Catalysts, buybacks, and shipping stocks
Search for share cannibals
Catalyst events are the money multipliers in investing. A spark can transform a bottom fish stock into a profitable investment. Conversely, an idea without a catalyst can alter a brilliant analysis into a dead money trade.
Catalysts are an integral part of my investing process. There are two simple rules about them:
No Catalyst, no Fun Rule: do not invest in ideas without catalysts
Winnie the Pooh Rule: the more catalysts, the merrier.
The first rule tells us that without a catalyst on the horizon, we simply multiply by zero. Skipping that step in our process ends with a value trap in our book.
The second rule implies seeking not only one spark, let’s say, on a company level, but more. The rationale behind this is simple: High-order catalysts (on macro, geopolitical, and industry levels) lead to company-level catalysts like share buybacks, not vice versa. So, we need at least one supporting catalyst on a macro scale that leads to a company catalyst.
In today's write-up, I will discuss one of my favorite catalysts, share buybacks. Combined with LEAPS options, they provide a formidable advantage to industrious market participants. Ask Navios Maritime investors in 2024.
In the article, I will cover shipping stocks. However, the principles apply to other TheOldEconomy businesses. Simply replace ships with mines or oil rigs and tonnage with reserves and resources. Buybacks are all about boosting per-share metrics. In other words, get more vessel tonnage, gold ounces, or oil barrels per share.
That said, let’s talk about share buybacks and shipping stocks.
Shipping buybacks 101
The recent carnage in the shipping market is a norm, not an exception. Remember, volatility in shipping is not a bug, but a feature. Softer day rates across all segments drove the market decline. So, now, we can buy high-quality floating steel at a black Friday discount.
Moreover, shipping companies have never been that healthy as measured by cash reserves and leverage. Just below ten companies of nearly 60 enterprises have greater than 50% leverage.
In other words, we have the two mandatory ingredients for an effective buyback program: a discount on NAV and cash on hand.
With spare cash, shipowners have five options:
Hoarding it
Repaying debt (if any)
Ordering new vessels
Purchasing secondhand vessels
Dividends
Buybacks
Each option has pros and cons, and it depends on where we are in the shipping cycle. We are halfway through the expansion phase, i.e., there is more room for growth. Plus, shipowners have cash to deploy in asymmetric trades, in other words, to buy back their own vessels at a considerable discount.
Stock repurchases create long-term value. By reducing the number of shares, the company boosts all per-share multiples: earnings, NAV, FCF, etc.
In a structural inflation environment, the rising cost of capital, materials, and labor pushes shipowners’ NAV up. Therefore, the more the tonnage per share, the faster the NAV/share growth. That said, I prefer a shipowner with ten ships and 50,000 outstanding shares to an enterprise with 20 vessels and 200,000 shares. In that way, I get more floating steel per share.
Buybacks are a way for management to express their view of future vessel prices vs stock prices. If they believe vessel prices will stay elevated compared to share prices, share repurchases are a viable option to create long-term value.
Recently, new vessel prices have reached new highs while the secondhand market has cooled slightly. The following table shows tanker prices:
Vessel prices look close to ATH. However, if adjusted for inflation, they are not that high. This tells two things. Firstly, there is a significant upside, and secondly, the downside risk is not that high.
This statement is valid not only for us as investors but also for shipowners. They can purchase their own ships at a massive discount. Instead of going out on the market to acquire second-hand vessels or order new ones from shipyards, the shipowner can create value via buybacks. Share buybacks are what shipowners should do when the stock market is (over) pessimistic but asset prices are elevated.
There is a long-lasting argument about buybacks vs dividends. The answer depends on who you are asking.
For dividend-oriented investors, the distributions they receive from their stocks matter. They are focused on present cash flows. On the other hand, buybacks are suitable for investors seeking future capital gains.
Dividends provide shareholders with instant gratification at any point in the cycle. But this comes at a price for ship owners and investors. For example, if the company’s shares trade at a 50% PNAV and management initiates buybacks, for every $1 allocated on buybacks, it is worth $2 to long-term shareholders, and dividends are worth $1.
Conclusion
Share buybacks are among the most potent catalysts on the corporate level. Supported by macro tailwinds, they create a formidable advantage for investors. Of course, there are many ways to mess up.
When executed poorly, share repurchases are capital destroyers. Just buy back your company's shares at PNAV > 100%. It's even better to have high interest-bearing debt with higher costs than buybacks. Keep buying shares, and do not extinguish that debt. This is just an example of how to screw up share repurchases.
As usual, it is all about management quality. Capital allocation strategy tells a lot about it, and buybacks are one of its integral parts. Like investing, the buyback outcome is a function of execution, i.e., timing, sizing, and management.
The recent pullback in shipping stocks, elevated asset values, and robust balance sheets create the perfect environment for buybacks. It will pay off handsomely in the long term (18-24 months).
Buybacks are a mandatory ingredient in my events-driven strategy. Combined with LEAPS calls (if available), they can create high RR trades. Seek a quality management who loves buybacks. And never forget the two basic rules: No catalysts, no fun, and the more, the merrier.
On the markets, we are wrong until proven otherwise. So, take the above thoughts with a grain of salt.
Everything described in this report has been created for educational purposes only. It does not constitute advice, recommendation, or counsel for investing in securities.
The opinions expressed in such publications are those of the author and are subject to change without notice. You are advised to do your own research and discuss your investments with financial advisers to understand whether any investment suits your needs and goals.