Maersk (OTCPK:AMKBY) is the world’s largest container ship operator and is working on transitioning from a conglomerate, formerly having holdings in energy and other industries, to the world’s largest integrated logistics company. With recent developments, their stock is likely in for a rough couple of weeks ahead, but this will present an attractive entry point for investors. Their transition and the positive impacts of the IMO 2020 transition are key to unlocking future value.
A Rough Couple of Months
It doesn’t look like Maersk is going to have an easy time in the coming months, between the Coronavirus, the new IMO sulfur cap, continued uncertainty in a second phase US-China trade agreement, and the anticipation around the company’s annual report.
The shipping industry is looking ready to get hit hard in the next month. A short list of headwinds for Maersk includes, but is no means limited to:
- The outbreak of the Coronavirus in Wuhan, spurring quarantines
- The coinciding Chinese New Year and the approximately two-week volume restriction that goes along with it
- Uncertainty over the rapidly rising price of low-sulfur fuel oil and its availability
- Uncertainty over whether the China-US trade agreement will have a positive trade impact and whether a second phase deal will be reached soon
Additionally, the release of Maersk’s annual report is expected on February 20th, and I expect that results will come in near the lower range of earnings projections. This is mainly because of Maersk CEO’s statement that the year was one of poor growth for the company, and also because of shipping rates bottoming out during the fourth quarter.
Overall, shipping volumes look to take a hit in the coming month, particularly China. The uncertainty surrounding low-sulfur fuel will add an extra layer on top of everything else, but the situation could turn out as a positive for Maersk. Finally, the new trade deal is not expected to significantly boost shipping volumes, according to Maersk’s CEO.
However, in the long term, these circumstances shouldn’t hamper Maersk’s transition and, if anything, will provide them with the opportunity to make the strategic acquisitions they need to boost their land-side logistics holdings.
Looking for an Integrated Approach
Maersk’s transition to land-side and integrated logistics has been an ongoing process for several years, but it’s still their main promise for future growth, a massive increase in global trade volume notwithstanding. With its logistics sector bringing in around a fifth of the revenue of its ocean segment, there is plenty of room for that growth if Maersk can convince its ocean customers to all stick with them from end to end.
Up till now, there hasn’t been a substantial shift in this revenue breakdown, something that Maersk is seeking to change. The company continues to make an active effort to further this goal, evidenced by Maersk’s integration of APM Terminal’s inland services with Maersk’s logistics segment back in August of 2019, their recent investments and acquisitions to strengthen their hand in logistics, and the opening of a new distribution warehouse in Vietnam.
Maersk’s freight forwarder subsidiary, Damco, has recently been focused on revamping their technology side and working on improving their operations, which parallels similar efforts within Maersk’s logistics segment. Though Damco is an independent company within AP Moller – Maersk focused on freight forwarding, their efforts to improve the interfaces and technological side are similar to Maersk’s efforts in its partnership with IBM (NYSE:IBM) for blockchain-based supply chain visualizer TradeLens, and Maersk’s tech incubator in India.
Another promising signal for the future of Maersk’s move to offer end to end logistics is the quick uptake of their product Maersk Spot, which promised guaranteed bookings on their ships. This product, in less than half a year, has risen to account for 25% of their total weekly volume . Technological innovations, such as Maersk Spot, are helping to drive efficiency gains, with this product noticeably reducing overbookings.
Maersk has the potential to become the dominant global player in logistics by connecting its massive ocean line with its land-based services and offering a fully integrated option for logistics all through one carrier. The good news here is that Maersk already carries approximately 20% of the world’s containers on its liners; the trouble is converting the eighty percent of its ocean customers who don’t use any of their land-based logistics services to using Maersk. Even better if they used Maersk exclusively from end to end.
With more and more focus being put on this segment, the company will be under pressure to show progress and lay out a roadmap for future logistics growth in the upcoming conference call in February. A successful shift towards a more integrated logistics-based business model can be expected to come with a higher valuation for the company and a hike in revenue, along with margin expansion if Maersk can prove a more efficient transporter as a single integrated service.
Low Sulfur Fuel Rollout
With the recent switch over to new IMO sulfur regulations, there has been a lot of change in a short period. As low sulfur fuel has quickly climbed in price due to supply restrictions, Maersk issued a fuel surcharge to help cover their rising costs. This decision was quickly followed by Hapag-Lloyd (OTCPK:HPGLY).
The new fuel standards have led to shortages in certain ports around the world, namely in India, but these are expected to be eliminated soon. Maersk took preemptive steps to contract for the new fuel as well as to produce their own out of their Rotterdam port in order to avoid the uncertainty.
Some shipping players seem to be suggesting the chaos from the switch is worse than it seems and may be far from over. If this is true, Maersk is likely to come out on top since it has already guaranteed fuel for its ships at many of their ports, which provides them with a reliable supply. Reportedly having 20% of their total consumption needs covered between a contract in America and their production in Rotterdam.
The higher costs are expected to lead to slow-steaming, which reduces fuel consumption, thus saving money for the shipping line, but also reducing the global ship supply by taking longer on each route. This is expected to prompt a rise in container rates, which we have already seen rise around 20% since the beginning of December 2019.
A Large Buyback and Future Dividend Growth
Back in May of 2019, Maersk initiated a buyback program to purchase up to the equivalent of $1.5 billion in shares, or around 6.1% of the company’s shares at current prices. Though this isn’t an enormous amount, the company looks to be executing this buyback very carefully, with buybacks slowing substantially with the recent pullback, suggesting that they are waiting for a further drop before coming in to repurchase huge blocks.
Based on recent reports, the company should have around 900 million DKK authorized in the second phase, which runs through February 28.
This buyback looks to increase the value of shares with many being repurchased and the company able to pad any significant drops by purchasing shares. This could be seen near the end of February if the company continues to wait for the remainder of the purchase and then place orders for the remaining 1 billion DKK at the end of the period.
The company plans to discuss cancelling the repurchased shares at the 2020 and 2021 shareholder meetings and as of the most recent report, held 3.76% of all share capital.
The company also pays an annual dividend, but this is not a large part of the company’s value proposition for shareholders with a yield of just 1.82. With a payout ratio of 52%, there isn’t much room for growth here, except as the company’s earnings increase. Based on 2021 earnings estimates, the company’s dividend could increase by 5 cents to $.16 per share, assuming the company continues to pay out approximately half of their earnings and ignoring the potential effect of cancelling shares as a result of the buyback. With this payout, the forward yield would rise to 2.55%, which is decent, but not reason alone to invest.
Valuation and Earnings Growth
Following the recent shipping selloff spooked by the Coronavirus outbreak, Maersk’s shares are trading around where they were in late October 2019. With this event, Maersk’s shares are reaching an attractive entry point for those looking to invest in Maersk’s long-term transition. I do, however, anticipate further downward action in the near future as the market lets off a lot of pressure around the uncertainty surrounding the situation in China and its potential effect on the global economy and trade.
The recovery for Maersk is expected to begin this year on the back of rising shipping prices, which hopefully will outweigh the higher fuel costs. Based on an average of 12 analyst estimates, Maersk will have EPS of $0.22725 per share for FY2020, and $0.3075 per share in FY2021. This earnings growth should drive an increase in share price, in addition to the value added by evidence of the company’s transition into a larger integrated logistics role.
With recovering margins expected and a more diversified revenue base, Maersk’s valuation deserves to be raised in line with its 5-year average EV/EBITDA of 11.07, which is still below the industry average of 12 and that of its nearest publicly traded competitor, Hapag-Lloyd with an EV/EBITDA of 13.35. With a current EV/EBITDA of 7.26, this would be a large growth in valuation, but a deserving one if the company is successful in achieving its goals of consolidation and improving efficiency along with growing its integrated logistics business over the next two years, which I expect it will be, given its significant scale which it can leverage and the dedication its executives seem to be giving the project.
Over the next month, investors should watch developments with the Coronavirus and trade to see any sentiment reversal in shipping, which is likely to provide a bottom to the ongoing slide in Maersk’s shares. Once the shares dip below $5.25, near their all-time low, I would consider starting a smaller position and continuing to monitor developments in their share price.
Conclusion
Maersk is on a good path to achieving its enormous shift to being an integrated logistics company. The next month looks like it may be a very rough time for Maersk and other shipping names, but this will provide a great valuation for investors to purchase shares in an already cheap company. Over the next few years, as Maersk comes into its own as a more streamlined logistics company, the stock should receive a higher valuation, boosted by the anticipated stronger earnings in the next few years. Furthermore, the company’s large buyback program stands to reduce the overall share count, boosting EPS and potential dividend payout. Overall, the ongoing selloff should present a great opportunity to purchase shares and take part in one of the greatest strategic shifts of this decade.
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