Earnings Call Transcript - DAC Q3 2021

Operator, Operator

Good day and welcome to the Danaos Corporation Conference Call to discuss the financial results for the 3 months ended September 30th, 2021. 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. Please note this event is being recorded. I would now like to turn the conference call over to Dr. John Coustas. Doctor, the floor is yours, sir.

Evangelos Chatzis, CFO

Thank you, operator, and good morning, everyone. This is Evangelos Chatzis, CFO. Good morning everyone, thank you for joining. Before we begin, I simply 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. 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 turn the call over to Dr. John Coustas who will provide an overview of the quarter.

John Coustas, CEO

Thank you, Evangelos. Good morning, and thank you all for joining today's call to discuss our results for the third quarter of 2021. We are certain that everyone is aware of the well-documented disruptions to the global supply chain that continue unabated. This situation, despite its negative effect on certain areas, has had extremely positive effects in our market, which continues to strengthen. Despite efforts by all participants to alleviate the disruptions to the global supply chain, there are no signs that conditions are improving. The main contributing factors are increasing demand, lack of available vessels to meet such demand, and low levels of productivity in the ports and other land-based infrastructure. Additionally, as new vessel deliveries in 2022 are expected to be lower than in 2021, we do not expect any respite from the vessel supply front in the near term. In 2023, increased deliveries are forecasted; however, there will be an offsetting effect from new environmental regulations that will likely tighten the effective supply of vessels due to the anticipated reduction in speed. Overall, we do not expect a dramatic difference, provided demand remains healthy. During the third quarter, we consummated the acquisition of Gemini and acquired six 550,000 TEU vessels, all with existing cash resources. On the back of these moves, we have achieved record EBITDA and net income. We have also expanded our charter catalogs and now have in excess of $2 billion of chartered backlog. Our share ownership in Zim, although adjusted as per our usual practice, will also contribute around $0.5 billion to our earnings for 2021, which is outstanding. Our liquidity in terms of cash and marketable securities is still close to $0.5 billion, and we are closely monitoring our options and strategy for next year to deliver even better results for the Company. In the meantime, liner companies are announcing record results, which is extremely positive for Danaos, as the strong credit quality of our customers continues to improve. The continued strong performance of Danaos is ensured by existing charters with an average charter duration of 3.3 years, and new charters that lock in current rates for several years. We expect slow market conditions to persist in the near term, which will support a strong re-chartering environment into next year and should ensure our stellar performance for the next three years. Once again, the market dynamics are in our favor, as we will continue to deliver the best results possible for our shareholders. With that, I'll hand the call back to Evangelos, who will take you through the financials for the quarter.

Evangelos Chatzis, CFO

Thank you, John, and good morning again to everyone. I will briefly review the results for the quarter and then give call participants the opportunity to ask questions. We are reporting adjusted EPS for the third quarter of 2021 of $5.32 per share, or adjusted net income of $109.5 million, compared to adjusted EPS of $1.91 per share, or $47.3 million for the third quarter of 2020. This increase between the two quarters is mainly the result of a $77 million increase in operating revenues and a $12.3 million dividend collected from Zim during the quarter, partially offset by higher total operating expenses of $17.3 million due to the increase in the average size of our fleet by eight vessels between the two quarters. Operating revenues increased by $77 million to $195.9 million in the current quarter compared to $118.9 million in the third quarter of 2020. This increase is attributed to a $30.6 million increase in revenues as a result of higher cap rates and $15.6 million of incremental revenues due to the vessel additions to our fleet between the two quarters. Revenue also increased by $21.5 million, mainly due to straight-line revenue recognition accounting, and further increased by $9.3 million, being the amortization of the assumed capital liabilities of the recent vessel acquisitions. Thus, operating expenses increased by $7 million to $34.7 million in the current quarter, from $27.7 million in the third quarter of 2020, mainly attributed to the increase in the average number of vessels in our fleet while the average daily vessel operating costs increased to $5,918 per day in the current quarter from $5,467 per day in the third quarter of 2020. This was mainly due to COVID-19 related increases in expenses. However, our daily operating costs remain among the most competitive in the industry. General and administrative expenses increased by $1.3 million to $7.3 million in the current quarter, compared to $6 million in the third quarter of 2020, mainly due to increased management fees attributable to the aforementioned increase in fleet size. Interest expense, excluding finance costs, amortization, and accruals increased by $7 million to $14.5 million in the current quarter, compared to $7.5 million in the third quarter of 2020. The increase in interest expense is a combination of a $0.7 million increase due to the rising cost of debt service by approximately 0.4%, partially offset by a decrease in our average indebtedness by approximately $80 million between the two periods, and a reduction in the positive recognition through our income statement of accumulated accrued interest of $6.3 million that had been accrued in 2018 in relation to two of our credit facilities that were refinanced this April. Consequently, adjusted EBITDA increased by 79.6%, or $66.3 million, to $149.6 million in the current quarter from $83.3 million in the third quarter of 2020 for the reasons outlined earlier on this call. We encourage you to review our updated investor presentation, which has already been uploaded on our website. A few highlights are: regarding operations, over the past few months, we have forward-fixed several vessels at significantly higher rates than current market rates. Our investor presentation contains analytical disclosures on our contracted charter book and the step-ups in the companies. As a result of these improved fixtures and including the Gemini vessels that were fully consolidated on July 1, 2021, and the acquisition of the six 5,500 TEU wide-beam container ships, our contract backlog now stands at $2.1 billion with a 3.3-year average charter duration, while contract coverage in terms of operating days is already at 100% for this year and 90% for 2022. With that, I would like to thank you for listening to this first part of our call. Operator, we're now ready to open the call to Q&A.

Operator, Operator

Yes, sir. We will now begin the question-and-answer session. Please note that at this time, we will pause momentarily to assemble our question queue. The first question we have will come from Randy Giveans of Jefferies. Please go ahead.

Randy Giveans, Analyst

Good morning, gentlemen. How's it going?

John Coustas, CEO

Hi, Randy. How are you?

Randy Giveans, Analyst

Doing well. My first question is, you stated in the press release you have about 90% of days already covered in 2022, and likely that number's higher when you assume the options get exercised. So, a two-part question there for next year: how many vessels become open in 2022, and when do you expect to fix those? And then secondly, can you give some kind of EBITDA guidance for next year? It seems like $650 million is a possibility?

Evangelos Chatzis, CFO

Yeah. Thank you, Randy. Starting from the last part, we obviously did not formally provide EBITDA guidance. However, you have the current quarter's EBITDA, which is $150 million. Given that over the next quarters when the new contracts kick in, it's obvious that this number is going to go up. The current, let's say, annualized Q3 points to $600 million. And I can tell you with great certainty that it's going to be north of that. We have disclosed our contracted revenue for next year, and people can do the math regarding EBITDA margins and financial reports. That's how it relates to EBITDA. The other thing is, because this is part of earnings for the quarter, we have a dividend from Zim, and next year it is anticipated that Zim will pay out further dividends, which will also be part of our earnings, although it's a 'non-operating item' if you wish; it's not earnings from the ships themselves. But this ought to be taken into consideration when looking at EBITDA and earnings for next year. On your question about re-chartering, yes, 10% of our days, we have also stated in our presentation, are open, which would point to about seven ships for the full year. It may be slightly higher than seven because ships open up gradually within the year. I don’t have the exact number at this point, but it’s maybe 12 or 14 ships or something like that. But as we pointed out, we calculate this based on minimum contract durations. There are options that charters have on several of these ships, but one would expect they will be exercised as they remain below market. However, we cannot make such assessments when publicly showing the contract cover numbers. In our 6-K, for your benefit and for all investors or analysts that want to review this, there is a very analytical breakdown of all the charter arrangements and the options. So, people can make up their own minds on what they believe may or may not be exercised.

Randy Giveans, Analyst

That's fair. Now, on the Balance Sheet side, it looks like you still have about 7.2 million shares of Zim, worth $350-plus million. I guess, with that, any updates on timing of the sale of those? I know you trimmed a million here in the last few weeks or so. On the other side of that, you clearly have a, to use your term, 'war chest' of cash now, and it's growing. What are you likely to do with that excess liquidity in the coming quarters?

Evangelos Chatzis, CFO

Before John addresses the question about the strategy with Zim, I want to highlight that in the third quarter, we invested $75 million in the Gemini acquisition and $260 million for six new ships. We have wisely utilized our cash, and while I wouldn't refer to it as a war chest, the cash we've accumulated has been effectively deployed. Moving forward, we expect that cash to build up again. At this point, we believe we have used our capital appropriately. I'll hand it over to John to answer the Zim question.

John Coustas, CEO

Yes. We believe that the Zim shares are actually undervalued. We wanted to sell some shares because if eventually we would like to exit, we need to assist in boosting the liquidity of Zim shares. I think for the time being, we are done with our sales. We are going to wait also to see Zim's results. From the guidance they're giving, you have a market cap that is equivalent to 2021 EBITDA. It's obviously a very cheap stock. We are not in a hurry. At this moment, we believe there is significant appreciation of the stock, and as Evangelos said, we've already made significant investments. We are monitoring any exceptional opportunities to invest. Nothing like that is visible at this moment, so we will continue first of all, to optimize our debt. Of course, we will definitely increase the dividend. We are committed to that, so I believe we will plan a cautious yet ready path to solid growth both for the Company and the dividend.

Randy Giveans, Analyst

That's fair. I think just to reiterate, Zim is still cheap. Clearly the analysis though will be good to hear that the dividend is going to be increased. We'll be watching for that. Thanks so much and keep up the great work.

John Coustas, CEO

Thank you. Thanks, Randy.

Operator, Operator

The next question we have will come from Chris Wetherbee of Citi.

Eli Winski, Analyst

Hi, this is Eli Winski sitting in for Chris Wetherbee. Congrats on the quarter, and thanks for taking the call. My first question for you is more conceptual. Given the higher congestion that we're seeing broadly, the upward pressure it's putting on a rate environment, what is your visibility in terms of the new builds? Do we find that some are holding off on new builds until we have more clarity on what the congestion environment might look like in the future?

John Coustas, CEO

Well, the congestion environment is not going to be solved by just more ships. That is exactly why we have seen, in general, a pause in new buildings. Of course, there are lots of ships in the pipeline, but for the time being, everybody really has a bit of a hold, both because new building prices have gone up, but also because we're talking about late 2024, 2025 deliveries when no one will know exactly what the demand-supply balance will be. On another front, you've probably been following what's going on with COP26, as shipping is really committed to achieving zero carbon shipping by 2050. But we need much more clarity about that from the governments who are going to provide fuel for that. It is important for everyone to understand that this creates limits on new buildings you order today, whether they are conventional or LNG because these are both fossil fuel propulsions. The ships which will be delivered in 2025 will last for 25-30 years, and every charter decision today doesn’t contribute positively for a de-globalization horizon.

Eli Winski, Analyst

That makes sense. Thank you. Going off of that a little more, given the age of the current fleet right now, do you feel that you might have more of a propensity to lean towards a more eco-focused fleet quicker than maybe some of the other peers in the market? Or do you expect just to try to capitalize on the higher rate environment with the current fleet and hold off on additional investments into the eco-category?

John Coustas, CEO

As I said, we are definitely among our peers. We have the largest resources, assuming we dispose of the Zim shares to proceed with a significant new building program. However, we don't want to order new buildings unless we are sure that these ships will not suffer technological obsolescence within the next 15 to 20 years. That is why we are extremely careful with all these decisions. I have been attending various conferences lately, and it's recognized that from an environmental perspective, it makes much more sense to extend the life of an existing ship for another 5-6 years to give the research toward more zero-carbon vessels the appropriate timeline, rather than just rushing to order new ships today.

Eli Winski, Analyst

That makes sense. Thank you. It will be interesting to see how this plays out in the coming years. I have three quick questions for you: in terms of the longer and improving fixtures, do you see customers asking to front-load any of those contracts given lower visibility in the longer term?

John Coustas, CEO

There are customers—not a lot, just a couple—who have asked that. This is mainly from their perspective. It's purely for their tax considerations. They have very high income during this year '21 and '22, so they would prefer to front-load the rate and then to have a lower rate going forward when people expect that from 2023, we will see a better normalization of the TEU rates.

Eli Winski, Analyst

Thank you. Can you provide some color on off-hire days and scheduled dry-docks moving forward? I don't ask you to crystal ball it, but just any information on the 137 off-hire days—was that just due to a broader labor shortage? Any information there would be helpful on how to think about it moving forward.

John Coustas, CEO

I mean, we typically— that's Evangelos. We typically have out of 365 days in the year, on average, our ships would operate 360 days. Those five days account for unforeseen off-hires, which are very small given the way we run our ships, as well as dry-dockings. That's a blended average for 10 years, so it’s pretty reliable. Of course, you may have unforeseen off-hires due to incidents like machine or engine failures, which cannot be predicted. In Q3, we did have such an incident with one of our ships which was off-hire for the full quarter. We don't expect that to be replicated in the coming quarters, or at least we hope it won't be. So, on a normalized run rate basis, 360 days is a reliable number.

Eli Winski, Analyst

That makes sense. Thank you all very much.

John Coustas, CEO

Thank you.

Operator, Operator

Next, we have J Mintzmyer of Value Investor's Edge.

J Mintzmyer, Analyst

Good morning, gentlemen. Congrats on a fantastic quarter. Excellent results.

Evangelos Chatzis, CFO

Hi, J.

John Coustas, CEO

Hi, J.

J Mintzmyer, Analyst

The one thing I wanted to dial in on, and Randy started addressing it, is you have that 1 million share sale in Zim. The question I had on that is you mentioned that you're done selling for now, you think Zim's cheap. I'm a little curious because the lockup ended at the start of September. The shares were at $55, $60, $61 all September. Then they didn't drop until after into October—it had dropped to $44. It seems like you sold them at the very bottom and now they're higher. Was that timing just bad luck or was it some sort of plan to sell after the quarter ended? What happened there? Because if you wanted to sell 1 million or 2 million shares, why not sell at $60?

John Coustas, CEO

We have to admit, yes, we didn’t time that sale properly. It would have been much better to do it when the shares were at $60, and that’s why we said we’re going to be more cautious in the way we handle future sales. With share sales, nobody has a crystal ball. We hope we will be more proactive and lucky when disposing of the rest of the shares.

J Mintzmyer, Analyst

Yes, that's fair. I mean, there’s a lot of hindsight. The reason I ask is, there are a lot of rumors swirling around that you saw rates dropping or you panicked or you didn’t like Zim anymore and decided to sell. But it sounds like it was a pre-planned timing of sale and you just got kind of unlucky. Is that fair to say?

Evangelos Chatzis, CFO

Well, it’s exactly right. We had planned to—we had already started approaches about these 1 million shares, and then we had the lockup. When we wanted to begin a process for these shares, we intended to institute a competition among two investment banks. We offered them $0.5 million each to see which one could sell best. That process was delayed, and then the stock dropped. We decided it was more important to see how this process worked once we started it, rather than just try to time the market.

J Mintzmyer, Analyst

Yes, it certainly makes sense. There’s a little bit of bad luck in your timing, and it’s too bad you couldn’t sell the shares earlier.

Evangelos Chatzis, CFO

And J, definitely we did not panic because we are in the market; we see how strong it really is from the inside. The equity capital markets were a concern during that period, but we were not concerned. It was a matter of unfortunate timing. However, this was not a big chunk of shares compared to the overall position, so I think we're hopeful our average, when we complete the disposal, will be much better.

J Mintzmyer, Analyst

I think that makes sense. You communicated very clearly that eventually, you're going to trim a little bit of your position. I think everybody expected you to sell 1 million or 2 million shares; they were just a little surprised when they saw the price, but I think your explanation makes sense. The other question I want to ask is looking at repurchases. Your net asset value is debatable; it depends on how much of a charter discount you attach. I have around $140, I've seen a couple of other analysts with similar numbers around $140 a share. You used to have a number in your slide that would show your calculation of NAV, now I notice that is not in this presentation. Do you have any sort of internal calculation that you're willing to share? Question two is, at what point does the value disconnect get so large that you feel you have to go back to repurchases? At what point does the disconnect just become too large?

John Coustas, CEO

As you can see, although we used to report our NAV on the basis of reasonably objective numbers, we decided to discontinue that because continuing with that basis was producing figures considerably higher than what we mentioned. We did not want to create expectations for a situation in the market that actually assumed selling all vessels at spot prices. It’s very difficult to adjust that based on your charters because that calculation was done in a more normal market, where you had fluctuations of 15%, 20%, or 30% in the prices. When you have appreciation of 500%, you create more confusion rather than objectivity about where things really are.

J Mintzmyer, Analyst

Yeah. It's definitely a quickly moving metric. It depends on what charter discount you attach. But clearly, there is significant value you can't clear when your stock price or your entire enterprise value is less than EBITDA value. Your charters, plus Zim shares, plus scrap, right? The Company's trading on those valuations, at what point do you start to step in and say, okay, we have to repurchase here versus just holding on to this cash?

John Coustas, CEO

That’s a decision we will need to visit with the board; we are closely monitoring that. We agree with you that the shares are undervalued. We don’t have a specific discussion about repurchasing shares at this time, but the more we grow our cash in the Company, the more this problem will become important to revisit.

Evangelos Chatzis, CFO

Yes, because at this point, just to add to what John said, we have used significant cash on hand to invest and reinvest in the business. So, at this particular point, we do not have the excess liquidity that we would otherwise have. Of course, as it builds up within Q1 and Q2, this will make capital allocation decisions more relevant.

J Mintzmyer, Analyst

All right, sounds like a moving target, but congrats on the fantastic quarter, and we look forward to the next one.

Evangelos Chatzis, CFO

Thank you very much. Thank you, J.

Omar Nokta, Analyst

Hey, guys. Good afternoon. I just wanted to ask—I noticed, and sorry if you already addressed this, but I wanted to ask is, in looking at your fleet list, you were a bit opportunistic with one of your vessels, the 6,500 TEU, I forget the name of it. But it had rolled off its long-term contract at $34,000 a day and was re-upped at $110,000 for six months; clearly, a very strong rate. I wanted to ask you in terms of liquidity in the chartering markets today, is there—a pause, and there's a lot of disagreement as to whether this pause has to do with people's questions on the outlook or if it's just simply a lack of available tonnage. But if you are looking in the market today for that vessel and its sister ships to roll off, what does the liquidity look like for, say, doing another six months at this $100,000-plus? Also, what does it look like to do a three to five-year contract?

John Coustas, CEO

First of all, I'd like to explain that it's not generally our policy to do just short-term charters. We prefer to lock-in lower rates, longer term. About this specific ship, which holds for another four sister ships we have, we had an agreement with the charter that these last six months of the charter would be at index. We took the index from one of the brokers, and that was the rate. The same thing is going to happen with the sister ships which will be opening some time in 2022. I don’t know what the index will be, but that's the story behind that. In general, there is pretty strong demand for ships, especially as 2022 will have lower deliveries than in 2021. On the other hand, charterers do not want to commit; the farther you go forward, the less they are eager to commit, but still, at pretty good rates. I mean, just yesterday, we chartered a 2001-built 2,500 TEU for three years, which opens this coming April and we've chartered that ship for three years at a gross rate in excess of $28,000 a day. These are really fantastic rates. The same ship might have been chartered for six months at $60,000 or $70,000, or I don't know, but historically, these rates are really phenomenal.

Omar Nokta, Analyst

Yeah, definitely. Thanks, John. And just one follow-up, the six eco-vessels you acquired that come with the low market charters. Any updates on forward fixing on any of those ships, especially those that come up for renewal around mid-year of '22?

John Coustas, CEO

We are in discussions with a number of parties. We are not in a rush, specifically for these vessels, because they generally compete with new builds and not with older ships. Today, if you go into the yard to build a new 5,500 TEU, that’s practically what you'll get. The longer we wait towards their opening dates, the better deal we can have. So, we are in discussions, but there’s no hurry to fix them.

Omar Nokta, Analyst

Okay, right, well, thank you. I'll pass it on.

John Coustas, CEO

Thank you.

Operator, Operator

Well, it appears that we have no further questions at this time. I would now like to turn the conference call back over to Dr. Coustas for any further comments or closing remarks. Sir?

John Coustas, CEO

Thank you, Operator. Thank you all for joining the conference call and your continued interest in our story. I look forward to hosting you in our next earnings call. Thank you.

Operator, Operator

And we thank you, sir, also, for your time today. The conference call is now concluded. At this time, you may disconnect your lines. Thank you, everyone. Take care, and have a great day.