpha Between the $2.68 billion market cap and $3.2 billion in net debt, ZIM has a $5.9 billion enterprise value. With the company guiding to generate up to $1.8 billion in adjusted EBITDA over the next 2 quarters, investors can hardly be faulted for thinking that the stock looks cheap here. However, some context is needed. As stated earlier, I estimate that the company will generate around $700 million in net income through the rest of the year. Assuming a 30% payout, that may equate to roughly $210 million in dividends paid out to shareholders, making up 7.8% of the market cap. However, investors are advised to think longer term and not focus on just the next two quarters. It is worth noting that even against the revamped guidance, ZIM does not look cheap at 3.3x adjusted EBITDA, as lessor Global Ship Lease (GSL) is trading at under 3x EBITDA in spite of lacking the same downside exposure to freight rate fluctuations (GSL is the kind of company that ZIM leases ships from). Importantly, I expect ZIM to see cash generation fall back down to more modest levels once the Red Sea crisis is resolved - the boom in the shipping industry during the pandemic understandably led to a surge in shipping supply, which in theory should bring tremendous downward pressure on freight rates long term. Assuming a 3x multiple on management’s prior EBITDA guidance of $1.35 billion (at the midpoint), that leads to a stock price of $6.60 per share. Even inclusive of the projected dividend payments this year, the projected stock prices losses may more than offset those gains. Crucially, the shipping industry has long seen a preference for adding to fleet capacity, which has not historically been the most shareholder friendly form of capital allocation. While it is possible that the Red Sea crisis continues for longer than expected, management’s preference for ramping up capEx spending means that shareholders are unlikely to see enough dividend payouts to offset the potential for multiple compression. ZIM Stock Risks This risk discussion will focus more on risks to my sell rating. It is possible that the world sees another supply chain disruption event similar to what we saw during the pandemic, when ZIM generated an astounding $9.2 billion in net income across 2021 and 2022. The current stock price would prove too cheap under such a scenario, though I am of the view that such a scenario is highly unlikely. It is possible that the market begins to reward ZIM with a higher valuation multiple, perhaps preferring to focus more on the exposure to upside to freight rates and focusing less on the corollary. Perhaps management can inspire such a shift by announcing intentions to pay down debt as well as increasing their return of cash to shareholders. Such a move, however, looks unlikely given that management teams in the shipping industry have historically focused on growing their fleet capacity, seemingly irregardless of the valuations of their stock prices. Conclusion  The most important detail in the ZIM stock saga is the quality of the business model. Because the company continues to have direct exposure to the volatility of market freight rates (as well as maintaining substantial leverage on its balance sheet), I expect the stock to continue to suffer from low valuation multiples. The current stock price appears to be pricing in an indefinite continuation of the Red Sea crisis, but I think that investors are underestimating the multiple compression risk present in the stock today. The company may distribute generous dividend payments over the upcoming year, but these might not be enough to cushion the stock price once freight rates return to more normal levels. I reiterate my sell rating for the stock.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.26.4","shortVersion":"4.26.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2460008846"}