J Mintzmyer Returns
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Bill: Ladies and gentlemen, welcome to The Business Brew. I'm your host, Bill Brewster. This episode features J. Mintzmyer. He's come back for repeat appearance on The Business Brew. J is one of the best shipping analysts out there and he runs Value Investors Edge on Seeking Alpha. J came back to discuss more logistics issues and opined on a number of shipping stocks. Thank you to J for joining again. I appreciate it. I think this will help round out some of the logistics picture when listened to in conjunction with Craig Fuller's episode.
J Mintzmyer, for return, a return appearance on The Brew. Thank you for coming. Actually, I have to refer to it as The Business Brew, I think, person copyright issue that I had.
J: Fair enough. It's good to be back.
Bill: How's everything going, man? I think this will come out in two Thursdays.
J: Okay.
Bill: We are currently recording on a day that the market is crashing.
J: Yeah.
Bill: You seem calm.
J: Yeah, May 5th and shipping and energy are my two areas, mainly shipping and energy related. And normally, shipping and energy have a 1.5 to 2.5 times beta on bad days. That means the market is down 3%, 4%. We're down 8%, 9%, 10%. And today, we're only down half as much as the market. So, I'm actually, I hate to say happy, but I'm fairly relaxed today.
Bill: Yeah, shipping, it has been interesting. I had Craig Fuller on and I'm interested in All Things Logistics. Now, I guess, I didn't know that I would be, but I do enjoy it. I saw some pictures on Twitter of boats in China that were completely stuck in the ocean and I thought maybe J can make some of this news makes sense and we can have a good conversation. I enjoyed your money show presentation very much.
J: Yeah. Well, thanks, Bill. It's definitely timely. It's been a few months since we talked and things are just as crazy as ever, if not crazier, especially after this Ukraine situation. We thought the craziness part was last summer. It looks like especially in tankers and dry bulk markets now, we're just getting started on some of the disruptions.
Bill: How would you characterize for those that haven't watched the money show presentation aren't familiar with what's currently going on? How would you set the stage?
J: Well, first of all, we had a once in a generation disruption with COVID-19. The global shutdowns that occurred, all lockdowns, and the corresponding shift of consumers shifting to goods and items, upgrading their houses, and their home offices, and that sort of thing coupled with all the mess we had out of China. The world's largest exporter which is also going through its own series of lockdowns and that sort of forced shutdown and restart just completely slammed the Global Logistics Industry. The last 20 years have been built on, yes, increasing global trade, but this just in time inventory management and that's not just consumer goods. That's a lot of the ways the oil supply works, gasoline, diesel, jet fuel, all that stuff as a just in time inventory and steady flows. We're not used to these disruptions.
That was the backdrop to what we saw last year in 2021, which was the global economy restarting and such a jam at the ports, not enough ships available, not enough trucks available, all that stuff happened. That was on the container ship side. There was congestion across the board, but the containership side is really what got the most focus. When folks see their prices going up at Walmart that hits their attention pretty fast and folks want to order new furniture, they had to wait six months on backorder, very high visibility, and then it became political item, too, last fall. Now, what we're seeing is a little bit less on the consumer goods side, on the containership side but the war in Ukraine has caused a lot of disruptions around the Black Sea and gasoline flows, oil flows. Everyone's probably noticed the higher oil prices. But what hasn't gotten as much discussion yet is the actual logistics of how the world is going to resource a lot of that oil and those trade flows. We'll get more into it, Bill. But one of the really interesting things we've seen recently is the spike in jet fuel specifically. Oil prices, yeah, they're a lot higher, but they've moderated around $100, $105, $110 per barrel. They're not skyrocketing. Jet fuel, completely different. It is skyrocketing and it's one a week over week over week for three months straight and that's something I think really going to grab folks' attention as we enter the summer travel season.
Bill: I have certainly noticed that some on ticket prices. I think people will probably spend through it just because they've been locked up for so long, but it will be interesting to watch. I thought it was funny when we were talking offline, I said to you, "Well, with this oil disruption, I would think that tankers would be where you'd want to be" and anyone that has been around for a while, you said, "Well, that's a good first order thought, but it's already priced in basically." You want to tell people what is going on with the logistics market around oil first of all?
J: Certainly, will do, Bill and I just want to caveat. I might be incorrect. I got to historical revisionism or something, but I think we were talking about LNG tankers, liquefied natural gas.
Bill: Yeah.
J: That was the one that was already priced. I think at that time, actually, the product tankers, Scorpio tankers, stock symbol STNG is the most liquid. I do have a long exposure to that name just so everyone knows, but I was buying around that time. So, just to be clear.
Bill: Okay.
J: We're talking about stuff that was priced. It was the LNG trade and those were the stocks that skyrocketed right away as they should have. But by the time people were talking about it, it was too late. With that caveat placed, just so I get my tanker commentary right. Yeah, what's going on with oil tankers? Well, first of all, and again, Bill, I know you saw the money show. A lot of that was covered and that presentation is available on YouTube. Whenever this podcast is up, if there's ability to link that, I think that will-- [crosstalk]
Bill: Yeah. I'll put it in the show notes.
J: Yeah, because, I had the benefit of slides and stuff to point, too. But the big disruption is going to happen with crude tankers and it's just getting started is, if the EU steps forward and completely embargoes Russian oil. There's been talk around that. Germany was a big opponent to the full embargo of Russian oil. They have stepped back. They have said, they no longer oppose that. If that happens over the next couple of months, we're talking about 2 million barrels of Russian oil that needs to be relocated, and they're going to have to take that oil, and ship it seaborne out of the western part of Russia over to places like India and China. This is significantly longer distance for seaborne oil. It can be up to eight, nine, 10 times further. It probably, by the time, you incorporate port delays, things like that. We're probably talking four to five times boost in ton miles for that particular route. That's 2 million barrels and global demand is around approaching 100 million barrels a day. Yeah, 2% of that, right? But you take 2% of that, well, and that's 2% of total, it's probably 5% of ocean going. And 5% of ocean-going oil is going to have its distance increased by four to five times because the major demand for oil tankers is not just by volumes. It's by volumes and by time, like, how long is it going to take those ships to reroute? So, little changes. We've seen this before. We saw it with COVID-19. Little changes, 4%, 5%, 6% can have global massive impacts.
And so, what we're expecting to see is if that 2 million barrels of oil gets fully rerouted and Europe has to replace that 2 million barrels of oil with not neighboring Russia, they're going to have to pull from the United States exports. We're starting to see that already, where they're going to have to pull from Brazil. So, think of how much further that is, US, Gulf, Brazil. So, you have two different pushing poles happening at the same time. We don't have enough crude oil tankers available for that kind of action. It could be just like containerships only for oil tankers.
Bill: Am I correct that, let's see, I actually have some of your service up right now, but James Catlin just wrote something about how thin the order books are. Is that in tankers as well?
J: Yes, that's a crossed dry bulk and oil tankers in particular. Those are the two segments that have very small order books. Of course, containerships because of what's happened in the last two or three years. It is a very fat [chuckles] order book. Everybody isn't building new containerships. When you look forward to say 2024, 2025, oil tankers and dry bulk are looking extremely under supplied. And tankers, it depends on how long this sort of disruption and embargo last. You also have to assume or figure that the global demand is going to be steady. If there's some global recession and oil demand crashes, then that super catalyst is off the table. You have to have that steady recovering to 2019 plus levels. You have to see that steady 100 million per day global demand if not higher. you also have to see OPEC continue to increase their exports. You have to see China move past zero COVID. There's a lot of things in play, Bill. It's not a sure thing. I'm telling folks that, "Hey, pay attention." Look at some of these oil tanker companies that are cheap, that are a little undervalued, and consider that as a bullish catalyst. I'm not saying 100% that's going to happen, but this is probably the most constructive and excite-- I would even say exciting I've been about oil tankers and I mean, probably since 2020, we have that crazy oil storage boom.
Bill: Yeah, that's right, because people were using the tankers as storage, because all the physical storage is all completely spoken for, right?
J: Yeah. Completely full. But that was such a short, lasting thing. We had a similar thing, Bill. I don't know if you thought it back then. Most folks didn't. Back in 2019, there's a similar thing that happened with COSCO. COSCO is a Chinese shipping company. C-O-S-C-O, not to be confused with.
Bill: Not Costco, but COSCO.
J: Yeah. You're not getting big jars of peanut butter, right?
Bill: [laughs]
J: But anyways, there's these huge sanctions that went down on COSCO, which was a Chinese shipping company. It related to dealings with Iran and stuff like that. The US, it was almost, I wouldn't say a misstep or mistake by the US, but I think they didn't quite think through the ramifications of their sanctions. They were trying to punish the Chinese company and they didn't think through the ramifications of, "Oh, wow, we're going to hit 500 tankers with these sanctions."
Bill: Yeah.
J: And because they were just trying to apply a little pain and they ended up punishing the entire global oil supply. My point being Bill was back in 2018, we saw a huge spike in tanker rates, too. But that was short lived. It was related to a sanction. It only lasted for about four months. We had the floating storage, short lift. It lasted about two months, three months. If we're going to have this global rerouting of Russian crude oil, how long is it going to last? Is it just a two- or three-month thing, and then Ukraine hits a peace deal, and it's over? Or, is it a multiyear thing? If it's a multiyear thing and Ukraine's not resolved for four or five years, then this could be a super cycle. And so, it's way too early to say.
Bill: I wonder if the Ukraine situation is "resolved," if-- I don't know. I think I'd be interested to see if everybody says, "Okay, let's just go back to how things were." It seems to me that even with a resolution, it could have some long ramifications.
J: It's a tough situation, dangerous situation. Scary. I don't want to get over my skis too far talking about potential Ukraine outcomes. But it's hard to imagine with the amount of Western support that Ukraine has received, and with the victories in the media, and the press, and all that. It is hard to imagine Ukraine accepting a peace settlement that's not at least better than the prior status quo. We might even have Crimea, might even be somewhat back on the table and that was unthinkable a month ago. And so, it's a scary situation. I don't think either party is in a position where they can accept a status quo peace deal at this point.
Bill: Yeah. It seems to me too that if nothing else, this has brought to the forefront Europe's reliance on Russian energy. And whether or not that's a good idea. Obviously, it's like how much pain are you running to versus what kind of pain are you running from, I think would be some of the calculation, but it's not unfathomable to me to see a world where there's more moving of oil on tanker ships.
J: Yeah. There's US led critique I would say of the European Union and NATO for a decade now. I think President Trump was probably the most vocal about it and probably received a lot of pushbacks for it. But the fact of European defense budgets being small and shrinking really post-cold war and Russian gas imports and oil imports surging post-cold war. Part of that is globalization and you should want to trade with your neighbors and develop strong ties. But this Ukraine situation, started with Crimea in 2014, but really now, Crimea was your wake-up call. Your first alarm going off.
But in this situation, you have a lot of nations who have slept walked into this situation. Defense budgets are down, and dependence on Russian energy is up, and that cannot maintain. We've already seen it. We've already seen lots of countries increasing their defense budgets, we've already seen certain countries, Poland was one of them, some of the Baltic states are another, who are a little bit further ahead of the curve. They were a little more defense oriented. They had already started investing in LNG and alternatives like Offshore Wind, and they're pulling away from Russia a little bit faster. Germany is one of the countries that-- It's going to be really difficult for Germany to replace that natural gas. Maybe they can do the oil, the natural gas is going to take, I would argue years for them to fully transition away from Russia.
Bill: Hmm. Yeah, interesting web-
J: Yeah, that's the thing about shipping, Bill-
Bill: -of incentives.
J: -is that, folks aren't always interested in shipping stocks, because it's a small corner of the market. I work with some global funds and such, who can't really invest in shipping directly, because the market caps are too small. But when you are thinking about the global geopolitics and the global macro, you have to think about these trade lines and you have to think about the moving pieces. I think that's what makes shipping so exciting and interesting. I think it's a conversation that no matter what part of the market you're involved in, you can learn something by paying attention to what's going on in global shipping and what's going on with global trade flows.
Bill: Yeah. When I talked to Craig, he said, "Normally, if people are hearing about me, that means that things are broken." Logistics are not something that's super sexy most of the time. But now, that I have gotten interested in it, it's really not like it. It's so complex, but then it works so well. It seems 85% to 90% of the time, but then when it breaks like it is, it's not something that you can just flip on and get back to maximum efficiency, it doesn't seem like.
J: Definitely not. And just to pivot real quick, because I pitch shipping as something everybody should be interested in just for global knowledge and fascination. But on the more micro side, if you're trading or investing in shipping stocks, I think the best part about this industry is that the first gut reaction, common sense is usually wrong. I'll give you one quick caveat. Right after the Russian invasion of Ukraine, I had several folks reach out to me and friends of mine, not shipping investors, personal. Friends of mine and fellow students here in my program and they said, "Oh, this Russian invasion of Ukraine, airspace is shutdown, trade is stopping, ships are embargoed. This can be terrible for you, J, isn't it? This is really bad for shipping." I was like, "No, no, it's actually really good for shipping." I'm like, "Disruption is good. It's going to slow the ships down."
I had to be careful of my language, because I would hate to hesitate associated conflict with being positive. But in terms of the shipping economics, disruption is always favorable. But most folks look at disruption and think it's bad. And so, a lot of shipping stocks went down after the Russian invasion of Ukraine for a few days, which created exceptional buying opportunity. We saw the same thing in 2020 with COVID.
Now, during March, I don't fault anybody for selling any stocks in shipping. But it became very obvious over the summer. It's obvious to us. It's obvious to folks who follow the industry closely became very obvious by July and August as the global economy was reopening that shipping was in an amazing position. I didn't know how good. I was bullish on shipping, Bill and I didn't see that container ship rates going this high. It exceeded my wildest expectations. But my point is that common sense in the middle of 2020 was not saying, "Throw all your eggs in shipping basket." That's why the understanding of this industry and I'm probably selling it too hard here, but the understanding of this industry can be fascinating for people, who don't even want to be involved, because they have too big of fund or they don't want to trade shipping stocks, and it can be profitable for those who have more nimble accounts, and want to get in there, and trade the stocks.
Bill: Yeah, well, you're a guy that, you've dedicated a long time to this. You did it before it was sexy, right? So, you're allowed to pitch it now. You're not a Johnny-come-lately?
J: [laughs] Yeah, I've been here a while, man. It's crazy getting old just thinking about it. But yeah, it's been about 12 years.
Bill: Some of the fragility-- I guess, let's close the loop on this the oil tanker discussion. So, let's say there is a recession. How are you thinking about downside risks here, and what could go wrong, and how to protect against that?
J: Yeah. No, that's a great question. Absolutely needs to be asked. That's another caveat or interesting thing about shipping is that it's really six or seven sub segments. We talked a little bit about the oil tankers, and why I'm interested there, and why there's some potential catalysts. We also have dry bulk, which is very heavy iron ore, coal, grains, things like that. We have the containerships, which I think pretty much everybody knows about that for the last year. We have all these different subsegments. When I think about a global recession, and the slowdown, and what that means, first of all, what type of recession is it? Is it a global or is it US centric, is it European, is it China, right? Is there endless zero COVID things that bring that economy down a little bit, but the rest of the world is slowly recovering? What are the areas that are impacted?
I think most folks think of the consumer recession in the United States. That impact would be very hurtful, I think, for containerships, the freight rates and things like that. If someone is worried about a global recession, especially a US centric consumer recession, which is what most of us think about, you want to be really careful with companies that have a lot of exposure to freight rates, especially containership freight. Companies like a big favorite of mine and I'm long it right now in a trade position, ZIM Integrated Shipping, it trades at about one and a half times earnings. If you strip out the cash, it's arguably less than one times earnings. I think that's attractive. I think it's a good trade right now, but it doesn't come without risk, Bill. Because that's the company that if we hit a recession, you're going to maybe get that one times earnings and then you're done. Then earnings are flattened, they might even be a little bit negative.
If you're concerned about a recession, you don't want to be putting large percent of your portfolio into very risky stocks like that. You want to be looking at stocks that either have contracted backlog for several years, so the near-term spot rates that really hurt you very much or you want to look into segments where a recession or slowdown is already priced into the stock. That's why we're shipping again, different subsegments, different things. If there's a global recession coming, I think some of the niche trades, for example, product tankers right now are probably going to be just fine. If it's GFC, global financial crisis level, the stocks are going to hit. Every stock's going to be hit. But if you're talking about the underlying cashflows and the underlying situation, something like product tankers, something like LNG, that's not going away. The powerplants are still going to be running, people are still going to be heating their homes, that trade is very steady. So, hopefully, that makes sense, Bill. It's complex answer, but that's a great thing by having six or seven subsegments and 50 or 60 stocks to pick from.
Bill: No, that does make sense to me. With ZIM, you had said that people compared it to WeWork, the bears did, you mind explaining the business model there, what they do, and why that comparison? Because obviously, to your point, when you hear one times earnings, the markets basically saying like, "Fine, maybe you can suck one year of supernormal profits." The terminal value is basically zero or negative.
J: That's exactly-- Yeah, the market is basically saying that, "You're going to get maybe one year out of this thing and then it's worthless," which, of course, I don't agree with. That's why I'm wrong. But there is some logic to that. I'm not going to come on today and say the bears are all idiots or whatever. I've mentioned that's been cited by bears. It's been cited by bears and ZIM was $20 a share. It was a little bit of a lazy analogy and not quite correct. But again, there's always truth in things. Usually, when you hear some outrageous statement, there's a little bit of truth in it. WeWork and I'm not a WeWork expert. [chuckles] That was a terrible company business model, poor leadership, poor management. What other state can I impale them on?
Bill: I think that at the end of the day, the commonality that people see is, their leasing space and then leasing it again. So, you've got a long lease and then you're trying to fill it with short leases.
J: That’s exactly. Yeah, that's exactly parallel. I just had to make sure I talked a lot of-- [crosstalk]
Bill: Yeah. No, I'm not saying that it's fraud or whatever.
J: Yeah, I had to make sure what you're talking about. No, no, no. The issue with ZIM is that they are chartering in all their tonnage, all their ships. They only own about eight ships out of a fleet of around 120. Over 90% of their fleet is leased in and the lease durations remaining are between about a year left and up to five years. They've also signed on a lot of new bills that come online between mid-23 and early 2025, which are fixed on anywhere from seven years to 12-year contracts. ZIM's cost structure is a lot of fixed costs in there. Basically, all their ship operating stuff is fixed. It's all leases.
Now, it rolls off. It's not fixed forever and there's new builds are actually going to bring down their fuel costs, and it's going to bolster their efficiency, but their cost structure is fixed really for 2022. In 2023, the cost structure is similarly fixed. Very high levels. Oh, not only that, you have oil prices going up. The fixed parts are fixed high, and the variable expense is around purely oil and a little bit of labor, well, with inflation you got labor going up with the oil price environment, you've got oil prices going up. So, ZIM's cost structure is [chuckles] not ideal, right?
Bill: Yeah. Because then if you get weakness in the containership market, they still have to make these payments, but they've got a lot less money coming in.
J: Exactly, Bill. Look, I'm long ZIM. All the incentive to come on here and say nothing but good things about it. But that's not the way I operate. There's risk in the model. The freight rates are part-- [crosstalk]
Bill: Wait, real quick. Do you control that with a sizing or do you say, "You know what, I'm so on top of this market that I'll basically be the first one out?"
J: [laughs] Well, that's always dangerous. The first one out [unintelligible [00:26:20] logic.
Bill: Yeah, I know, it's dangerous. But that doesn't mean people don't play the game.
J: Yeah. So, there is, I guess, a three-pronged approach. I got to be careful when I say three, because I always start a list and forget the third one.
Bill: [laughs] I'll count them for you. Let's go on.
J: Yeah, so the most important thing about this, Bill, is having an attractive interim pricing and attractive discount to what you believe based on whatever model you want to use is a fair value. And right now, I believe ZIM's fair value is about $75 a share. I think it's pretty conservative, but that's what I'm comfortable paying for them is $75. So, back in March, I actually got out of ZIM. It was the first time I was out of ZIM in 13 months. I was long that thing since the day after IPO. And of course, the size vary. I had option trades bolstering and things like that. But I was long some form of ZIM for 13 months. In March, it went over what I believe was a fair value. I sold and I told folks probably, Twitter. I said, "Hey, look, I've been long this thing, 13 months, but it's no longer attracted to me." We saw it fall past 75, we saw it fall to 65 and I said, "All right, I'm going to wait for some trough, some support as long as it's sufficiently below that 75, I'm comfortable getting along again. Now, that's part one.
Now, part two is what you alluded to is the sizing. My sizing is pretty basic. The more below the fair value it is, the larger the size is going to be. ZIM is $71.50 and my fair value is $75, it's going to be a small position [crosstalk] percent or two right? If I believe the fair value is $75 and ZIM is $54, which is where it was when I got back in, it's going to be a little bit larger. Now, it didn't go lower than 54, so, I didn't get J. Mintzmyer's supersize position, but I will see moderately long ZIM. That's part two.
And then part three is what you alluded to, is looking at the cycles, and seeing where we are, and seeing where the trends are blowing. But I can't just rely on part three alone. One of the reasons why is because it's like rats fleeing the ship. [chuckles] No pun intended I suppose with ZIM. But if you're getting in something purely thinking you're going to beat other people out-- You've seen how ZIM trades, Bill. It's so cyclical. You really have to incorporate those potential bearish outcomes before you decide to buy the stock. You're a day trader like you do you, right? I don't day trade, but if you're just going to buy this thing for a couple hours or maybe one day overnight, then yeah, you can play those games. But if you're going to have a position like I do, which is ideally six months, 12 months, you've got to really understand where the value is. So, I guess, three things there. Hopefully, I got all three of them.
Bill: Yeah, you got all three. I was counting.
J: All right.
Bill: So, how do you get comfortable with the backend cashflow risk?
J: Yeah. No, that's a great question, Bill. The reason why I'm really comfortable with ZIM is because I understand how their cost structure is shifting. I understand in 2023, I would say, late 2022, early 2023 is going to be the peak of their cost structure. But starting in mid-23, a lot of the legacy charters of these older ships roll off. Those ships they paid record amounts for $70,000, $80,000 a day are going back to the owners. The new builds are starting to come online and those new builds are either eco design, which means they save in this environment. They save about $15,000 to $20,000 per day in bunker fuel expenses or their LNG dual fuel, which not only will save them money on fuel expenses, it will also qualify them for the latest environmental standards. They will have to spend extra money upgrading their ships in the next five or 10 years. So, that's why I'm more comfortable, I think, Bill with the backend is that I understand this cost structure is not going up in a straight line. The cost structure is already peaking, I would say, late 22, maybe Q1 23 is the peak cost structure. So, that's part 1.
Part 2 of why I'm comfortable at this point is that starting May 1st, we're recording May 5th. So, this just happened. Starting May 1st, ZIM just rolled all of their contract fleet onto new rates at anywhere between-- and they have disclosed the exact number, but anywhere between 100% and 150% above last year's contract volumes and that's 50% of their-- [crosstalk]
Bill: This is what they're charging their customers.
J: Exactly. I should have said this first, Bill. There're two parts of their freight. It's not true that all their freight is like WeWork. It's not all spot. 50% of their freight approximately on the Trans-Pacific. Trans-Pacific is Asia-US basically, the Trans-Pacific. 50% of that is fixed. So, that's contract business is usually about one year on duration that rolls over every year. This year it was so strong that ZIM was actually able to fix some of that contract business for two, maybe two and a half years. That's never happened before.
Bill: Yeah, that's right, because I did listen to the earnings call and what they said that customers were asking them to extend the duration, so that they had certainty of availability, right?
J: Exactly. And these are customers like Walmart or Home Depot, companies like that, that are very reliable. It's not your small, mom and pop import business or flip, that's sort of thing. It's very stable companies. Again, Walmart, or Home Depot, or Costco, [chuckles] you mentioned.
Bill: Yeah. [laughs]
J: That freight business is very steady. It's not all spot in that case. The other 50% is indeed spot and those rates can go all over the place. They've been remarkably strong and stable throughout the entirety of this year. I'm shocked by how strong they've been. But that's the riskier part. The 50% spot, Bill, if we see a consumer recession, now, I'm not saying I believe that. It's going to happen. But if you believe that's a viable risk, that spot rate can go down almost immediately. And so, that is a viable risk for ZIM. But Bill because I understand where the cost structure is going and because I understand the percent they have on fixed charters or excuse me fixed rate contracts, I'm not too worried about it. I don't see a colossal negative issue for ZIM. I should go without saying. If you look at their balance sheet, you see their cash balances as well. This is not a company that is on the wire in any circumstance. At the end of Q1, I estimate they're going to have and they're going to report these numbers in about two weeks. By the time the podcast is out, these numbers are probably public in US. But my estimate is they're going to have around $25 in cash reported as of 31 March. And again, by the time they report that they'll have another $8 or $10 more, that's Q2-- [crosstalk]
Bill: Yeah, it's built up.
J: The company is drowning in cash. No debt, zero conventional debt either.
Bill: Yeah. Well, it's all off balance sheet. If you were to trough up the leases, you would call that some form of debt.
J: Right. But you also have to give them credit. And of course, the right of use. It's like renting a warehouse for 10 years, or renting an office for five years or something.
Bill: Yeah, that's right. Yeah, it's interesting. I was not that afraid of a recession, but then thanks to the Twitter folks for explaining to be-- I don't know. I guess, I am a little bit concerned-- Well, I guess I'm actually concerned about what rates putting slowing on the housing market does because there's a paper that I'll drop in the show notes. But it's basically like, "The business cycle is the consumer cycle and if you look at on the margin, a lot of that is housing." Housing has got a big multiplier effect. We're trying to slow down house price appreciation, but then if you depress existing home sales, you have the remodel activity, that said, I do watch the lumber market some, and the lumber market would seem to say that activity is pretty strong. So, who the hell knows, man? These are hard questions.
J: [laughs] Well, housing is way outside my lane. I won't contribute anything else to that, that particular line of discussion. But I will agree with you that I have seen a massive amount of armchair global macro economists coming out on Twitter.
Bill: [chuckles] Yeah.
J: It's amusing. Yeah.
Bill: I guess, I like to think about it, but I also know that whatever I say is going to be pretty wrong.
J: Well, that's true for any isolated predictor. Don't feel too badly about that. We always have to take the averages of all the predictions and even the average is wrong.
Bill: That's right. Yeah, that's right. Then when we were talking, you had said, some of these contracted-- The people that are leasing too, ZIM. Is that's the lessor or the lessee.
J: That's correct. Yeah.
Bill: I always mess that up.
J: Yeah. Those are the owners. The Costamares, Global Ship Leases, Danaos Corp, those companies. Yeah.
Bill: Yeah. That was an area that you said is closer to, if I'm familiar with the airlines like AerCap or whatever-- [crosstalk]
J: Exactly. That's it. That suits the perfect analogy. Yep.
Bill: You want to explain how you're thinking about those?
J: Yeah, sure. Absolutely. And then for those who might be familiar with something like AerCap, the ship owners are even more interesting because not only do they lease the ships to companies like ZIM, or Maersk, or The Liners, Matson is a US Liner that some folks might be familiar with. They also operate them. They provide the captains and the crewing. It's an additional layer of sonar specialization. AerCap is purely finance. These guys are finance and operators. They really understand how to maneuver the ship, and upgrade it, and care for it, and it's a full-service lease, if you will.
I'm really bullish on a few of those, because it's just a simple locked in discounted cashflow scenario. I look at a company like Danaos Corp. That's one of my top one. Global Shift Lease, GSL is another one. Both of those companies right now trade below the value of their locked in free cashflows plus the residual demolition value they're fleeting. What I mean by that is if you just took a company like Danaos Corp, DAC, and they simply operated the ships they have on the fixed contracts that they've already signed at the rates they've already signed them for. At the end of each one of those contracts, if they got the shift back in the market was terrible, and they simply demolished it, and got rid of it, you would end up with more money just on that scenario than the stock trades out today. Danaos Corp-- it has been terrible market, and I don't want to quote right in front of you, was around $80, mid-80s.
The number of Danaos Corps locked in cashflows plus demolition is roughly $115, $120 depends on what discount rate you apply. But if you want to do 8%, 10%, 12%, whatever you want apply to that, it's around $115, $120 just in like that worst case bearish scenario. This company is, in my opinion massively underpriced because folks don't quite understand it. They treat it like a derivative on the freight markets. When folks get nervous about the global economy, a stock like DAC, it dropped all the way back from $107. It hit a 52-week high about a month ago, fell all the way back from $107, all the way back to the mid-70s. Because folks were panicking about the imminent global recession because of the Federal Reserve and all that sort of thing.
The reality is nothing really changed at Danaos Corp. The contracts are still locked in, they have world class counterparties. That's the biggest risk with a company like Danaos Corp is that how strong is your counterparty? Is your counterparty going to honor their obligations? Well, the Liners are stronger than they've ever been in modern history and they are drowning in billions of dollars in cashflow. They have paid off substantially, basically all of their risky debt. A company like ZIM, we just talked about, sitting on $25 per share, 2.5 pushing $3 billion in cash just sitting there. Companies like Maersk are stronger than they've ever been. So, the counterparty risk is close to nil. And so, you can take those three, four, five charters and very high investment grade certainty that those will be paid.
Bill: You know what I liked about the ZIM interview that you did, you asked the guy, "Why isn't he buying a stock back?" He was basically like, "Well, we just IPOed."
J: [laughs]
Bill: It wouldn't feel right to buy in shares which I like that answer. I don't know that I agree with it, but there's a moralistic bend to that that I like, but I guess-- [crosstalk]
J: Well, how often have you seen this stock that IPO is at 15 or whatever dollar. IPO is at 15 and in 13 months, they pay out 21.50 in dividends. I don't think that's ever happened in modern history.
Bill: Yet the dividend yields 120%. [laughs]
J: I don't think there's ever been a company in modern history. Now, I see modern history, because way back with, I don't know, the railroad companies in 1885 or something maybe. But I don't think there's ever been a company in modern history, the last 100 years that has IPOed and paid out, what is that, polling at 130%, 140% of its IPO value in 13 months. I don't think has ever happened.
Bill: Yeah, that's wild.
J: It's insane. Yeah. The IPO wasn't done for traditional IPO reasons. The IPO wasn't done, because they needed to raise cash. The IPO was done because it was a private company, who had an owner, who wanted to diversify a little bit. It had a bank that owned a large portion of it from the restructuring, it didn't really want to own it anymore, and it just wanted liquidity. It was the same reason Blackstone went public. It was 20 years ago. Now, it's been a while. But Blackstone went IPO in the mid-2000s for the same reason. The founder, Schwarzman wanted liquidity. That's what made ZIM so interesting and that's something-- If you go back and read my initial write up on the IPO, that was something I seized on. I was like, "Look, these guys accepted a ridiculously under build IPO pricing, because they really don't even care. They just want liquidity.
Bill: Huh. Interesting.
J: The IPO 10%, it was a small IPO. They IPOed I think was 14% of float. Most IPOs have a larger float and they actually minimize the float on purpose, because the valuation was so terrible on IPO. They didn't really care. They just wanted to publicly list the stock symbol.
Bill: Huh.
J: Yeah. [crosstalk]
Bill: So, what, they had a lockup and then after their lockup for a little while they could come out and sell?
J: Exactly. They had a six-month lockup on everybody. That was like the big bear case. It's funny. You go back and read my writeups on this thing and look back on it. When ZIM IPOed at 15, they dropped to 11 the next day. It was peak game Gamestop, like when Gamestop was going to do a million share [chuckles] and all the hedge funds were going to blow up. For three days, there was some viable valid concerns that this Gamestop thing could bring down the market. I don't know how many people subscribed to that, but it was one of those tail risk scenarios and ZIM IPOed in this thing. They were at 15. They dropped all the way to 11.
But anyways, the bear case against ZIM right off the bat wasn't even economic. It wasn't even like, "Oh, these guys are going to not make earnings, or oh, these guys are overpriced." The bear case was like, 85% of the stock is locked up for six months. And in six months, there's going to be a rug pull and a dump. I just thought that was ridiculous because the economics were so good. But that was legitimately, Bill, that was bear case. Well, the lockup came and went, and then we saw what happened.
Bill: Yeah. When you making that much money, it doesn't even matter.
J: No, it doesn't. I think folks are just so used to these tech lockups on these ridiculously overvalued companies that they put ZIM in the same bucket.
Bill: It's weird because I look at those boats sitting off the coast of China and I think, "Well, those are probably empty." They're on their backhaul leg waiting to dock. How does this work? How does the shipping company make money when a ship is just sitting out there empty waiting to come into the port?
J: Great question. And just a caveat on the picture of all the ships because I've seen that one circulating. It's been circulating for a couple of weeks. It is true that the backlog outside Chinese ports like Shanghai, and [unintelligible [00:42:51], and some of the others is almost a record high. It's very high. However, one of the pictures circulating around that shows-- it's like a scatterplot. [laughs]
Bill: Yeah, dude, it's like there's boats everywhere.
J: Boats everywhere. A lot of those are like buoys, and fishing boats, and it's a poorly labeled-- The scale is all jacked up. There're big red circles for fishing boats.
Bill: Yeah.
J: The picture itself is hyperbole. But no and it's-- [crosstalk]
Bill: We're correcting fake news out here.
J: Yeah. I got to fix what I can, right?
Bill: Yeah.
J: Because folks see like, "Oh, my God, it's insane."
Bill: Well, that's why I sent it to you. I was like, "What's going on here?" You're like, "It's a bunch of fishing boats and stuff." I was like, "Okay, that makes sense."
J: It's a crazy picture. But part of it, again, I said earlier, with every crazy story there's always a little bit of truth. The congestion factor is indeed true. We're 30% or 40% above where we should be normally. In regards to your original question, Bill, who gets paid. The ship chartering companies, the owning companies like Danaos Corp and Global Ship Lease, the ones that are really, really favorable on right now, they get paid regardless. It's a matter of the ships in there for six months. If it's going back and forth and if it's going in circles, they get paid. Just like you're renting an apartment building, or a truck, or anything else, you get paid.
The companies like ZIM, they get paid for taking cargo from point A to point B. A company like ZIM is going to see their volumes go down. We already saw this last year. Last year, I had a lot of congestion. However, the congestion also artificially reduces supply, which keeps rates-- You can say artificial if you want, but it keeps rates very strong. You're going to take a 10%, maybe 20% hit on volumes, but you're going to double or triple your rates. I've done this public math example before, but if you take two times 0.8, you get 1.6. If you take three times 0.8, you get, oh shoot, 2.4 And that's a lot bigger than one, right?
Bill: Yeah.
J: The net impact of ZIM is-- [crosstalk]
Bill: The math checks out.
J: The math checks. Damn, I am in this PhD program and I struggle to multiply 0.8 by 3 sometimes.
Bill: Well, public math sucks, man.
J: It does. But point being this congestion is good for ZIM, but it does hurt their throughput. It is unequivocally good. Without a doubt, it is good for every single ship owner and lessor, because they're getting paid no matter what happens. And another company I've talked about a lot, the box lessors, even more boring. It is the most boring company you can imagine. It is very similar to an AerCap is a company like Textainer, TGH. And they own and finance the 40-foot metal boxes. It is a super boring business. But those metal boxes are on seven, eight, nine, even 12-year leases. They get paid every day. That's $1.50 a day. They get paid $1.50 a day or whatever the rate might be for 10 years straight. And so, congestion, and disruption, and all sorts of things, unequivocally a good thing for box lessors and for ship lessors. So, the fact that the stocks are all down over the last month, it's crazy in my opinion, Bill.
Bill: Why is it a good thing for the box lessors? Is it because there are fewer boxes hitting the market, and then in the longer term, it creates a tighter market?
J: Exactly. Each year, there's about 6% or 7% of turnover boxes that come off their old leases and get signed on new ones. A lot of times what happens historically is, they would finance these boxes. They're usually good for 14 to 15 years. The first contract would usually be about half life, anywhere from six to eight years. Then as that lease expires, the container, as it were, is returned to the company and they can extend that lease. And usually, the extensions are done in the negotiation that the container never actually changes hands but that's a pure waste of logistics. But the point being is, when the market is really, really tight, the container liner companies are going to offer or may not offer but willing to accept very high costs on those lease turnovers. As this old contract, every year, there's 6% or 7% turnover of those of those containers.
That's why extremely tight utilization situation is very good for a company like Textainer or Triton, because not only do their rollovers go on higher and higher rates, any new growth that they're underwriting that they're financing is going to be at very, very strong levels. So, that's why I say they're winners. You're right the fixed volumes are fixed, they're not going up or down, but the rollovers are going to be at higher rates.
Bill: Yeah, interesting. So, with all this happening, should we all be expecting higher for longer in shipping rates and the impact on consumer products do you think?
J: A lot of that's going to depend on the strength of the consumer demand side of the equation. Last year, it was both ends working at the same time. The consumer demand was relentless. You had a completely jacked up global supply situation. That's why you have the all-time record high rates that we saw last September, last October, both ends working in conjunction. Right now in 2022, we're seeing consumer demand moderate if not outright slowdown, but we're seeing the supply side be as bad as ever. Right now, it's really the supply side doing all the heavy lifting.
As we turn into the summer, it's going to be a matter of how strong is that consumer comeback and how quickly or how efficiently does the supply side recover. What I'm looking at this summer is really two things. One, besides consumer demand is obviously the underpinning, but what I'm looking at on the supply side is, when will China reopen? When will they get past this COVID policy and completely reopen their ports and their manufacturing hubs? And then, secondly, because a massive West Coast Union, it's called ILWU, International Longshore and Warehouse Union, that contract, it's a seven-year labor contract. It expires June 30th. So far what's seven weeks away as we're recording this.
Last time, seven years ago, when they renewed this thing, it took months to negotiate. There was a multi week almost like a sit in whatever they did, like, it wasn't an outright strike, but there was disruptions and all sorts of stuff going on. Well, this is seven weeks away. The opening negotiations don't even start until next week. The union is in the strongest position you've ever been. Supply chains are in max focus, whiner profitability, port profitability are record highs. There's a lot of political attention on this. There's an administration-- For better or worse, don't want to make political judgments, but there's an administration that has historically been very union supportive.
This union is in the most powerful position they've ever been in. This contract expires in seven weeks. What happens if there's a month or two of disruptions at the ports? Just imagine that, Bill. You saw what happened last year. Everyone was working as hard as they could and you saw what happened. Now, imagine, if everyone is working half as hard as they could, it could be a very, very interesting summer even if consumers aren't full force.
Bill: It's going to be interesting to watch. I have zero clue, obviously, how this all plays out. But seeing trucking rollover a little bit and then seeing all this congestion, I don't know, it's a wild movie, I guess is the best way to describe it.
J: I do want to throw one quick caveat into the trucking story, because I've followed Craig Fuller's work very closely and I think you've had him on your podcast recently.
Bill: Yeah.
J: The trucking market is much, much different than the ocean liner market. I'm sure Craig mentioned this on his discussion. The ocean liner business is highly consolidated. There're really two major global alliances which control over 50% of trades. I sound like a congressional witness here to testify or something [crosstalk].
Bill: [laughs]
J: It's similar to global air traffic. There's global air traffic alliances as well. It's actually efficiency creating in the long run, but in the short run it creates a lot of cost discipline. You have two major alliances control over half the trade. The top five liners control 65% of global capacity. Top five companies, two-thirds of the market. Top 10 companies, 85% of the market. You want to anecdote how crazy the US trucker market is. This thing is insane, Bill. I think it was from Friedman's article. In February alone, so, February 2022, there is more than 40,000 new "trucking companies" established.
Bill: Yeah.
J: [laughs] 40,000.
Bill: Yeah, that's what he was saying.
J: Oh, yeah.
Bill: He said, "Those are obviously the guys that are going to get killed first," because it's a bunch of guys that were like-- [crosstalk]
J: Yeah. Well [crosstalk]
Bill: Yeah. And they were going through the Truckstop, and they were talking to their friends, and their friends are like, "You're a sucker, driving for JB Hunt. you got to buy your own rig, and sell it spot, and then you flood the market, and then you got to work through that." So, yeah, no doubt. It's a different dynamic.
J: Yeah, it was chasing the bubble rates, and get rich quick schemes, and all sorts of crazy stuff. I feel really bad for some of the folks that got sucked into that. It's always the folks that can't afford it that gets sucked in and hurt the worst. It's actually a really sad story. I don't want to gloat or anything. But it's a crazy market and I don't think there's a whole lot of parallels to be gained from that versus what's going on with ocean shipping.
Bill: Yeah, I agree with that. I think what I'm interested in is you've got that dynamic going on and then you've also got the COVID zero policy in China. I don't know. Then with the port's, potentially going on strike, or half working, or whatever that looks like-- I don't know. The goods in let's call it July 31st, it's going to be interesting to see what inventory levels look like.
J: It's going to be crazy, Bill. Every year, the peak ocean freight seasonality is always from end of July through October, November. That's the peak global shipping season.
Bill: Yeah, that makes perfect sense.
J: Yeah. Quality stocking, right? Pre-quality stocking.
Bill: Yeah.
J: The lull, the trough of the season is always every year without fail, it's January/February through about April and May. When folks say, I have seen all these crazy headlines saying, "Oh, shipping rates are falling or shipping rates are down," they're comparing October of last year, which is the peak seasonality till April of this year, which is the ultimate trough. Be careful, guys. Be careful because if you look at April of this year-- I remember what happened last year. April of this year to April of last year, the rates are twice as high this year. That's crazy.
Bill: Wow.
J: In fact, I'm almost more concerned, Bill, that those rates are just too high. I'm more concerned, Bill, if anything, just as a US citizen. I'm concerned that if those rates are this high now, and China reopens, and US consumer doesn't fall on their ass, and ILWU is striking, I don't even know if I want to see that. The rates would be insane. I don't know. It's a lot of what ifs, a lot of balloons in the air, but yeah.
Bill: Well, I was talking to somebody who is a macro investor that listens-- Shoutout to you, if you're listening now. He's subs to your service actually. I don't want to name him, but he was saying about-- He grew up in Brazil and he watched what an inflationary spiral had done. He was just talking about how important it is to not let that get out of control. I don't even really fancy myself a historian and I don't mean that in an ignorant way. I just mean it's not where my attention normally goes. I'm more learned from talking to some people, I realized there's may be problems with that. But it gave me an appreciation of what a problem this could really be, if we get in one of these like, stuff is tight, so, prices go up, so, labor gets raises, so stuff is tight. It could really get away from you. And then stopping that and having some a soft landing can be really, really difficult-
J: Absolutely, absolutely.
Bill: -which is where we may currently be.
J: Yeah, we're in a dangerous--
Bill: Or, not.
J: Yeah, we're in a tight global predicament and I don't want to, again, get out of my lane too much. But I use 0.5% raise that happened yesterday. It was announced yesterday. The quantitative tightening that's going to start this summer. Oh, man, if anything-- If you're bearish on your investments because of that, what the hell are you investing in?
Bill: [laughs]
J: You got to get better in investing. This Fed raise and tightening is, if anything it's a year overdue.
Bill: Yeah.
J: I am an energy and shipping guy. Stocks will do what stocks do, right, Bill. And for traders, traders have a different timeframe and different considerations. But as an investor, I'm not worried about the QT, I'm not worried about the 0.5% raise, I'm not worried about another 0.5 around the next corner. It's overdue. it needs to happen. We have to rein this thing in before we risk. Like you mentioned, an inflationary spiral and things get out of control. I'm happy that we're doing, the raisings we're doing. [crosstalk]
Bill: Well, I listen to Logan. I love how he looks at it. He looks at it from a housing perspective. His point is, he figured if we could go four years with 25% price appreciation, that would be a quasi-healthy housing market given his forecasts. It would not be healthy, but it'd be manageable. Well, we did that in year one and then we did another 15 to 20 in year two. It's like you got to ta stop this. We can't have that become the norm.
J: Yeah.
Bill: I tend to agree with you. This is one of those healing moments. I think the interesting thing about some of these companies whose valuations move a lot based on rates, I think I've told myself and this may be incorrect, but I think it's true. You probably have a better idea than I do. You've been doing this a lot longer. There's a lot of guys that trade acceleration, deceleration, right? I think a lot of those guys are pretty levered. I think you have like that going on combined with a number of passive people. There's not a lot of active owners of the businesses. Then if you are an owner of the business with the duration that a lot of those businesses require, if you just look at how long bonds trade, it makes sense. But I've always said that living through that would be really tough. I think it was a lot of fun on the upside. I don't know how people are doing on the downside, but I hope a lot of them have conviction, I hope a lot of them are right, and then they got to have the right LPs, because the path dependency of you being right, plus your LPs making money, plus you making money. Those are different questions, I think.
J: Absolutely. There's just a lot of companies out there that are phenomenal, just fantastic companies. The Peter Lynch model of like, "Buy what you love, buy what's good." But the valuations, they just don't make sense. I'm not an expert in these companies. I don't want to embarrass myself in naming companies I'm even thinking of talking about, but think of the FAANGs, the big ones. Great companies. Nothing negative to say about them. But the math to make a discounted cashflow model work, new discount rate is going to be 2%. It's just crazy math. I think as we're seeing the interest rates rise, again, I'm not saying anything negative about the company. It's not my expertise. But you see corrections and stocks like Amazon and that's going to happen when you have insurance rising and discounted cashflow model that depended on tiny interest rates forever.
Bill: Yeah, I think some of the valuations also depend on assuming certain things about growth spin that we'll see if that's true or not. But I get more nervous about some of this hypergrowth companies than I do the FAANGs, but famous last words.
J: Yeah. Well, there's a difference where you have a FAANG company like an Amazon. Again, not my expertise. I'm just speaking generally. But your downside and it's already been, what, 45% down. Your downside is survival mode. Whereas a hypergrowth company, your downside is 100% loss and never recovery. Your downside is bankruptcy and delisting. There's a different sort of downside. Again, we might listen this podcast in 10 years and things have changed in a crazy way. But I don't think you're ever going to see a Google, or an Amazon, or Microsoft, or probably even a Meta, Facebook go 90% down or bankrupt. But almost everything that's in an Ark ETF survivability is like a key question.
Bill: Yeah, or it's got 60% forward returns. It all depends who you're talking to.
[laughter]
J: Everyone can make a napkin model, right?
Bill: Yeah, that's right. One thing that interests me about your models or at least the sector that you cover is the residual values are somewhat supported by inflation. It's a reasonably decent inflation hedge and scrap value I'd think.
J: Yeah, that's true, especially for the companies that have a fixed leverage. All their debt is hedged or fixed and the ship has a shorter charter a couple of years and then after the charter, it can be re contracted or it can be demolished. It's hard to imagine a better inflation hedge and something like that.
Bill: Yeah. Well, man, I got nothing else. I just wanted to have you back on for an update. You have anything else you want to talk about?
J: No. Bill, it's always great to talk with you. It's always fun and I hope your listeners enjoyed this and have learned some stuff.
Bill: I've got a number of requests for you. So, I know at least that number of people will be happy. The rest, I don't know.
J: Hey, people have been really kind and it's good to work with such good folks. Something like Twitter, when I got more involved with Twitter, this was just a year and a half, two years ago. I was nervous about it’s a toxic environment in social media, but folks, by and large, have been pleasant to deal with and that's good. Of course, we'll have to see what happens if there's a downtrend, if anything-- [crosstalk] [laughs]
Bill: Yeah. Well, yeah.
J: But no, by and large, people have been very professional. It's always good to come on podcasts like yours with reason, intelligent questions, and a good debate. I think really Bill, that the closing comments, if you were as it were, it would be things to watch for the summer. I think we already hit them, but just so they're concise in 30 seconds. I think we have to watch the EU embargo of Russian oil and see what happens with that, if it's serious or if it's just pie in the sky. If it's serious and it actually does happen this summer, this fall, you got to watch crude tanker rates. Those can be phenomenal.
And then secondly, on the containership side, you got to watch the China reopening with zero COVID and you got to watch domestically what's going on with the ILWU contract that expires June 30th. Those are the two actionable must watch. Get your popcorn out items for this summer in those two sectors. So, maybe next fall, we'll talk more and we'll see what happened.
Bill: Yeah, man. We'll have a follow up. I look forward to it.
J: Fantastic. Thanks, Bill.
Bill: All right. Thank you. Have a good one.
J: Thanks.