Global Ship Lease: Recession fears buyers are piling up
Container shipping stocks like Global Ship Lease, Inc. (New York Stock Exchange: GSL) have been decimated recently as global macro headwinds have worsened significantly.
Despite the earnings visibility offered by GSL’s multi-year fixed charter rates with its container shipping companies, the market downgraded the industry as a whole. We believe the blows are warranted, as a much weaker macro environment could put additional pressure on renewal rates going forward. Nevertheless, the company remains convinced that the dynamics of the order book within its target market (below 10,000 TEU) is well below the industry average. Coupled with regulatory tailwinds favoring slower travel speed in the future, it would continue to support robust charter rates over the next few years.
However, the sharp correction in global freight rates from their 2021 highs has alarmed shipping investors. In addition, pressure on the global supply chain has fallen to levels last seen at the end of 2020, as port congestion has further eased. Therefore, we agree with the market’s assessment that even GSL’s gains need to be digested to reduce its execution risks in the face of an impending recession.
We also noted that GSL’s valuation has fallen from its early 2022 highs. We believe the market was right not to revalue the stock despite its “seemingly low valuations”. However, we also noted that GSL is approaching its nascent long-term support, which could help sustain its momentum of recovery if the underlying shipping dynamics do not worsen significantly.
As such, we rate GSL as a buy, with a medium-term (PT) price target of $20.
The headwinds are getting worse
The panic in shipping stocks is understandable, as investors rushed out to lessen the impact on their portfolios. As a result, selling pressure has forced GSL down more than 50% to its June lows, bringing lows back to May 2021.
In addition, the headwinds seen in the shipping industry have further worsened in recent months. Global freight rates continued to decline through October, down nearly 67% since their September 2021 highs. Nonetheless, they remain well above their pre-COVID lows, mitigating the impact on shipping line profitability.
Nevertheless, global trade flows could also weaken further until 2023. The World Trade Organization (WTO) recently reduced its previous forecast of 3.4% trade growth for 2023 to 1%, taking into account the macroeconomic fallout, compounded by the Fed’s increasingly hawkish stance. The WTO said:
Global merchandise trade will slow next year as multiple shocks such as Russia’s war in Ukraine, high energy costs in Europe and tighter US monetary policy increase manufacturing costs and squeeze households. – Bloomberg
Additionally, Moody’s has also become increasingly negative on the outlook for the order book through 2024, suggesting excess supply under the hood. He revised his outlook for the industry to negative, indicating further pain for shipping investors as global demand deteriorates. He articulated:
The launch of new ships in 2023 and 2024 could accelerate the reversal of the industry’s fortunes. The backlog-to-fleet ratio of 28% is the highest since 2010, and this increase in capacity will exceed forecasts for global trade volumes. Although service reliability issues and high freight rates will likely persist well into 2023 as the transportation ecosystem continues to recover, we believe carrier profits have now peaked as increased supply of vessels responds to declining demand. – Bloomberg
Does that make sense? We believe so. As noted above, the Global Supply Chain Pressure Index (GSCPI) has moderated significantly from the highs seen at the end of 2021, which is also broadly in line with the highs seen in the rates of global freight.
Notably, the latest reading from the GSCPI suggests it has fallen to levels last seen in late 2020. However, it remains high (compared to pre-COVID averages) but could continue to decline as the Global shipping demand is deteriorating due to the global macroeconomic slowdown. . Therefore, we believe the headwinds against the shipping industry appear far from over.
But GSL’s estimates factored in sluggish growth
However, as seen above, we understand that GSL estimates have already been revised down significantly to reflect the deteriorating macroeconomic climate through 2024.
Therefore, we posit that GSL’s discount reflected a significant level of downside risks to its revenue and earnings growth throughout FY24.
Additionally, the earnings visibility provided by its fixed-rate charters should keep its profitability robust through the cycle, supporting its current dividend payouts.
But we think the market is looking further ahead after FY24 to assess whether supply and demand dynamics might normalize further for GSL and its peers. If so, it could lead to a further decline in its profitability to reflect headwinds in charter rates, leading to further value compression. We believe this is the main risk in our thesis that investors should consider carefully.
Is GSL stock a buy, sell or hold?
With an NTM dividend yield of 9.3%, we believe its reasonable returns reflect management’s caution through the cycle. Additionally, its relatively low TTM dividend payout ratio of 19.46% (based on GAAP EPS) underscores our belief that it could be sustained through FY24.
We understand that GSL has decisively moved into a medium-term bearish bias on its medium-term chart. However, it remains in a long-term uptrend and has reversed from its long-term decline since its March 2020 low.
Therefore, we postulate that GSL is currently at a critical juncture. The bear trap price action in July 2022 appears to have further halted the decline in sales. Additionally, buyers have stepped in vigorously to support GSL’s near-term support ($14.5) during the recent pullback from its August/September highs.
Therefore, we urge investors to watch this level closely, as it may unveil clues to the market’s directional bias going forward. However, we see further downside risks to retest its $12 midway support if the headwinds worsen.
This would effectively wipe out nearly two years of gains, which could cause a sellout move in GSL and reduce risk from its entry zones. Therefore, we urge investors to consider spreading their exposure over time to take advantage of potential downside volatility.
We rate GSL as a buy, with a mid-term PT of $20.