Earnings Call Transcript - DAC Q4 2020

Operator, Operator

Good day and welcome to the Danaos Corporation Conference Call to discuss the Financial Results for the Three Months Ended December 31, 2020. As a reminder, today’s call is being recorded. Hosting the call today is Dr. John Coustas, Chief Executive Officer of Danaos Corporation; and Mr. Evangelos Chatzis, Chief Financial Officer of Danaos Corporation. Dr. Coustas and Mr. Chatzis will be making some introductory comments, and then we will open the call to a question-and-answer session. I would now like to turn the conference over to Mr. Chatzis. Please go ahead.

Evangelos Chatzis, CFO

Thank you, operator, and good morning to everyone, and thank you for joining us today. Before we begin, I quickly want to remind everyone that management’s remarks this morning may contain certain forward-looking statements and that actual results could differ materially from those projected today. These forward-looking statements are made as of today, and we undertake no obligation to update them. Factors that might affect future results are discussed in our filings with the SEC, and we encourage you to review these detailed Safe Harbor and risk factor disclosures. Please also note that where we feel appropriate, we will continue to refer to non-GAAP financial measures, such as EBITDA, adjusted EBITDA and adjusted net income to evaluate our business. Reconciliations of non-GAAP financial measures to GAAP financial measures are included in our earnings release and accompanying materials. With that, let me now turn the call over to Dr. Coustas, who will provide the broad overview of the quarter. John?

John Coustas, CEO

Thank you, Evangelos. Good morning, everyone. In the fourth quarter of 2020, we witnessed the most outstanding turnaround in the container industry for as long as I can remember. Market participants were caught by surprise as the chronic underinvestment in capacity coupled with a sudden resurgence of demand created a spike that drove container box rates to all-time highs. This led to a massive increase in our customers’ profitability and significantly diminished counterparty risk that was so prevalent at the end of the first quarter of 2020. The charter market, in turn, rapidly strengthened, resulting in decade-high charter rates across almost all vessel types. Now everyone is focused on whether the current market strength is sustainable and for how long. Fortunately, incremental vessel supply will remain low for the time being. Although there have been new orders placed, the current order book is at historically low levels. Since there is a two-year lead time for new orders to hit the water, supply growth should be moderate for the next couple of years. What will happen next depends a lot on the environmental initiatives, regulations, and of course demand. As far as Danaos is concerned, we experienced a strong quarter, completed delivery of all contracted vessels, realized significant gains, displayed exceptional rechartering performance, and entered into agreements for a very important refinancing. This quarter we saw an improvement in adjusted EBITDA and adjusted net income compared to the same quarter in the prior year. This improvement should be even more pronounced in the coming quarters as new contracted charters at significantly higher rates start to contribute to our top line. We have concluded 27 recharterings over the past three months for a period of 12 to 24 months at rates between 2x and 3x the rates of the expiring charters. In doing so, we have practically covered 91% of our 2021 operating days, and a significant portion of our 2022 operating days. We currently expect revenue in 2021 to exceed 2020 revenue by at least $100 million. The recent performance of both ZIM and HMM has resulted in a $23.8 million increase in the recorded value of our bond holdings in these two companies, which increased in value to approximately $63 million as of the end of 2020. The ZIM IPO has also provided a mark-to-market value for our 10.2 million shares in ZIM, which has a value now exceeding $200 million based on ZIM’s closing share price of $20.12 a share on February 12, 2021. These shares were valued at $75,000 in our books as of the end of 2020. We’ve also recently concluded a $300 million bond offering, which was over 3x oversubscribed, an extraordinary accomplishment for a first-time issuer. These funds, together with another $950 million of bank and lease financing will be used to refinance most of our existing credit facilities and form the basis of our new strategy as we will not have any maturities until sometime in 2025. We are happy that the market has acknowledged our accomplishments, leading to a dramatic outperformance of our share price as compared to our peers. We are well positioned and committed to continue to take actions to create value for our shareholders. And now, I will turn the call over to Evangelos to guide you with some of the financials.

Evangelos Chatzis, CFO

Thank you, John, and good morning again to everyone. I will briefly review the results for the fourth quarter and then we will open the call to Q&A. We reported adjusted EPS for the fourth quarter of $2.29 per share or adjusted net income of $47.8 million compared to adjusted EPS of $2.01 per share or $38 million for the fourth quarter of 2019. This almost $10 million increase between the two quarters is mainly the result of a $9.4 million increase in operating revenues and a $0.5 million improvement in the operating performance of our equity investment in Gemini, while a $6 million improvement in finance costs was offset by higher total operating expenses mainly due to the increase in the average size of our fleet by four vessels between the two quarters as a result of recent acquisitions. More specifically, operating revenues increased by $9.4 million to $119.6 million in the current quarter compared to $110.2 million in the fourth quarter of 2019. This increase is attributed to a $13.7 million increase in revenues as a result of higher charter rates and the addition of four vessels to our fleet, a $2.1 million increase in revenue due to higher fleet utilization, partially offset by a $6.4 million decrease in revenues due to lower non-cash revenue recognition under U.S. GAAP accounting. Vessel operating expenses increased by $4.2 million to $28.7 million in the current quarter from $24.5 million in the fourth quarter of 2019, as a result of the increase in the average number of vessels in our fleet while the average daily vessel operating costs increased to $5,571 per day for the current quarter from $5,215 per day in the fourth quarter of 2019 and still remains as one of the most competitive in the industry. G&A expenses decreased by $0.6 million to $6.4 million in the current quarter compared to $7 million in the fourth quarter of 2019, mainly due to decreased non-cash recognition of stock-based compensation. Interest expense, excluding finance cost, amortization, and accruals, decreased by $6 million to $7.1 million in the current quarter compared to $13.1 million in the fourth quarter of 2019. This improvement is attributed to a $92.6 million decrease in our average indebtedness over the two quarters and a reduction of our debt service cost by 2% between the two periods. Adjusted EBITDA increased by 6.3% or $4.9 million to $83 million in the current quarter from $78.1 million in the fourth quarter of 2019 for the reasons outlined earlier on this call. We would like to note that results for the fourth quarter and full year 2020 reported today, although improved across the board versus 2019, do not fully capture the significant improvement in the market fundamentals that were outlined by our CEO earlier on this call. This is all laid out in the investment presentation that has already been posted on our website, and we encourage you to review it. A few of the highlights of what is ahead of us are; asset values have improved with the charter-attached value of our fleet today at $2.2 billion on the basis of year-end 2020 charter-free valuations provided by independent brokers and calculation of charter premium, wherever applicable, in accordance with our finance agreements. We also now have visibility as it was mentioned before on the value of our shareholding in ZIM, since ZIM shares are now trading on the New York Stock Exchange. The shareholding today is valued at $205 million, while at the same time the valuation of the ZIM and HMM bonds have also improved. On the back of stronger asset values, the net asset value of Gemini currently stands at $85.1 million, which translates to a value of our 49% participation of $42.1 million. On the basis of all the above, we currently calculate our net asset value at $1,050 million or $51.60 per share. On the operating side, over the past three months, we have fixed 27 vessels at significantly higher rates than previously. And within our investment presentation, we laid out the improved charter arrangements for each one of them. As a result of these improved fixtures, our contract backlog today stands at $1.2 billion and our contract revenues for 2021 alone currently stand at $543 million, which is already $81 million higher than total revenues of 2020. We still have 9% of our operating days open for 2021, and we expect overall improvement in revenues to exceed $100 million in 2021 versus 2020. Needless to say, there typically is no marginal cost associated with this increase in our supply. Such improvement is expected to also be reflected in earnings. With that, I would like to thank you for listening to this first part of our call. Operator, we are now ready to open the call to Q&A.

Operator, Operator

We will now begin the question-and-answer session. And the first question comes from Chris Wetherbee with Citigroup. Please go ahead.

James Monigan, Analyst

Hi. Good morning, guys. James on for Chris. Just wanted to get your view on the rate environment post-Chinese New Year. What indications are you seeing in the chartering market, any indication that it will soften? Also, if you could provide a little more color on what you're seeing in the Panamax market, I think that would also be helpful? Thanks.

John Coustas, CEO

Chris, for the time being, the market is still strengthening. The only thing I can tell you is that even today every new fixture that we are doing is at higher levels than the previous one. Practically, the whole industry has slowed down. There is demand, but there are no vessels to match. I cannot really tell you what will happen in a year's time, but definitely for this year, it looks like the market is going to continue to be strong as we are entering what is supposed to be the strong period spring onwards, and I’m personally very optimistic.

James Monigan, Analyst

Got it. And given that and essentially where vessel values are, do you still think that it's an attractive opportunity to be active in the S&P market in 2021, or is that something where you might think of a different use of capital?

John Coustas, CEO

To be honest, we don't like chasing the market up. It's pretty hard now to go in the market and pay almost double the price for the ships that we've bought in the last year or so. So, we will keep on looking, of course, for any interesting off-market opportunities. But to be honest, I think this is more of a time to beef up your cash reserves and to be ready for the next move.

James Monigan, Analyst

Got it. I also wanted to touch on capital structure and the issuance of the $300 million in unsecured. Just wanted to understand how you are thinking about balancing bonds with bank debt, and how you are thinking about the capital structure moving forward and if you're going to move more towards one and away from the other, just kind of wanted to get your thoughts on the long-term capital structure in that issuance?

John Coustas, CEO

Yes. What we have seen is that bond capital is getting harder and harder to find. Not only that, but also the actual amount that each bank is preparing—the limits per client are going down, because banks are getting more and more conservative with shipping. If one wants really to have a reliable source, then the bond market is where to look. Our existing facilities were due until the end of 2023. So, we've had a lot of leeway, but we decided to make this move in order to be well positioned. I think that with our performance in the bond markets, we will be able to lower significantly our borrowing costs going forward. This will give us the strength and competitive advantage to pursue large deals and not to depend on the banking market, which of course will always be there as we all wish for in part of our capital structure, but I don't think it can be the only source.

James Monigan, Analyst

Got it. So are you saying that we should expect unsecured bonds essentially to be a greater portion of your capital structure and you'll expect a fairly routine amount of maturities to be issued and sort of think that more bonds with a smoother maturity schedule? Is that kind of the way to think about where you're targeting or moving over time?

John Coustas, CEO

We will do whatever we have to do to optimize the cost of capital. As we are first-time issuers, this was a very successful bond issuance. As time goes by and we become a seasoned issuer and the market starts knowing us better, we expect the cost to start going down. We expect with our performance, most of which, as I said before, is contracted, that we will be upgraded. This will gradually get us to a better place, and there will always be a mix between secured and unsecured, because secured debt is very competitively priced. All these decisions will be made based on optimizing costs and the profile of the debt, because how your debt is profiled is also important, as it relates to the free cash flow you have available to deploy and pursue growth opportunities.

James Monigan, Analyst

Got it. And so given that there is sort of a gradual improvement just on the cost of debt side, just wondered also to understand how you're thinking about the dividend given that and how you're balancing buybacks versus the dividend, and that will be all for me.

John Coustas, CEO

So as far as the dividend is concerned, this is the first thing that the Board will discuss as soon as we have consummated the financial transaction, which we expect in April. So, a decision about the dividend will be by the Board on our next earnings call, where we would have completed our refinancing and we will have a very clear path ahead.

James Monigan, Analyst

Got it. Thank you.

John Coustas, CEO

Okay. Thank you, Chris.

Operator, Operator

The next question comes from Randy Giveans with Jefferies. Please go ahead.

Randy Giveans, Analyst

Hi, gentlemen. How’s it going?

John Coustas, CEO

Hi, Randy. How are you?

Evangelos Chatzis, CFO

Hi, Randy.

Randy Giveans, Analyst

Very good. A little snowed in here in Houston, but I'm doing all right. So, obviously, your turnaround has been quite remarkable here since this time last year, a lot of that being market driven, but also a lot due to pretty prudent management decisions, smart chartering, the share repurchases, obviously, overhauling the balance sheet, so congrats first on a pretty stellar year there. Now kind of looking ahead, a couple of questions. With the stronger balance sheet and the comprehensive refinancing package, and obviously now the substantial cash flow, I think you mentioned over $100 million in revenue more in '21 than '20, so where do you kind of grow from here? Obviously, one competitor is focusing on much older, smaller tonnage while another is focusing on kind of much larger, new LNG powered newbuildings, right? So, is Danaos looking at either of those transactions? Why or why not?

John Coustas, CEO

Well, we have looked at both of these transactions. The transactions from the very large ships produce extremely small equity returns. We have participated in another major liner company’s tender, and in the end, the liner company decided to do it themselves, because they felt even more competitive, and although we had really huge margins. On the other strategy of buying, let's say, all the vessels, practically to have, is a bit too much. We prefer to gamble like that with younger vessels, as we have done with the vessels that we have bought somewhere between, let's say, 10 to 14 years old at maximum when we bought them. As I said, shipping is a cyclical industry. It doesn't make sense to continue investing no matter where the cycle is. At this moment we are concentrating on beefing up our balance sheet. As we know, apart from the free cash flow that we are going to generate through this with new facilities and the assets that we have in our books, like the shares and bonds, we could very well be looking at liquid assets exceeding $400 million by year-end. So, we prefer to sit back and see what is happening. We are doing a lot of work and research on the environmental issues and where we are going to head. Yes, we are not just going to keep buying vessels through the market cycle.

Randy Giveans, Analyst

Got it. Okay. I’ve got a next question kind of alluding to what you were signaling there around your short-term available liquidity and other kinds of assets you have now, how are you viewing the HMM notes, the ZIM notes, and the ZIM shares here? When will you collect cash on the notes and what are your plans on extracting some value out of the ZIM shares?

John Coustas, CEO

Well, as I said, first of all, as far as the bonds are concerned, I think ZIM with the massive liquidity that they have at present, they will most probably recover within this year. We have a bunch of HMM bonds. If we wanted at a very small discount, we could also sell these bonds if we wanted liquidity. As far as the shares are concerned, we will consider our options after the lockup period. We are not natural holders of liner companies' shares. These shares were given to us during a presumed restructuring in 2014. We will think about it at the time. If we need to realize some cash for projects, then we will consider our options after the lockup period ends.

Randy Giveans, Analyst

Sure, that makes sense. All right. I guess last question, you mentioned kind of dividend timing likely following 1Q results, maybe some announcement on the 1Q call in May. Is there an amount you are targeting either in terms of dollars return or kind of percent yield at that time? How should we think about that? And would it be like fixed or floating?

John Coustas, CEO

Yes. In general, we are going to have a fixed dividend. The stock has been performing well so that will be the strategy above the level, which is something that the Board will need to decide. On the other hand, as you have seen, we are in growth mode. We have proven that with whatever we have done. And, of course, the dividend will reward our shareholders to a certain extent, but it will also increase interest for our possible shareholders, because there are a number of institutions that demote and hold equities that do not pay dividends. I think the Board will decide what it's going to be.

Randy Giveans, Analyst

Got it. That's fair. And I know some nitpicky questions there. The stock’s gone from $3 to $37. So whatever you're doing, keep up the good work.

John Coustas, CEO

Thank you very much. Thank you.

Operator, Operator

The next question comes from Omar Nokta with Clarksons Securities. Please go ahead.

Omar Nokta, Analyst

Thank you. I also echo Randy's comments. Congratulations on such a real turnaround and moving the company in the right direction. You guys bided your time quite patiently and it's nice to see things worked out. I did want to ask, you talked about in your opening comments the refinancing that you've just recently done forms the basis for Danaos’ new strategy, and you've touched on that in the Q&A. Can you expand on that just a bit more? You mentioned obviously beefing up the balance sheet, collecting the free cash and then also you're evaluating the dividend come April. Is there a way you're leaning at the moment? Do you see yourself maybe going back to your “roots” of having new buildings contracted long-term? Do you see that being a direction of company going into? I know you mentioned that equity returns being too low at the moment. Are there opportunities potentially coming in that direction, or do you prefer to stay a bit more nimble and then sticking with the S&P market whenever there are opportunities?

John Coustas, CEO

Well, Omar, as I said, today we are in a situation where liner companies have pretty strong balance sheets. They are making a lot of money. If we want any new buildings, they could very well go and build them themselves. If they decide to go to tonnage providers, then exactly because we are benchmarked at that level, our own cost of capital is pretty low. On the other hand, to be able to do these deals, you need to go to extreme amounts of leverage, 90% or even more. It's a completely different strategy.

Evangelos Chatzis, CFO

And Omar, if I may add, it may not just be newbuildings, but of course there's going to be at some point—and we hope it's not very soon—but people will start ordering. The order book is very low and there will be orders going forward. Even if it's not for newbuildings, liners may want some cash to order the big ships themselves, which is what they usually do, right? They build them themselves. There may be opportunities of sale-leaseback alternatives in young assets to unlock cash on their balance sheets. We do expect transactions to present themselves. It's just that we will enter into projects provided we meet our return threshold. We're not going to grow for the sake of growing, I guess is the message. We’re mindful of returns and equally mindful of managing residual value risk. We're not going to acquire a ship that offers good short-term cash on cash returns and then get stuck with a high value on the other end of the charter, which would impair the equity. So that's how we view growth.

John Coustas, CEO

And also, Omar, we are in a very transitional phase that we have new regulations coming up. On the other hand, we have a creaky, old midsized fleet. The flow into these midsized fleets has been up to now purely from the larger vessels cascading. Depending on how the regulatory environment moves, that might not be enough in the future. So it's very important to see who is going to build the required midsized fleet today that will be environmentally friendly, and where charters are not so much willing to invest because they prefer to direct their investment in the larger vessels.

Omar Nokta, Analyst

Thanks for that. So it sounds like potentially if there were to be some opportunities, you may be jumping in that midsized, call it 3,000 to 8,000 TEU?

Evangelos Chatzis, CFO

Yes.

Omar Nokta, Analyst

Good. All right. And follow up also just looking on your slides. You note the 27 vessels that have been rechartered over the past three months, there's quite a good amount of those new charters that really just get you into the fourth quarter, early 2022, which is where things are now. It looks very appetizing. When you think about that, what's the charter appetite at the moment for fixing those vessels forward? At the moment, are they approaching you? You also mentioned the liners are preferring to own their ships outright. Is there interest in them simply buying the vessels from you?

John Coustas, CEO

We have demand for selling vessels. In general for us, it doesn't make any sense to sell a vessel when for a jump in the price, we can sell each equivalent to the present value of the charters, and we can fix today plus their scrap value; we have the same position. We have an option when the market is higher to make even more money. Of course, that will be different for someone who just needs the cash now, because it’s a different proposition. We are generating cash, so we can fix the ships today forward for a number of years that will bring the ships practically down to scrap.

Omar Nokta, Analyst

Yes. And then just final question on that. Can you give us a sense of if you were to put a vessel today on say a one-year charter and that same ship if there were offered a three-year charter? What would be the difference or the discount to go longer-term?

John Coustas, CEO

I think that it depends, of course, on the ship price. If we are talking about larger vessels, I think that you could have in a negotiation of one-year charter at least a 70% if not 40% more than what you could get for a three-year charter.

Omar Nokta, Analyst

Got it. Okay. Thank you. I appreciate that and congratulations again. I’ll turn it over.

John Coustas, CEO

Thank you.

Evangelos Chatzis, CFO

Thank you.

Operator, Operator

This concludes our question-and-answer session. I would now like to turn the call back over to Dr. Coustas for any comments or closing remarks.

John Coustas, CEO

Thank you everyone for attending our call. We thank you for your continued interest in our company, and we'll continue our best for our shareholders. Thank you.

Operator, Operator

This concludes today's teleconference. We would like to thank everyone for their participation. Have a wonderful afternoon.