ZIM: The Market Is Bearish – A Contrarian Buy For The Brave

The Over-Supply Is Coming Indeed

In the recent FQ3’22 earnings call, ZIM Integrated Shipping Services Ltd’s (NYSE:ZIM) management has guided that 25 of its vessels will be scheduled for renewal in 2023 and another 37 vessels in 2024. The obligation could lapse, due to the worsening macroeconomics impacting demand over the next few quarters. This fleet management strategy may naturally allow the company to moderate cash burn, while also reducing its existing fleet by -41.6% to 87 chartered vessels.

Nonetheless, the biggest concern among ZIM investors would be the staged delivery of 47 new chartered vessels between Q1’23 and Q4’24, reportedly at an expanded capacity compared to the lapsing obligations. These are broken down as such:

• ten 15K TEU LNG-fueled container vessels, to be delivered between Q1’23 to Q1’24 – unspecified charter agreement.
• ten 7K TEU LNG dual-fuel container vessels, to be delivered between Q4’23 and Q4’24 – unspecified.
• five 7K TEU LNG dual-fuel container vessels, to be delivered in H2’24 – unspecified.
• three 7K TEU LNG dual-fueled container vessels, to be delivered by H1’24- eight-year charter.
• five 4K TEU secondhand container vessels, delivered by 2022 – four-and-half-year charter.
• eight 5K TEU newbuild vessels, to be delivered between Q3’23 and Q4’24 – five-year charter.
• six 5.5K TEU newbuild vessels, to be delivered between Q2’23 and Q1’24 – seven-year charter.

Specifically, most of ZIM’s new builds will utilize LNG, which suggests faster steaming with reduced carbon emissions, as mandated by the 2023 IMO. Due to the apparent economic downturn, speed may be of little importance in 2023 indeed. However, 2024 may be a better year as macroeconomic conditions improve, though freight rates are unlikely to return to pandemic heights. Notably, these new obligations will only be recorded on the company’s balance sheet upon delivery, moderating the headwinds momentarily.

Unfortunately, the ZIM management has reported that its long-term contracts (six to twelve months long) have been adjusted downward, due to the steep decline in spot freight rates. This naturally triggers more headwinds in its forward profitability. In addition, it may suggest a reversal of the previously excellent guidance of up to 50% in annual net income for Q4 dividend payouts. For liquidity reasons, the management may choose to only pay out 30% for the quarter and keep the rest. While the strategy may prove prudent, the reduced payout may disappoint dividend hunters and, subsequently, trigger another drastic correction.

ZIM’s intermediate execution may also be hampered by the oversupply of shipping fleets and containers alike. The current container-ship order book is at 7.1M TEUs, with 2.3M scheduled for 2023 deliveries and another 4.7M in 2024. In addition, with 81% of the global container fleet younger than 20 years old (as of November 2022), there is a reduced likelihood of scrapping, considering the historical average scrapping age of 23 years.

Therefore, the global fleet supply may eclipse demand growth at a time of peak recessionary fears, triggering another potential decline in freight rates to pre-pandemic levels of $1.3K. These suggest further headwinds to ZIM’s execution and dividend growth through 2024 indeed.

However, It Is Not All Gloom & Doom

Nonetheless, we remain optimistic about ZIM’s long-term prospects, since the management has guided its focus on optimizing profitability for the benefit of its shareholders. Eli Glickman, CEO of ZIM, said in the recent earnings call:

The objective of the company as far as it goes remains the same. We intend to be profitable in the trade where we operate and we don’t wish to sell capacity at a lot. (Seeking Alpha)

The same has been observed with shipping giants such as Maersk (OTCPK:AMKBY). Soren Skou, Maersk CEO, said:

In the second quarter (2020) demand was sharply down by 15% global demand, but prices stayed flat because all of the networks adjusted capacity and basically item the tonnage that was not needed. And certainly going forward will also be our philosophy in, how we operate the network that we will provide the capacity that our customers need. Still, we will not sell all the capacity that we have unless there’s demand for it… Clearly, this assumes that everybody will continue to operate networks the way they do today, but I see little reason to think that people would do something different. (Seeking Alpha)

The latter referred to Hanjin’s bankruptcy, due to the global container price war between 2015 and 2016, after massive new-build deliveries in 2014. While it is uncertain how things may develop over the next few years, one thing is for sure, these pessimistic macroeconomic outlooks may not last forever. Once the inflation rate has been successfully tamped down and the Feds reduce interest rates, speculatively the end of 2023, demand may recover moderately. This may ideally coincide with the phased deliveries of ZIM’s newer fleets then.

In the short term, depending on China’s reopening cadence, we may also see a flurry of revenge spending, attributed to the pent-up demand from three years of lockdown as witnessed globally in 2021. Therefore, there may be a potential recovery in freight rates after the Chinese New Year festivities in February, assuming that the country’s demand temporarily offset the global deceleration in 2023.

In the meantime, ZIM’s prospects remain decent, significantly aided by its robust balance sheet, with $3.15B of cash/investments and minimal long-term debts of $140M in FQ3’22. The stock continues to trade at a massive discount as well, at $17.06 at the time of writing, against its book value of $48.40.

Those who added ZIM at the $20s level may benefit from one (or maybe two) more quarters of excellent dividend payouts. Therefore, brave investors may still nibble here for the speculative short-term FQ4’22 dividends of between $2.65 (based on the reduced FY2022 guidance at 30% payout) or up to $9.50 (based on 50% payout). However, the headwinds may normalize its top and bottom-line growth from 2023 onwards, due to the pessimistic market sentiments and unpredictable spot rates, impacting its dividend growth momentarily. One should also be aware of the stock’s elevated short interest at 19.76%, suggesting its volatility in the short term.

Nonetheless, that does not mean that there are no opportunities for investing. Once the blood bath is over, ZIM may emerge stronger, with newer and more efficient fleets. Its operating expenses may subsequently improve as well, triggering expanded shareholder returns assuming stable spot prices ahead. The plunge in freight rates is already moderating to ~$2.4K at the time of writing, notably still improved against the pre-pandemic level of $1.3K, though moderated against pandemic highs of $10.36K.

Naturally, portfolios should be sized appropriately since we may see more volatility through 2024. Investors that add here should also consciously lower their dollar cost average accordingly. If another price war breaks out, the company may also be priced out, leading to a dividend cut or, worse, a suspension. Therefore, conservative investors may consider getting out promptly, since ZIM’s dividends may be insufficient to cover the drastic gap.