With long-term rates on the rise, bonds, technology/growth stocks, and even precious metals have been under pressure. Last week saw a relatively significant increase in volatility across the financial markets, causing many investors to wonder if it is time to take profits. Indeed, with most stocks trading at a record valuation and COVID lockdowns lasting longer than most expected, the equity market’s outlook is precarious, says an article published on Seeking Alpha.

Container shipping rates

In light of the situation, investors are rotating away from high-valuation stocks toward those with lower “P/E” ratios and more secure earnings. There are very few “secure” sectors today where low valuations can be found. However, the writer believes those few discounted sectors may see substantial inflows as overvalued segments see outflows. One industry which is awash with value opportunities is container shipping.

Container shipping stocks have seen stellar performance over the past few months. As discussed in-depth in “Costamare Outlook Boosted On Rising Charter Rates“, container shipping rates have skyrocketed due to a substantial global shipping container shortage. Since last year, consumers in developed nations have not been able to spend money on services such as travel, restaurants, etc., and instead have increased spending on goods.

This has brought greater demand for containers. Additionally, there has been a decline in production in developed countries which has caused fewer containers to travel back to Asia. Overall, this has caused a mounting number of ships to be stuck in U.S. ports and empty containers to be shipped back.

Global Inflation

Indeed, the surge in shipping rates is a major factor contributing to the rise in global inflation, which catalyzed the recent rise in long-term interest rates. It has also caused many e-commerce platforms to experience shipping delays.

The situation has caused a surge in new container construction, but this is limited by a shortage of steel and lumber (see skyrocketing lumber prices). Overall, it appears that shipping stocks are the keystone investment for investors who expect inflationary pressures to continue to mount.

Since last summer, the shortage has caused ocean freight rates to skyrocket. As you can see below, 3500 TEU container shipping rates have hit extreme levels as has the shipping company Global Ship Lease (NYSE:GSL):

Interestingly, GSL’s price is far below the levels it was trading at when shipping rates were this high before. The stock has more than doubled in value over the past year, but its forward “P/E” valuation remains low at 9.5X. Indeed, shipping rates have risen since it last published its contracting schedule, so it is possible that its earnings outlook increases even more.

A Look at Global Ship Lease’s Prospects

The spike in shipping rates has been a saving grace to many shipping stocks. Over the past few years, trade conflicts, excessive supply, and economic instability have caused many container shipping companies to struggle to survive. Global Ship Lease was subject to hardly positive operating cash-flow, declining creditworthiness, and a lack of working capital.

Fortunately, the high charter rate environment has caused GSL to significantly boost its long-term contracting at high rates. As of its most recent quarterly report, 93% of its fleet was covered for 2021 and 73% for 2022. The company’s credit rating was boosted from B+ to BB- (was rung up) and I believe it may see another upgrade given ongoing improvements. The company also has virtually no idle capacity so its margins are likely to be very strong throughout the year.

It is possible and perhaps likely that we will see a reversal in the spike in North American goods consumption demand which is the primary cause of the shipping-rate boom. Many retailers/importers are struggling with shipping costs which will eventually cause prices for goods to increase. Additionally, the increase in new container construction may cause a glut in containers.

It is fair to say that global container shipping rates are unsustainable. This is a one-off situation that has highlighted systemic risks in the global supply chain that will eventually be fixed. That said, the long-term container shipping market is still supported. There has been a decline in global vessel construction since the 2000s boom as well as a sharp slowdown last year due to COVID. This means it is generally unlikely that a glut will return to the market unless there is a substantial long-term decline in global trade.

Is GSL Still A Value Opportunity?

Overall, the economic environment appears supportive for GSL. The firm has secured solid long-term contracts and, while shipping rates will almost certainly reverse, they are unlikely to return to extreme lows.

As you can see below, the consensus earnings outlook for GSL reflects its supportive economic backdrop

At a 2022 forecasted EPS of $2.85, GSL has a long-term forward “P/E” of merely 5.4X. GSL’s valuation has risen dramatically over the past year and was a stellar value opportunity last March. That said, its valuation over the past three years was abnormally low since many investors were concerned the environment would push GSL into insolvency and potentially bankruptcy. As you can see below, GSL is actually cheap compared to its 2012-2015 valuation:

The years of 2012-2015 saw a “Goldilocks” environment wherein the economy recovered from the 2008 crash but before the disastrous commodity price collapse of 2015. Today, it seems the commodity market is out of its glut and the goods economy (as opposed to the service economy) is in a surprisingly strong position. Thus, the writer believes a higher valuation could be warranted.

Global Ship Lease still has higher net financial debt than it did before the crash, so insolvency risks remain – though this risk is much lower than it was a year ago. Overall, the writer believesy GSL has a fair-value long-term forward “P/E” of around 7-10X which implies a fair-value stock price of $20-28 (using the $2.95 2022 EPS forecast). If GSL attains this valuation, its stock price would rise around 30-80%.

The Bottom Line

Overall, Global Ship Lease is among the few stocks which the writer believes is still a bullish opportunity. It has high factor rankings with “A” grades in value, growth, profitability, and momentum. It is also among the top-ranking stocks in the shipping industry. The core reasons he believes GSL is a superior investment compared to its peers are its extensive contract cover and positive credit outlook. The company is not currently paying a dividend, but investors who want an 8-9% yield can look to its preferred shares (GSL.PB). That said, the writer believes GSL has the best appreciation potential and he sees many reasons to avoid preferred equities today.

The most significant risk investors in GSL should keep in mind is a potential reversal in shipping rates. A return in global trade tensions and/or oncoming container supply may cause rates to decline dramatically. GSL’s contract coverage provides a shield from such a reversal, but it would still upend my $20-28 fair-value target.

The company recently sold equity at $13/share which implies management may not have such a strong long-term outlook for its equity value. Of course, such a sale is reasonable considering GSL is at the highest valuation in around six years. Volatility-averse investors may want to avoid betting too big on GSL, but the writer does believe it is one of the few solid long-term investments today.

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Source: Seeking Alpha