Equity Valuation of Shipping Companies
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Equity Valuation of Shipping Companies

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Presentation to NTU Short Course on Ship Finance

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    Equity Valuation of Shipping Companies Equity Valuation of Shipping Companies Presentation Transcript

    • Equity Valuation of Shipping Companies
      As part of “A Short Course in Ship Finance”
      Nanyang Technological University
      April 2, 2011
      by: Teddy Tsai
      Managing Director at Markis & Company (Asia) Ltd
    • Agenda
      2
    • Course Goal
      By the end of the talk, participants should have a basic understanding of how analysts value shipping equities, and what metrics can be used to benchmark the market performance of shipping equities.
      3
    • What Equity Analysts Do
      4
    • Basics of Financial Statements
      5
    • The Basics
      6
    • Income Statement
      7
      Source: Bloomberg
    • Income Statement - Per Share Data, Reference Items
      8
      Source: Bloomberg
    • Cash Flow Statement
      9
      Source: Bloomberg
    • Cash Flow Statement – Reference Items
      10
      Source: Bloomberg
    • BalanceSheet
      11
      Source: Bloomberg
    • Basics of Financial Analysis
      Purpose – The assessment of the profitability, solvency, liquidity, and stability of a business.
      Use of financial ratios to make use of financial statement data.
      Methods – Past performance, future performance, and comparative performance
      12
    • Ratios Analysis
      13
      Source: Bloomberg
    • DuPont Analysis
      14
      Source: Bloomberg, Wikipedia
    • What is Valuation?
      15
    • Equity Valuation
      In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability.
      – Wikipedia
      16
    • Equity Valuation
      What is it used for?
      Quantifying how much a company (or new business) is worth.
      Can be used in investment analysis, capital budgeting, M&A transactions, financial reporting, taxable events, litigation, etc.
      How is it done?
      Assessing future cash flows, profits, and investments
      Assessing risk involved in generating cash flows and profits.
      Compare risk-reward potential versus other peers and projects.
      And any other reason that can add value, or worth to a buyer.
      What it is NOT –
      Valuations is not a market price. It is an estimated worth.
      Stock valuation is not a prediction. It is a convention, for the purpose of stability and liquidity of investments.
      17
    • Valuation Myths
      Valuations is a long-term fair value and stable over time.
      The best valuation is where the most precise estimate can be calculated
      The more complex and quantitative the model, the better
      18
    • Technical vs. Fundamental Analysis
      19
      Chartist approach
      Intrinsic value approach
      Source: Bloomberg
    • Relative vs. Absolute Valuations
      20
      Relative Valuations
      Absolute Valuations
      Source: Bloomberg
    • Direct vs. Indirect Valuations
      21
      Direct Valuations
      DCF
      Multiples
      … using metrics to arrive at an “intrinsic value” of the stock.
      Indirect Valuations
      Equity IRR from LBO approach
      Accretion/dilution in EPS from merger analysis
      IRR from capital budgeting projects.
      IRR or break even rate based on purchase price, debt capacity, etc.
      ….assuming a range of assumptions in a model to arrive at an estimated return.
    • Equity vs. Ship Valuation methods
      22
      Equity/Stock Valuations
      Price Multiples
      DCF
      NAV
      SOTP
      ….etc.
      Ship Valuations
      Market valuation
      Demolition value
      Historical value
      Damaged value
      Replacement values
    • Common Equity Valuation Methods
      Comparative Valuations
      Valuations using ratios, multiples, etc.
      Cash Flow Based Methods
      Valuations using forward estimates of cash flows, growth, and cost of capital.
      Asset Based Methods
      Valuations based on current market value of assets, sum of the parts, net asset values.
      23
    • Valuation Ratios
      24
    • Understanding Valuation Multiples
      Multiples are the simplest to understand, but also can be the most theoretically rigorous approach.
      A relative valuation approach, because valuation is compared to another benchmark.
      Issues: Source of data and comparables, what metric to use, what discount/premium to apply?
      Common valuation multiples
      Price / Earnings
      Price / Book
      Dividend Yield
      EV/EBITDA
      25
    • The Basics: P/E Ratio
      26
      P/E Ratio
      Current share price / EPS
      Market Cap / Net Income
      Pros:
      Accessible, easy to understand, easy to apply (pick a number).
      Cons:
      Not as relevant for cyclical sectors.
      No standard definition for EPS
    • The Basics: P/E Ratio
      Low P/E doesn’t necessarily mean “cheap”. Cyclical sectors would have low P/Es when earnings are very high. Probably peak of the cycle and worst time to buy the stock.
      Related Metrics:
      Earnings Yield
      PEG Ratio
      27
    • P/E Ratio Valuation Graph
      28
      Source: Bloomberg
    • Earnings Summary
      29
      Source: Bloomberg
    • P/E Band
      30
      Source: Bloomberg
    • The Basics: P/B Ratio
      31
      P/B Ratio
      Market Cap / Total Equity
      Current share price / book value per share
      Pros:
      Accessible, easy to understand, easy to apply.
      Complements to P/E & ROE.
      Cons:
      BV is a historical cost number; can vary from market value.
    • The Basics: P/B Ratio
      P/B Ratio is a favorite metric for asset-intensive industries such as shipping.
      P/B used with ROE can indicate periods where returns generated were higher than market expectations.
      Total Equity is less “adjustable” versus net income, but may also be distorted by historical costs,
      Similar Metrics:
      Price / NAV
      32
    • Price / Book vs. ROE
      33
      Source: Bloomberg
    • P/B Band
      34
      Source: Bloomberg
    • The Basics: Dividend Yield
      35
      Dividend Yield
      Annualized cash dividend per share / share price
      Pros:
      Tangible rate of return metric.
      Represents actual cash payments.
      Cons:
      Tax issues involved
      May be distorted by special dividends, no set dividend policies.
    • The Basics: Dividend Yield
      Annualized dividend per share = Annualized in terms of the year in which the dividend was earned rather than paid. Combine interim and final to annualize, or “current indicated annual rate” or quarterly div x 4.
      Dividends set by Board of Directors. This may be in accordance to a set dividend policy, vary in terms of payments from year to year, or vary in terms of payouts. Higher payout, lesser retained earnings for investments in new projects.
      Similar Metrics:
      Free Cash Flow Yield
      36
    • Dividend History
      37
      Source: Bloomberg
    • Dividend Forecasts
      38
      Source: Bloomberg
    • The Basics: EV/EBITDA
      39
      EV / EBITDA
      Enterprise value / Earnings before interest, taxes, depreciation, and amortization.
      Pros:
      Capital structure neutral.
      Takes out distortions due to accounting differences, taxes
      Cons:
      Ignores capital intensity
      Difficult to adjust value drivers
    • The Basics: EV/EBITDA
      Enterprise value: The value of all claims on the assets and cash flows of a company
      EBITDA = Operating income + Depreciation & Amortization
      Related Metrics:
      EV / Sales
      40
    • The Basics: EV/EBITDA Issues
      Net debt + market capitalization reverses the impact of capital structure during the current period.
      EV and EBITDA can be adjusted to take into account the impact of operating leases, or chartered-in vessels. This would make for a fairer comparison between ship-owners and ship owner-operators.
      EV/EBITDA can be used to value companies, with the intention to take on debt to acquire strategic targets.
      41
    • EV/EBITDA Valuation Graph
      42
      Source: Bloomberg
    • Other Valuation Ratios
      Basically most financial statement line-items can be used to generate a valuation ratio.
      Price / Cash Flow
      Free Cash Flow Yield
      EV / Sales, Price / Sales
      Price / Cash Earnings
      EV / dwt
      …. etc.
      43
    • Tricks of the Trade
      Aggregate P/E vs. Weighted average P/E
      Peer group selection
      Consistent application of “EPS adjustments”
      Application of time-weighted shares outstanding, historical adjustment factors, diluted vs. basic shares outstanding.
      Use of year-end price versus average price.
      Forward P/E vs. trailing (historical) P/E
      44
    • Summary – Valuation Ratios
      45
    • Cash-flow based valuations
      46
    • Cash Flow Based Methods
      Valuations using forward estimates of cash flows, growth, and cost of capital.
      Free Cash Flow to the Firm (FCFF) – The sum of cash flows to all claim holders, including debt, preferred, and common shareholders.
      Free Cash Flow to Equity (FEFC) – residual cash flows after meeting debt payments, preferred dividends, and providing for capex for existing and new assets.
      Dividend discount model (DDM) – based on the idea that the value of equity is all future dividends discounted back to today.
      Residual Income model (RIM) – Value is derived from current book value of equity and the present value of expected future residual income (ROE in excess of Cost of Equity)
      47
    • Pros & Consfor Cash Flow Models
      48
      Absolute valuation based upon expected cash flows
      Captures cyclical variation in cash flows
      Captures the impact of future capex plans
      Effective for modeling operating companies
      Not standardized, or easily obtainable
      Sensitivity to cost of capital and terminal growth.
      High variation in risk premium estimates.
      Theoretical approach may be difficult for non-financial managers to understand.
      Advantages
      Disadvantages
    • Key Inputs
      Terminal Value
      Weighted average Cost of Capital
    • An Example
      50
    • 51
    • Dividend Discount Model
      52
      Source: Bloomberg
    • Tricks of the Trade
      Compromise between rigor and a pragmatic approach
      Forecast in three stages: 1) near-term detailed forecasts, 2) intermediate growth period, 3) assumed steady state.
      Tweaks
      Forecast period – How long will growth last?
      Fade period – time it takes to reach long-term growth
      Cost of equity, risk premium, which risk free rate?
      Raw beta or adjusted beta
      Best practices – Run sensitivity analysis on key drivers.
      53
    • Asset-based valuations
      54
      • This is probably the most familiar way to value companies for ship owners.
      What would it cost if I buy all the vessels from the secondhand sale & purchase market?
      • No standard definition, but valuations can be based on current market value of assets, value of contracts, newbuilding contracts, and adjusting for non-operating items.
      55
      Asset-based Valuations
    • Ship Values
      56
    • Pros & Consfor an asset-based approach
      57
      Familiar to ship owners
      Sector-specific metric
      Links equity value to industry metrics
      Adjustments can be made for value of contracts, newbuilding contracts
      No standardized definition of NAV
      Based upon secondhand prices, which are not always readily available for all ship types
      No premium given to management capabilities
      Tends to over-estimate during exuberant markets
      Advantages
      Disadvantages
    • An Example – Market adjustment vs. Book Value
      58
    • An Example – Newbuilding Price approach
      59
    • Tricks of the Trade
      Should you including chartered-in vessels? Value of charter contracts? Include financial & operating lease obligations?
      What “market price” do you use?
      “Average” price? What time frame is “recent transactions”?
      Secondhand, newbuilding, and/or scrap prices?
      Extrapolate for age and size? What about quality?
      Can combine this with a sum of the parts (SOTP) valuation. Appropriate for holding company structures, or companies with different business lines.
      60
    • Other Issues / Metrics
      61
    • Valuing Transactions
      Back into the value of the company based on transactions:
      Leveraged Buyouts – Entry & exit multiples, debt capacity, and EBITDA growth assumptions. To be used to see how much you can pay and finance, to obtain an acceptable equity rate of return.
      Value of Contracts approach – contracted rates, cash flow generated, and debt capacity assumptions in a capital budgeting model. Generates NPV and IRR estimates.
      Merger Integration – financing and accounting adjustment assumptions. To be used to see how much you can afford to pay and achieve accretion in earnings.
      Venture Capital approach – Investment, IPO terminal value, and discount rate assumptions. Percent of ownership and high discount rate is needed, due to the risky nature of these investments.
      62
    • Other Valuation Approaches/Techniques
      Contingent claims – Capital structure arbitrage
      Economic Value Added
      Option pricing
      Sum of the Parts (SOTP)
      63
    • Further Studies
      Economic value added – EVA, ROIC, etc.
      Financial Analysis – DuPont analysis, free cash flow analysis, capital intensity, margins, ratios analysis
      Strategic Analysis – SWOT, five forces, etc.
      Capital structure – bonds, preferred shares, convertible bonds, voting rights, options, dual listings, etc.
      64
    • Summary
      Valuation is the process of estimating what something is worth.
      Fundamental analysts approach valuations in three major methods
      Comparative methods, using valuation ratios.
      Cash flow-based methods, estimating future growth, cash flows, and cost of capital.
      Asset-based methods, estimating current market values of assets, and adding it up.
      There are many tricks of the trade, and care needs to be taken when reviewing other people’s estimates.
      At the end of the day, this is only a tool, and should reflect your views on the sector, management, company strategies, and opportunities.
      65
    • Copyright & Disclaimer
      Copyright
      Equity Valuation of Shipping Companies by Teddy Tsai is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.
      http://creativecommons.org/licenses/by-nd/3.0/
      Disclaimer
      This presentation is provided for information purposes only. It is not a complete analysis of every material fact respecting any company, industry, security or investment. Opinions expressed are subject to change without notice.
      While every effort has been made to ensure that the information contained in this presentation is correct with no errors and omissions, no responsibility can be nor is accepted as to the accuracy or completeness of the statements, facts, and examples included herein. No liability is accepted whatsoever on the part of Markis & Company (Asia) Ltd., or of any other parties whose material is contained in the presentation for any loss of profit or damange or any liability to third party whatsoever arising from the use of this presentation.
      Neither this report, nor any opinion expressed herein, should be construed as an offer to sell or a solicitation of an offer to acquire any securities or other investments mentioned herein. The company accepts no liability whatsoever for any direct or consequential loss arising from the use of this report or its contents.
      66
    • 67
      Markis & Company (Asia) Ltd
      Teddy Tsai
      Managing Director
      +852 8127-7587
      teddy.tsai@markis.asia