EuroseasNASDAQ:ESEA) is a Greek managed, Marshallese flag owner of containerships (intermediate and feeder size). The company saw its value rise and fall in line to containership charter rates between 2020-2022.
In August I wrote a bearish recommendation on ESEAIt was based on the fact that the industry was cyclical and had been overinvested in and that the company’s management wasn’t good at capital allocation. Since then, the stock has fallen by almost 28%.
In this review with 3Q22 dataI believe that the containership market is already in collapse and that ESEA has not reversed its course. ESEA’s future developments are still dire. There is a lot more supply than there is demand, which will increase ESEA’s depreciation costs. ESEA is still highly overvalued.
All information, except where stated otherwise, has been obtained from ESEA’s filings with the SEC.
Industry that is cyclical and commoditizedThe containership industry is characterized by high fixed assets, high exit barriers, commoditized products, and huge fixed assets. This has created a classic industrial cycle of undersupply and prices rising quickly. After which, a lot more supply is built (with lead times of almost 3 years), prices drop again and the market becomes bloated. The cycle is re-started after the supply is slowly reduced.
Capital allocation is not a skill that management excels at: This type of industry requires that you play the cycle in reverse, from a capital allocation perspective. Management must first accumulate cash, without investing in the upper half of the cycle, and then buy capacity from the lower half.
Unfortunately, ESEA’s management have not done this. As if they didn’t understand their own industry or were naive enough to think ‘this is different’, the company made huge investments in the previous cycle (2003-2007), only for it to sell those ships at massive impairment losses during its downward cycle (2008-2020). They ordered new ships (9 in all, for $350million) and bought second-hand vessels at close to record levels. I can almost predict that there will be huge impairment losses.
Family relationships are not always clear: ESEA is run by its founder family. This is generally a good sign. ESEA has too many commercial relationships with other companies that are not part of the founder family. It has bought and sold ships to the family, at market prices, but at terrible timings. It also pays a large managerial canon to a company owned by the family. This service can easily be outsourced to improve cost control.
The price has already fallen: The New Contex Container Index It has already returned to near pre-COVID, unprofitable pricing. Prices appear to have stabilized temporarily around $15 000 for the feeder category and around $19 000 for the intermediate category. Although I don’t plan to forecast future prices it is possible that they will not fall below $10 000 per day (as before COVID), given the inflation that has been experienced around the world.
ESEA has two years worth of profitable contracts and then the market PricesChartered at record-breaking prices of $30,000. per ship per day, a significant portion of ESEA’s fleet is currently in operation. The contracts mature in stages in 2023, 2024.
These chartered contracts will ensure that the currently operating line is profitable until 2024. Given that the cycle has already reversed, the new ships will likely be chartered at lower prices than current prices, with the exception of two charters at $48 thousand rates up to 2026. Most ships will be chartered at close to current prices by 2024.
Expect an explosion in interest costs and depreciationESEA will begin depreciating its 9 new boats as soon as it receives them in 2023 and 2024. With an average depreciation life of 25 years and a cost of $350 million, I expect $14 million in additional annual depreciation expenses by 2025.
ESEA is unable to generate the cash needed to pay for the ships and will have to increase its overall debt. ESEA still needs to pay $287million and has generated approximately $100 million in CFO TTM. To pay for the new ships, ESEA must increase its debts by $100million if it is to maintain the same CFO level in 2023 and 70% in 2024. It will reach net debts minus cash of $190million by 2024.
ESEA’s borrowing interest rate (informed in the latest 20-F for FY21LIBOR + 3.5% (which could have changed in the future). The effective interest of the company over its average debt in 3Q22 was 5%. This is lower than expected considering that LIBOR had already risen to 4% during that period due to hedges of $60 million.
With a long-term interest rate of 5%, the company will likely pay $10 million by 2024.
ESEA’s average operating cost was $10000 per day, which includes dry docking expenses, as I reported in August.
The company will have vessels with a gross cost of $600 million, which will depreciate at a cumulative rate $25 million per annum. This amounts to approximately $1 million per vessel or $2.8 Thousand per day. This is not the same thing as the ship’s market value loss. According to the investors presentation from NovemberA ship of 2,500 TEUs loses $20m in value within the first ten year of its operation. This is compared to a $40 million initial price.
The $10 million in interest costs add $1000 per day per ship. ESEA will need a charter rate of $14 000 per day after 2024 to break even. The company can allocate $25 million per year to debt repayment, as depreciation is not an accrual. To repay its principals, it must make even more.
With a market cap of $140million, rates should rise by an average $1.5 thousand per day to help the company generate $14 million in after-tax profits. This means that a profitable charter rate should be at least $15.5000 per day.
Prices are already close to those levels and supply has not fully hit the markets yet. ESEA estimates that the feeder fleet grew by 6.6% in 2022. It is expected to grow another 8.5% in 2023, and 5% by 2024. Intermediate ships are charged 10% in 2023, and 10% in 2024.
ESEA operates within a non-profitable industry and has a subpar management team. It has lost hundreds of millions of shareholder value and has continued to operate at a loss. This new cycle saw the company repeat the bad decisions that caused under profitability and value destruction during the 2010s decade.
To put it another way, asking for a 10% return based on ESEA’s current market capital is exceedingly generous. You could ask for the same return on companies of higher quality in the current market.
ESEA’s increasing expenses and the fragile containership market make it difficult for ESEA to achieve this return in the long-term. ESEA’s investment today does not guarantee a low-quality company with a low return. ESEA is, in my opinion, a no-go.