Investment Bargain? — Danaos Corp (DAC)

Photo by Ian Taylor on Unsplash

This turnaround company has a compelling story.

With technology stocks in Bear Market territory since the beginning of the year and with other stocks not far behind, it is a good time to review my investment holdings with a view to rebalancing and perhaps taking advantage of some compelling bargains.

In general I’m a pretty conservative investor. I have a wide range of holdings across many industries with not too much money in any one investment. I am a fan of the Warren Buffett philosophy of “Never lose money.” In order to support that philosophy I tend to invest in companies which are priced well below what I consider their intrinsic value. In addition, I look for dividend income. The combination of the two of these helps me sleep at night, even when the stock market is doing weird things.

One past holding of mine that I have revisited is Danaos Corp (DAC). Danaos is an owner of container ships which provides shipping services to other shipping companies throughout the world.

I last bought shares in the company in 2020 when, in my opinion, it was significantly under priced due to a combination of the effects of the Covid pandemic and a lack of appreciation of the turnaround the company from the negative impacts of the bankruptcy of one of their major customers in 2016. When I sold the stock the following spring it had more than doubled in price so I took my profits. Unfortunately my crystal ball was pretty cloudy. After selling, it proceeded to continue to climb in price to the point that by early this year it was up about seven times from what I paid for it. Oh well. That’s the breaks with investing. A doubling of my investment was still a very nice return over less than a year.

As of today’s closing price, it is down over 35% from its March high so I figured it was worth a revisit. Here’s what my analysis came up with:

Pros:

• DAC started paying dividends in May of 2021, for the first time in over a decade. It increased that dividend by 50% in February this year. At the current trading price the dividend forward yield is 3.63% which is a pretty decent dividend return and the current payout ratio is only 4.7% which is well covered by the company’s free cash flow.
• The stock price to book value ratio is 0.65. This means that the stock is selling for 35% less than its per share value if all its assets were sold off and all its debts paid. I understand that technically the book value is an accounting and tax reporting figure that doesn’t always reflect the actual asset value minus debts. However, it is a reasonable estimate in light of no better information. This does indicate that the stock has a significant margin of safety.
• The price to earnings (P/E) ratio is incredibly low at 1.35. This basically says that for each dollar it costs to buy a share, the company is earning $0.74 each year. Most companies that are either not in trouble or in a high growth industry usually have a P/E ratio in the range of 10 to 20.
• The Chairman and CEO of the company owns 43.48% of the company’s shares which means that he is well motivated to operate the company in a shareholder friendly manner.
• Six years ago the company took a serious financial hit when one of its main customers went bankrupt leaving Danaos with a significant short term debt problem. Danaos itself looked to be on the brink of bankruptcy with a current ratio of 0.05! Then in 2018 the company negotiated a shares for debt exchange that wiped out a chunk of that debt and took steps to turn the balance of it into long term debt. Since then the company has worked hard at reducing its overall debt while increasing its net assets. Now the company is in much better shape with a current ratio of 2.86 and a debt/equity ratio of 0.47, both of which are indicators of decent financial strength.
• Based on the last 12 months financial history and using the Graham Formula for calculating intrinsic value, I get a minimum intrinsic value calculation of at least $118.48 per share. This is the lowest value of a range that goes much higher than this. Based on this low valuation, the shares are trading at a margin of safety of 39% at the current price.
• The company successfully navigated a major financial crisis that would have put many companies into bankruptcy and instead managed to weather the crisis, manage its debt, and turn everything around so that it is in a strong operating position. In my opinion, this is one of the advantages of a company whose senior management is a primary shareholder. They are too invested to give up easily.

Cons:

• The intrinsic value calculations for DAC based on a ten year financial history comes out with a minimum valuation of $57.65. However, as this ten year history is disrupted by the financial issues in 2016 and 2017, I feel that this valuation is suspect.

Here’s my opinion and plan:

• Given the above and given that Danaos is now trading 35% below its March high, is paying a dividend of 3.6% with a very low payout ratio, has a favourable debt to equity ratio, a very low P/E ratio, and, by my calculation, a decent margin of safety, I think it is time to buy this stock again.
• Given the high cash position of the company and the low dividend payout ratio, I expect dividend payments to continue to grow.
• Overall, to me, there seems to be limited down side risk against a very large potential upside opportunity.
• My plan is to take an average size holding and then, if the price continues to decline, add to that holding, which will increase my margin of safety and my dividend rate of return.

It will be interesting to see how this turns out.

Disclosure — I am not a professional investment advisor. What I’ve written here is just my opinion based on my personal investment studies. In no way should any of this be taken as a recommendation. It is simply my thinking regarding my own investments. Please seek professional advice before making any investment decisions.