ZIM Integrated Shipping: Red Sea Disruption Is Here To Stay, Over 100% Upside Potential

Friday, 15 November 2024

Investment Thesis
ZIM Integrated Shipping Services Ltd. has re-emerged as a formidable cash machine, with the potential to generate $24 in earnings per share (EPS) annually at current shipping rates. While that EPS level would reflect an extremely optimistic scenario, my more realistic assumption is $11.45 EPS for 2024. What's more, the company boasts over $23 in cash per share and holds additional assets valued at $5.3 per share, including vessels and containers, while currently trading at approximately $13. With these robust figures, the minimum fair value I estimate for ZIM is $30, reflecting an impressive upside of more than 100%, with potential for further adjustments based on rate fluctuations.

Business Overview
ZIM Integrated Shipping Services Ltd. stands as a prominent Israeli global container liner shipping company that has recently diversified its portfolio by venturing into the car carrier segment. At the forefront of ZIM's distinctive approach are the pillars of an actively managed fleet capacity model, remarkable agility, and a commitment to technological innovation achieved through robust big data capabilities and strategic technological partnerships.

ZIM has a clear path, during 2020-2021 ZIM made strategic investments of approximately $1 billion and started a fleet renewal program through 46 long-term newbuild leasing agreements, slated for delivery between 2023 and 2024. While these newbuilds will reduce current OPEX and emissions, at current market rates ZIM could have leased comparable or older tonnage quite cheaper. By 2025, with the complete delivery of newbuilds and the renewal of charters secured during the container boom, ZIM anticipates a significant reduction in its cost structure, positioning itself as a highly competitive player in the industry.

With a global footprint spanning over 90 countries and a service network encompassing more than 300 terminals, ZIM caters to approximately 34,000 customers. The company maintains a fleet of 145 vessels, consisting of 136 charter-in and 9 owned vessels. This operational model, characterized by flexibility and scalability, distinguishes ZIM from its peers, enabling it to efficiently align its fleet size with market dynamics and customer demands.

ZIM's primary route is Asia-USWC (US West Coast), with the Pacific market representing 39% of the total ZIM volume, closely followed by Inter-Asia at 29%. Other markets contribute smaller shares, accounting for approximately 10% each.

Of particular note is the fact that only 10% of ZIM's business is derived from the Cross-Suez route. This suggests that any potential additional costs linked to rerouting around the Cape of Good Hope are unlikely to significantly affect ZIM's overall costs.

Furthermore, in 2023, there was a notable shift in cargo movement towards USWC as congestion issues vanished. In the event of new congestion challenges, ZIM retains the flexibility to redirect some volume back to the US East Coast (USEC), showcasing the company's flexible model with an actively managed fleet. This dynamic approach positions ZIM to benefit from potential disruptions effectively while optimizing its operational efficiency.

Finally, ZIM has a generous dividend policy, distributing 30-50% of the annual net income to shareholders. ZIM distributes 30% of its net income each quarter and includes a catch-up dividend with Q4 results to achieve the targeted 50% of the annual net income. While the current status of this dividend policy remains unclear, the upcoming release of Q4 results is expected to provide clarification.

Considering the substantial discount I estimate ZIM stock is currently trading at, I believe there is potential for a buyback program to serve as a complementary strategy to the dividend policy. Such a program could enhance shareholder value and signal confidence in the company's financial health.

Red Sea Disruption
The disruption in the Red Sea commenced on November 19th, when Houthis seized control of the car transporter Galaxy Leader. On the same day, the Houthis explicitly stated their intent to target vessels owned or operated by Israeli companies, or those bearing the Israeli flag. Subsequently, in the following days, the Houthis initiated missile and drone attacks, predominantly targeting container vessels. Recognizing the heightened risk, ZIM took proactive measures on November 27, announcing the rerouting of their ships to circumvent the Red Sea, where they had become clear targets. Subsequently, many other liner companies swiftly followed suit, redirecting their vessels around the Cape of Good Hope.

Notably, CMA CGM stood out as a notable exception, continuing its Red Sea transits until February 2, 2024. This decision to suspend Red Sea transits was made in response to mounting pressures on seafarers and heightened risk concerns, marking a distinctive timeline compared to the actions taken by its industry peers. This is particularly noteworthy as CMA CGM was the last major liner company to transit the region, and the announcement came after ceasefire rumors.

The widespread diversions, necessitated by these security challenges, have led to a surge in utilization. Transiting around the Cape of Good Hope takes approximately 40% longer than the route through the Suez Canal. Consequently, this capacity constraint has driven rates up by more than 100% on major shipping routes since the onset of the disruption. The industry now grapples with both operational complexities and economic ramifications resulting from this significant shift in maritime traffic patterns.

What I Expect
In considering the unfolding events, my primary scenario envisions a prolonged disruption spanning several quarters. The inherent challenge lies in de-escalation when rockets have already been launched. I anticipate a temporary softening of rates in February, influenced by the Chinese New Year holidays. Subsequently, I expect some surge as more ships divert around the Cape of Good Hope, coupled with potential congestion from rerouting. Once these effects are factored into the market, rates are likely to stabilize, easing due to schedule normalization and the delivery of new vessels. Notwithstanding this softening, rates are poised to remain considerably higher than December levels, ensuring sustained profitability.

Even in the event of a ceasefire, a swift return of liner companies to the Red Sea and a cessation of Houthi attacks seems unlikely. In my perspective, the only plausible scenario for such a shift would be a comprehensive peace deal involving Israel's withdrawal from Gaza—an outcome with a very low probability. Should such a transformative event occur tomorrow, Q1 will already have good rates, with sustained positive impacts extending into Q2 due to lasting knock-on effects.

ZIM currently maintains a robust financial position. As of Q3-2024, the company holds $3.114 billion in cash and cash equivalents, equating to over $25 per share, providing a substantial two-year buffer based on the 2023 cash burn. Originally, this ample cash reserve allowed ZIM to weather the period until costs align with lower rates in 2025. However, the landscape has shifted significantly with the Red Sea disruption, potentially transforming ZIM into a cash machine once again.

At the same time, while the debt may appear elevated, it predominantly comprises lease liabilities (amounting to $4.62 billion) from chartered ships. With the delivery of newbuilds and the rechartering of vessels signed during the container boom, costs are expected to decrease significantly in 2025, rendering ZIM more resilient to weaker rates.

Q3-2023 marked a challenging quarter, realizing a rate of $1,139/TEU and incurring a loss of $230 million (excluding impairment). Given rates evolution in Q4-2024, I expect similar figures, with a conservative estimate suggesting a reduction in cash of around $300 million, resulting in year-end cash exceeding $23 per share.

Estimating Q1 2024 presents challenges due to the rapid movement in rates and the mentioned lagging effects. Assuming a stabilization of rates around current levels of $4,500/FEU for Shanghai to Los Angeles, ZIM's primary route, this implies a doubling of Q3-2023 realized freight rates to $2,250/TEU. Given an unchanged carried volume of 867k TEU, these projections translate to a net income estimate of $700 million or approximately $6 in EPS for a quarter.

However, Q1 might not reach these figures due to lagging effects. Assuming a conservative rate of $1,800/TEU, my estimate suggests that ZIM will generate around $2.85 in EPS for the quarter.

As mentioned earlier, I anticipate a softening in rates once the situation stabilizes. Assuming a 10% reduction from current rates and some contracted volume, Q2 is expected to be around $2,025/TEU, and $4.5 EPS. This projection imply $7.35 in EPS for the first half of 2024, and a $2.2 dividend per share.ies

As newbuilds arrive, Q3 and Q4 are likely to see further softening in rates. Assuming a continuous 10% reduction each quarter, rates are projected to be $1,800/TEU in Q3-2024 and $1,575/TEU in Q4-2024. Considering these adjustments, my EPS estimation suggests $2.85 for Q3 and $1.25 for Q4, without factoring in the reduction in costs. For the entire year of 2024, I project an EPS of $11.45 and a dividend of $5.75 per share.

In summary, ZIM is poised to hold $23 per share in cash by the end of 2023 and potentially generate $11.45 in earnings per share during 2024. These factors alone indicate a valuation of $35 per share. Yet, there are additional considerations. ZIM has strategically invested over $1 billion in ships and containers without incurring debt. At current values, even after accounting for impairments, these assets hold a significant worth exceeding $600 million, equivalent to $5.3 per share. Furthermore, starting in 2025, ZIM is set to benefit from a highly competitive cost structure, enabling the company to generate profits even in challenging rate environments.

Considering all these factors, the valuation of ZIM could potentially surpass $40 per share. Adopting a conservative stance, and considering the uncertainties surrounding future rates, a fair value estimate might lean toward $30 per share, presenting an upside of over 100%.

Even in the unlikely event of an immediate ceasefire in Gaza and the withdrawal of Israeli troops, which I consider highly improbable; the only condition for Houthis to cease attacks. Q1 and Q2 are anticipated to be strong quarters, possibly leading to a small profit in 2024 just before the reduction in costs expected in 2025. Without ongoing cash burn, it would not make sense for the stock to trade significantly below cash levels. The fair value could still be $20 or more per share, suggesting a substantial upside potential. In such a scenario, the stock might initially experience a decline and trade at notably low levels until there is clarity on stabilized rates.

Recognizing the potential for a ceasefire announcement in the coming days or weeks, I am personally gradually adding small positions daily and plan to double the position when a ceasefire is officially confirmed.

Bonus – Elevated Short Interest And Analyst upgrades

ZIM currently has a substantial 27.51% of the free float held in short positions. As rates persist at these heightened levels, short sellers are likely growing increasingly uneasy, and at some point, they may need to cover their positions. The notable surge in ZIM's daily volume since the Red Sea disruption suggests heightened market activity, and when short positions are eventually covered, it could serve as an additional catalyst for a boost in the share price.

Furthermore, analysts initially anticipated that the disruption would endure only for a few days or weeks. As it becomes evident that their estimates are too conservative, there is a likelihood that they will revise their outlook for ZIM, potentially coinciding with the release of Q4 results.

Risk
A main risk is the sudden stop of Houthis attacks and safety guaranteed. In that event, rates would be poised to experience a rapid decline as soon as liner companies return to operations through the Red Sea. Although rates might initially stabilize above December levels, there is a possibility of a quick return to loss-making levels.

Recession. Historically, container shipping has a strong correlation with GDP growth. If there was some deceleration, rates could fall due to excess supply.

Another risk is the orderbook and reduced scrapping. In recent years, the container order book exceeded the 50% threshold. While some containers have already been delivered, over 200 are anticipated in 2024. At the same time some liner companies are still placing new orders. Moreover, since the majority of ships are under contract and current rates are elevated scrapping has been delayed.

Conclusion
In conclusion, the investment thesis for ZIM Integrated Shipping Services Ltd. is supported by its robust financial position, cash reserves, actively managed fleet capacity model and progressive cost reductions resulting from newbuilds and recharters. The stock is currently trading at a substantial discount, offering more than 100% upside.

The Red Sea disruption has transformed ZIM outlook and based on my estimations 2024 EPS looks promising. Anticipating a softening in rates from Q2-2024, my projections still point to a remarkable $11.45 in EPS for 2024, and $5.75 dividend if the current dividend policy is maintained. In the improbable scenario that rate holds throughout the year, ZIM could generate $24 EPS.

However, it is crucial to acknowledge potential risks. A sudden stop of Houthis attacks is the main risk that will tumble rates. Additionally, delivered newbuilds will be a constant weight on rates that needs continuous monitoring and assessment.

In summary, the investment case for ZIM Integrated Shipping Services Ltd. is compelling, with a strong emphasis on its impressive cash position, optimistic 2024 EPS estimations, and the prospect of lower costs by 2025. ZIM is an attractive opportunity with significant upside potential.