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Equity Valuation of Shipping Companies

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Presentation to NTU Short Course on Ship Finance

Presentation to NTU Short Course on Ship Finance

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  • 1. 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
  • 2. Agenda
    2
  • 3. 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
  • 4. What Equity Analysts Do
    4
  • 5. Basics of Financial Statements
    5
  • 6. The Basics
    6
  • 7. Income Statement
    7
    Source: Bloomberg
  • 8. Income Statement - Per Share Data, Reference Items
    8
    Source: Bloomberg
  • 9. Cash Flow Statement
    9
    Source: Bloomberg
  • 10. Cash Flow Statement – Reference Items
    10
    Source: Bloomberg
  • 11. BalanceSheet
    11
    Source: Bloomberg
  • 12. 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
  • 13. Ratios Analysis
    13
    Source: Bloomberg
  • 14. DuPont Analysis
    14
    Source: Bloomberg, Wikipedia
  • 15. What is Valuation?
    15
  • 16. 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
  • 17. 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
  • 18. 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
  • 19. Technical vs. Fundamental Analysis
    19
    Chartist approach
    Intrinsic value approach
    Source: Bloomberg
  • 20. Relative vs. Absolute Valuations
    20
    Relative Valuations
    Absolute Valuations
    Source: Bloomberg
  • 21. 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.
  • 22. 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
  • 23. 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
  • 24. Valuation Ratios
    24
  • 25. 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
  • 26. 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
  • 27. 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
  • 28. P/E Ratio Valuation Graph
    28
    Source: Bloomberg
  • 29. Earnings Summary
    29
    Source: Bloomberg
  • 30. P/E Band
    30
    Source: Bloomberg
  • 31. 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.
  • 32. 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
  • 33. Price / Book vs. ROE
    33
    Source: Bloomberg
  • 34. P/B Band
    34
    Source: Bloomberg
  • 35. 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.
  • 36. 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
  • 37. Dividend History
    37
    Source: Bloomberg
  • 38. Dividend Forecasts
    38
    Source: Bloomberg
  • 39. 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
  • 40. 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
  • 41. 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
  • 42. EV/EBITDA Valuation Graph
    42
    Source: Bloomberg
  • 43. 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
  • 44. 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
  • 45. Summary – Valuation Ratios
    45
  • 46. Cash-flow based valuations
    46
  • 47. 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
  • 48. 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
  • 49. Key Inputs
    Terminal Value
    Weighted average Cost of Capital
  • 50. An Example
    50
  • 51. 51
  • 52. Dividend Discount Model
    52
    Source: Bloomberg
  • 53. 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
  • 54. Asset-based valuations
    54
  • 55.
    • 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
  • 56. Ship Values
    56
  • 57. 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
  • 58. An Example – Market adjustment vs. Book Value
    58
  • 59. An Example – Newbuilding Price approach
    59
  • 60. 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
  • 61. Other Issues / Metrics
    61
  • 62. 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
  • 63. Other Valuation Approaches/Techniques
    Contingent claims – Capital structure arbitrage
    Economic Value Added
    Option pricing
    Sum of the Parts (SOTP)
    63
  • 64. 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
  • 65. 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
  • 66. 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. 67
    Markis & Company (Asia) Ltd
    Teddy Tsai
    Managing Director
    +852 8127-7587
    teddy.tsai@markis.asia