Danaos Stock: Time To Buy This Cash Flow Monster Again (NYSE:DAC)

My Thesis

Danaos Corporation (NYSE:DAC) is a small-cap containership operator that provides ocean transportation services by chartering its 68 vessels [421,293 twenty-foot equivalent units of capacity] to liner shipping companies. On May 15, 2023, the company released a quarterly report that far exceeded analysts’ expectations:

I’ve been covering Danaos stock since May 04, 2021, and have been bullish on the stock all along, despite the difficulties the container shipping industry has faced in recent quarters. The recently released results for Q1 FY2023 clearly show that the company is doing well and is likely to continue to generate relatively good total returns for its shareholders.

My Reasoning

First, let’s take a quick look at the results for Q1. Danaos Corporation’s adjusted net profit declined by 38.2% YoY to $145.3 million ($7.14 per share), primarily due to the absence of a non-recurring $110.0 million dividend from ZIM. Net income for the quarter was $146.2 million ($7.18 per share) versus $331.5 million ($16.00 per share) in FY2022, which included a non-recurring $209.5 million gain on ZIM (ZIM) investment. Operating revenues increased by +6.0% to $243.6 million, and Danaos concluded new charter agreements worth $380.7 million during the quarter. Cash and cash equivalents stood at $359.6 million, while total liquidity reached $730.8 million – that’s almost 61% of DAC’s market cap at the time of this writing.

Additionally, Danaos invested $4.3 million in Carbon Termination Technologies Corporation, and the company made an early prepayment of leaseback obligations, eliminating lease obligations from its balance sheet. Adjusted EBITDA decreased by 33.6% to $179.0 million. Total contracted cash operating revenues as of March 31, 2023, amounted to $2.3 billion, with contracted charter coverage at 97.3% for 2023 and 73.2% for 2024. Net Debt was $137.9 million, and 44 vessels were debt-free.

DAC is going to pay a dividend of $0.75 per share of common stock [declared for Q1 FY2023, payable on June 7, 2023] and bought back 368 thousand shares outstanding compared to last year [1.78% of total].

Danaos was able to spend $40.5 million [683,889 shares] under its share repurchase program of up to $100 million announced in June 2022 – more repurchases will most likely follow, because, again, the total liquidity levels on the balance sheet are leaving no choice. The net debt to LTM Q1 2023 adjusted EBITDA ratio of 0.2x is the lowest ever ratio in the history of the company – in fact, management has nowhere to put so much cash except for buybacks and dividends, in my view.

Danaos Corp boasts a robust charter backlog of $2.3 billion, extending through to FY2028, with renowned liner companies – this fact ensures strong cash flow visibility going forward. Additionally, Danaos benefits from a high operating days contract coverage of 97% for 2023 and 73% for 2024, having a solid contracted income base and limited downside risk.

In terms of generating strong operating cash flows, Danaos is more than okay:

The 6.8% YoY increase in CFO was primarily driven by 3 factors, according to the 6-K filing: higher charter rates, which contributed to a $30.4 million rise in operating revenues; a reduction of $10.2 million in net finance costs; and a $3.4 million change in working capital. However, these positive factors were partially offset by $21.0 million of revenue recognition related to pre-collected revenue from a charterer in May 2022, an $8.4 million increase in operating expenses, a $3.3 million decrease in operating revenues due to a net decrease in the average number of vessels in the fleet, a $2.7 million decrease in dividends collected from ZIM, and a $0.5 million increase in dry-docking expenses.

DAC’s free cash flow for Q1 FY2023 amounted to $114.1 million, compared to $77.4 million last year (+47.42% YoY). Considering that revenues for FY2023 and FY2024 are already 97% and 73% contracted, respectively, I expect DAC to continue to generate strong FCF for at least a few more years, as most of the forward-looking voyages have been contracted at fairly high charter rates:

At the same time, HARPEX – a sort of weather vane for future rates – recently reversed the trend after a tediously long decline, which was largely the reason DAC stock fell ~50% off its high by early 2023.

The recovery of HARPEX and the expansion of the fleet with new builds which are likely to attract more interest in the market and likely to be chartered at above-the-market rates indicate that DAC’s earnings potential is most likely not yet fully realized by the general public. At the moment, the company’s consensus numbers are based on the calculations of only 2 analysts, which in my opinion is very little for averaging purposes. After the release of financial results for Q1 FY2023, the forward-looking consensus was revised significantly upward:

I expect Q2 FY2023 results to be another reason for Wall Street analysts to raise their FY2023 and FY2024 revenue/EPS forecasts – positive revisions are always good for stocks. Also, DAC is currently trading at ~2.3 times next year’s (FY2024) earnings, giving the stock a large margin of safety as the remaining buybacks continue.

Your Takeaway

From whatever angle I look at the company’s recently released financial results, Danaos’ success is impressive. As Jefferies analyst Omar Nokta said during the recent earnings call, management has put the company in the best financial position it’s ever been in, or at least since it went public. I totally concur with Omar Nokta.

But judging by the stock’s performance in recent months, the general public of investors didn’t agree. Only now, after the release of such a strong report, DAC stock is starting to react positively to the facts – but this reaction is still quite weak. I mean, the DAC valuation is still cheap enough to fully reflect all the positive results and plans of the company – I think this should improve in the foreseeable future.

Of course, some risks need to be mentioned. Changes in charter rates, demand for shipping services, or the cancellation or non-renewal of charters by customers could have a negative impact on the company’s financial performance, as DAC’s revenue relies on charter agreements. Of course, if HARPEX continues to decline, this risk may materialize in 2024-2025. In addition, the entire shipping industry is subject to fluctuations in global economic conditions, supply and demand imbalances, and geopolitical factors. For example, BIMCO recently revised its FY 2023 demand growth forecast for head-haul and regional trades from 3-4% to 1-2% YoY, while raising its FY2024 growth forecast by 2 percentage points to 5-6%; given the existing risks, a downside scenario forecasts growth of only 1-2% in 2023 and 2.5-3.5% in 2024. This doesn’t beat the supply side, which is growing faster – this imbalance doesn’t play into the hands of companies in the industry.

Despite the risks involved, however, I believe that DAC has a tangible margin of safety and upside potential at a valuation of just over 2x of forwarding earnings. The prospective buybacks and a relatively good 5% dividend appear to be stable – they should correct the existing market inequity regarding DAC stock. So I reiterate my previous Buy rating this time around.