ZIM Integrated Shipping: Too Low Consensus. Buy ZIM
1. Rating and Target Price
I have a buy opinion on ZIM and a $51 price target. The upside is 68% from the current price of $19. My target valuation is P/B of 1.0x, my 2024 forward BPS estimate is $51, and my diluted EPS estimate is $10.20. My EPS estimate is roughly 4.6x higher than the market consensus of $1.8. While you may consider this excessive, I believe it is achievable given the current state of the container industry ZIM is in, ZIM's earnings structure, and ZIM's operating leverage in past cycles. As such, I believe the current market estimate is too low, the stock is undervalued, and investors can enjoy abundant upside.
Marker Consensus
My estimates
2. Investment Thesis
On June 7, 2024, ZIM's stock plunged 18.74%, likely due to two pieces of news: a downgrade to investment grade on ZIM by Citi analysts and insider selling. The Citi analyst focused on the potential for lower freight rates in the future and issued a sell opinion.
NEGATIVE NEWS FLOW
I agree with the Citi analyst's long-term outlook, and I understand the insider selling behavior given that the stock has doubled in the short term.
However, I view the recent stock price dip as a buying opportunity and issue a Buy opinion. Here's why :
1. ZIM is in the container ship business, and container freight rates are constantly rising due to geopolitical conflicts in the Middle East.
2. ZIM's operating profit will improve steeply as container freight rates rise.
3. Market estimates for operating profit and dividends are too low. Despite the recent share price rally, I believe there is plenty of upside.
The container market has long been an oversupplied industry, and until the beginning of the year, it was expected to remain so. It is both supply and demand factors that have created a reversal of this situation: on the supply side, the geopolitical conflicts in the Middle East; on the demand side, an improving economy in Europe and China, a stronger US economy, and the start of an early peak season following the impact of US tariffs on China.
Container shipping outlook of Maritime Strategies International at Jan/2024
Supply growth estimated 8% vs Demand growh estmated 4%
Container shipping outlook of BIMCO at March/2024
Supply growth estimated 9.1% vs Demand growh estmated 9.5%
(More information about outlook: Container Shipping Market Overview & Outlook March 2024 (bimco.org) )
Some investors are characterizing the current strength in container freight rates as temporary. But how long is "temporary"? Is it a month? A quarter, half a year, a year? Just as all of this year's forecasts were wrong, we don't know the near future. The current upturn is stronger and could last longer than bears think - and that's a key point that could propel ZIM's stock even further.
Another point of comparison is that unlike China's Cosco shipping and Korea's HMM, a significant portion of ZIM's fleet is chartered rather than owned. If ZIM borrows a vessel when container freight rates are high (i.e., when charter rates are high) and freight rates fall during the operating period, ZIM will lose money. Furthermore, when a vessel expires at a high charter rate, ZIM will have no choice but to lease it back at a higher rate, which worsens ZIM's cost structure. This is why Cosco shipping and HMM were profitable in 2023, even when container freight rates plummeted, while ZIM was in the red.
On the other hand, a large share of chartering means that if you charter at a low price and container freight rates rise, you can achieve higher profits. This is why ZIM's margins were higher than its competitors when container freight rates soared during the pandemic in the past.
Profitability Of ZIM
Profitability Of Cosco shipping
Profitability Of HMM
Currently, ZIM is using the money it made during the pandemic to take delivery of new vessels it ordered and return expiring charters. This means that ZIM's recurring profit cost structure has improved and its asset value has increased (because it owns the vessels directly).
3. About ZIM
ZIM was founded in 1945 and is Israel's largest shipping company and the 10th largest shipping company in the world. Some of the ships in its early fleet were used to transport European immigrants to the fledgling state of Israel. It also transported supplies to the fledgling nation as it struggled to survive the War of Independence. In the early 1950s, the company was able to focus on expanding its business into shipping. It expanded its fleet by acquiring several new ships, including passenger ships, container ships, and bulk carriers. In the late 1960s, it abandoned passenger services to focus solely on the transportation of goods, cargo, and containers. In the 1970s, it really took off when it expanded its container services. In 1972, it launched a revolutionary new service, a 100-day voyage to three continents and ports in the United States, Europe, and Asia. In the 1990s, Zim expanded once again, building 15 new ships. Since its founding, the company has been gradually privatized, and in 1999, the Israeli government no longer owned shares in the company. In January 2021, ZIM made its debut on the New York Stock Exchange.
Zim has a global reach with multiple scheduled routes, hundreds of ports, and several international hubs and logistics offices. It calls at more than 180 ports around the world and operates from 10 international hubs. Its weekly and scheduled routes include more than 70 service destinations.
Zim serves several global trade lanes, including East Asia-West Africa, East Asia-South Africa, Mediterranean-Gulf of Mexico, Mediterranean-West Coast, Mediterranean-East Coast, China-Singapore-Israel, and Mediterranean-South America East Coast (Brazil, Argentina).
Container Market Leaders
ZIM's Volume breakdown
Business Strategy of ZIM
According to its 1Q24 conference call, ZIM currently operates 147 vessels, 16 of which are car carriers. ZIM expects to increase its operating capacity by double digits by the end of 2023 as it takes delivery of all newbuildings ordered in 21 and 22. ZIM will take delivery of 46 vessels this year (six of which have been delivered). Meanwhile, there are 30 vessels whose charter contracts are expiring (nine of which have already been delivered). ZIM says it is always re-evaluating whether to keep some vessels for a short period of time or renew them, as the case may be.
After all, ZIM's core strategy is to continue to reduce its cost per TEU as cost-effective newbuildings replace older, less efficient and more costly chartered capacity.
Meanwhile, the company stated that its spot exposure in the transpacific trade will remain relatively high for the year ahead, as the new annual transpacific contracts, which came into effect on May 1, account for about 35% of its expected transpacific volumes. In the past, the company split its spot and contracted volumes 50/50, meaning that it has a greater exposure to the spot market, which is helpful in a rising freight rate cycle such as the current one.
Last but not least, it's important to note the benefit-cost structure. ZIM has stated that they are not exposed to the current charter market at all, because they have already finalized the contracts for their charters three years ago. As far as the cost structure is concerned, ZIM has stated that they are not exposed to the current charter market environment.
4. Dive into Investment point.
Investment Point 1. ZIM is in the container business and container freight rates are constantly rising due to geopolitical conflicts in the Middle East.
The SCFI has risen 73% from 1760pts at year-end to 3045pts at end-May. This is due to the conflict in the Middle East causing container ships to divert to the African Cape of Good Hope instead of the traditional optimal route through the Red Sea. The increased distance has significantly reduced the effective supply capacity of container ships. In addition, the possibility of strikes at US Gulf and East Coast ports and the need for shippers to ship early due to US tariff hikes on China have driven demand strongly so the peak season arrives early. US President Biden announced a tariff increase on some Chinese imports, including electric vehicles and semiconductors exported to the US, starting in August (electric vehicles 25%->100%, semiconductors 25% ->50%).
According to sources, idle capacity has recently reached 0.4% of the total fleet, which is similar to the level during the February 2022 pandemic. In addition, carriers are cutting the capacity they allocate to forwarders. The supply-demand balance for container ships is currently very tight. According to Loadstar, European shippers are actually reporting that freight rates are rising much faster than the index is rising.
CMA CGM has announced further freight rate increases on its Asia-North Europe route. Other container carriers have also announced freight rate increases, suggesting continued strength in spot freight rates.
Investment point 2. ZIM's operating profit will improve sharply as container freight rates rise.
ZIM is in the container shipping business and its operating profit fluctuates significantly with container freight rates due to the high fixed cost nature of the industry.
In 1Q2024, the SCFI average index stood at 2,010 points, nearly doubling from 1,089 points in 4Q2023. However, in 1Q24 ZIM's revenue only grew by 30% q-o-q. Operating profit also turned positive from a loss in the previous quarter, but fixed cost leverage was not as strong as expected. Why?
Most shipping lines, including ZIM, don't trade all of their vessels on the spot market; more than half of their capacity is contracted with shippers at contracted freight rates. So for a spike in spot freight rates to be fully reflected in the company's results, there is a lag time until the contract freight rates are renewed. This is typically three months. Therefore, I should see a steep improvement in ZIM's performance from Q2 onwards.
Investment point 3. Market estimates for operating income and dividends are too low. Despite the recent share price rally, I believe there is plenty of upside.
Given the current state of the container market, market consensus is far too low, and I am confident that ZIM will outperform market consensus by a wide margin this year.
Now it's modeling time.
For 2Q2024, the revenue consensus is USD 1,726 million and the operating profit consensus is USD 190 million. The average container freight rate for the quarter was up 126% YOY. Given that a significant portion of ZIM's operating fleet is on fixed contracts, I believe ZIM's revenue is in the range of 1,700-2,000 USD million, given that the increase in spot freight rates is an adjustment to contract freight rates. I also believe that most of the revenue increase will be added to operating profit, as the company has already covered all fixed costs and turned positive in Q1. Therefore, I believe operating profit is in the range of 300-500 USD million.
The consensus is for revenue and operating profit to decline quarter-over-quarter starting in Q3. However, given the current market conditions, it is likely that freight rates will trend higher through Q3. I expect Q3 results to be better than Q2.
In my financial model, You can match the average SCFI for the quarter, ZIM's revenue and operating income, and OPM. I used historical levels to create a forward-looking forecast.
Based on the SCFI index published through early June, I estimate that the 2Q24 SCFI average freight rate will be over 2200 pt. I estimate the 1H24 SCFI average freight rate to be 2117 pt, taking into account the time lag in which spot freight rates are reflected in revenue. A similar level was seen in 1Q21, with a 4Q20-1Q21 average freight index of 2377 and revenue and operating income of 1744 USD million and 682 USD million, respectively.
I expect the current container freight rate strength to continue for a considerable period of time, so I assume an average freight rate of 2433pt for this year. Therefore, I believe that 2024 revenue and operating profit will be located between 2020 and 2021.
Consensus Details
Guidance of ZIM
5. Valuation
My Target P/B valuation is 1.0x. My target share price is 51 USD.
This is a methodology that utilizes historical valuations. It is not theoretically based - the most theoretically perfect is DCF. However, for cyclical stocks like shipping stocks, the volatility of annual earnings is so high that it is not empirically helpful to value and invest for the long term. Instead, it is more helpful to understand the current industry and the company's earnings structure, and then compare it to similar periods in the past to arrive at a fair price. The current freight bull market has no historical comparator other than the pandemic. During the pandemic, PBRs rose to 2.0X. I don't expect a multiple to 2.0x, but I do believe there will be significant earnings revisions and I believe a PBR of 1.0x alone represents 2x upside from the current stock price.
6. Conclusion
At the beginning of the year, the container ship market was expected to be severely oversupplied. Container freight rates, which soared to 5000pt after the pandemic, have fallen back to pre-COVID levels due to normalization of excess demand and increased supply. The surge in container freight rates this year came as a surprise to everyone watching the container market, as low freight rates were expected to persist due to oversupply. The medium- to long-term container market outlook is still forecast to be oversupplied.But who can know the future so well? Just as we didn't see this year's spike in container freight rates coming, no one knows if container freight rates will fall in 2025. If anything, given the current state of the world, with geopolitical conflicts sticking around, it may be less Bayesian to predict that they will be resolved and freight rates will normalize. Use the current price dip as a buying opportunity.