Greece Marine Shipping That Mohnish Pabrai Investing In, Should You Buy?

$Danaos(DAC)$

Let’s explore the key reasons behind Monish Pabrai’s recent investment in Danaos Corporation. Although this is currently a small position for him, Pabrai is known for his highly concentrated investment approach and rarely makes decisions lightly. When he invests, it’s because he genuinely believes the opportunity is worth both his time and capital.

Today, we’ll do analysis to understand why Pabrai chose to invest in a stock that has been largely overlooked by other major investors. Notably, Danaos has received little attention since 2009 when David Einhorn exited his position.

Danaos Corporation is one of the world’s largest owners of container ships, boasting a fleet of 68 vessels and recently expanding to include 10 bulk carriers. The company doesn’t directly operate its fleet but instead focuses on leasing, which simplifies its business model and provides more predictable revenue. Remarkably, the company employs only four full-time staff, yet it has a market capitalization of $1.6 billion.

To give you some historical perspective: if you had invested $1,000 in Danaos 10 years ago, you would have purchased 13 shares, which would now be worth approximately $1,027. Additionally, over that period, you would have received $99 in dividends, bringing your total to $1,126—a modest 12.6% gain over 10 years. While these past results are underwhelming, the future doesn’t have to mirror the past.

Stock Ownership:

• Insider Ownership: 49.6% of the company is owned by individual insiders. Notably, Chairman John Coustas owns 48.3%, effectively giving him control over the business. While this concentrated ownership ensures he has a strong incentive to take care of the company, it also poses a risk if decisions go awry, as there’s limited oversight.

• Insider Buying: Unfortunately, there haven’t been any recent transactions from insiders.

• Super Investor Ownership: Monish Pabrai is the sole super investor holding shares in Danaos, with the position comprising 1.6% of his portfolio. Whether this signals the start of a larger buying spree or remains a small bet is yet to be seen.

Fundamentals

Pabrai purchased his shares in the most recent quarter, so let’s dive into the company’s fundamentals to better understand his reasoning:

• Return on Invested Capital (ROIC): The 10-year median ROIC stands at 4.4%, far below the ideal threshold of 10%. This is a disappointing metric.

• Net Profit Margin: Danaos boasts an impressive 5-year average net profit margin of 66.2%, compared to the industry median of 19.3%. This highlights the effectiveness of its leasing-focused business model.

• Share Buybacks: Mixed. Over the last decade, Danaos increased its share count by 146%, which looks bad at first glance. However, since 2012, the company has been actively buying back shares, reducing its share count by 18.9% in the past four years—a positive trend.

• Debt: Danaos would need just over two years of free cash flow to cover its long-term debt. Ideally, this figure should be under two years, but it’s close enough not to raise significant concerns.

In summary, Danaos shows strengths in its profit margins and recent share buybacks, but its ROIC and historical financial decisions present some challenges. Still, Pabrai’s interest in the company signals potential for growth, making it a stock worth watching closely.

What Do We Know About Danaos Corporation’s Growth?

Revenue Growth: Over the past 10 years, Danaos has achieved a compound annual growth rate (CAGR) of 5.2%, falling short of the desired 10%. However, as a cyclical industry, growth trends can vary significantly depending on the timeframe. For example, over the past five years, revenue growth surged to 24.9%—an impressive result.

Free Cash Flow Growth: In the last 10 years, free cash flow growth has been a modest 4.8%, which is also underwhelming.

Earnings Per Share (EPS) Growth: Over the past 10 years, EPS grew at a strong rate of 19.8%, and in the past five years, it skyrocketed to nearly 52%. This highlights the importance of evaluating cyclical industries with caution, as historical growth may not accurately reflect future potential.

Dividend Yield: Danaos currently offers a dividend yield of 4.1%, equating to approximately $3.25 annually per share.

Dividend Payout Ratio: The payout ratio is 10.5%, which is lower than the desired range of 20%–50%. While this indicates the dividend is very secure, shareholders are receiving only a small portion of the company’s earnings.

Dividend Growth: Danaos began paying dividends only in 2021, making it impossible to calculate a five-year growth rate. That said, the dividend has grown by an impressive 38.9% annually over the past three years.

Valuation and Analysis

The company’s price-to-earnings (P/E) ratio is just 2.7, meaning investors pay only $2.70 for every dollar the company earns. This extremely low valuation suggests an attractive opportunity, but to better understand its worth, a discounted cash flow (DCF) analysis is necessary.

For this analysis, we use a five-year average free cash flow to account for the cyclical nature of the industry. Here are the assumptions for growth:

1. Low Scenario: A 3% decline in the first five years, followed by a 5% decline.

2. Medium Scenario: No growth for the next 10 years.

3. High Scenario: 2% growth for the first five years, followed by 1% growth.

Using these estimates, the intrinsic value of Danaos is as follows:

• Low Scenario: $122 (adjusted for a 30% margin of safety: $85)

• Medium Scenario: $163 (adjusted: $114)

• High Scenario: $184 (adjusted: $129)

With the current share price around $80, Danaos appears attractively priced.

Key Considerations

Strengths:

• Danaos benefits from excellent profit margins and secure multi-year chartering agreements.

• The company’s recent expansion into dry bulk shipping is expected to diversify and enhance its revenue streams.

• At its current valuation, the stock seems like a great deal.

Weaknesses and Risks:

• Danaos operates in a highly cyclical industry, which is sensitive to market fluctuations.

• An increase in new container ships from competitors could drive down charter rates, reducing income.

• The dry bulk market is particularly vulnerable to fuel price volatility, which could impact profitability.

• Geopolitical tensions, a common risk for global transportation companies, add an additional layer of unpredictability.

Conclusion

Danaos is ranked as the 18th cheapest company out of over 100 in a stock ranking analysis. It also boasts the highest profit margins among its peers, which is worth noting. However, while Danaos demonstrates several strong qualities, it is not without its uncertainties.

The significant insider ownership—nearly 50% held by Chairman John Coustas—plays a major role in investor sentiment, as his decisions will greatly influence the company’s trajectory. These factors likely explain why Monish Pabrai invested in Danaos, but it’s clear that the stock carries both potential and risk.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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