Equity Valuation of Shipping Companies


Published on

Presentation to NTU Short Course on Ship Finance

Published in: Economy & Finance

Equity Valuation of Shipping Companies

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