In 2022, Danaos Corporation (NYSE:DAC) benefited from the hiked charter rates to the extent that the management was able to make early repayment of $909 million of bank debt, lease, and bond indebtedness. Container rates are now significantly lower than a year ago. However, in the past few weeks, the rates start increasing again. The inflationary pressures are decreasing and the global container trade volumes are expected to improve in the second half of the year. As of 31 December 2022, DAC's remaining average contracted charter duration was 3.4 years. Also, its total contracted cash operating revenues were $2.1 billion. Furthermore, it is important to know that as of 14 February 2023, DAC had a contracted operating days charter coverage of 92.6% and 63.3% for 2023 and 2024, respectively. This operational position, combined with the improving market condition, increase the cash generation potential of Danaos significantly. The stock is a buy.
Financial results
In its fourth quarter and full year 2022 financial results, Danaos reported operating revenues of $993 million, compared with $690 million in 2021. DAC's operating days increased from 23004 in 2021 to 25111 in 2022, up 9% YoY, and its average gross daily charter rate increased from $29973 in 2021 to $39558, in 2022, up 32% YoY. It is worth noting that in 2020, DAC's average gross charter rate was $22841. The company reported an income from operations of $653 million in 2022, up from $358 million in 2021. However, despite stronger operational results in 2022, DAC's other income of $700 million in 2021, vanished in 2022. (DAC recorded a gain on investments of $578 million and a gain on debt extinguishment of $112 million in 2021). Thus, despite better operational results in 2022, the company's net income in 2022 was lower than in 2021. DAC's net income dropped from $1053 million in 2021 to $559 million in 2022. However, its adjusted net Income (largely adjusted for the change in fair value of investments, equity income on investments, gain and loss on debt extinguishment, and gain on sale of vessels) increased from $362 million in 2021 to $711 million in 2022. Also, its adjusted EBITDA increased from $508 million in 2021 to $851 million in 2022.
The liner companies are projecting 2023 earnings materially lower when compared with 2022, and we are still waiting to see the full effect of the looming recession," the CEO commented. "Fortunately, we are insulated from current market conditions as 93% of our available days are already contracted for 2023, providing us with excellent visibility for the year ahead. Given our limited near-term downside risk and our minimal debt obligations, we have ample firepower to opportunistically take advantage of the forthcoming downturn," he continued.
The market outlook
Figure 1 shows that the HARPEX (HARPER PETERSON Charter Rates Index) increased in the past few weeks, and is getting close to the six months average. The HARPEX is still much lower than a year ago; however, the market condition has changed and container charter rates may increase further. According to Figure 2, Drewry's composite World Container Index (WCI) is now down 78% YoY. Also, compared with the peak of $10377 per 40-foot container in September 2021, WCI is now down 84%. The average composite index for the year-to-date is $1908 per 40-foot container, which is 29% lower than the 10-year average. It is important to know that last week, the average composite index for the year was 36% lower than the 10-year average, implying that the rates are increasing. Higher container freight rates can support the increasing trend of container charter rates.
Figure 1 - The HARPEX (HARPER PETERSEN Charter Rates Index)
Figure 2 - Drewry's composite World Container Index
Due to global economic challenges, high inflation, and high interest rates that resulted in lower consumer purchasing power, container rates started decreasing after an extraordinary jump in 1H 2022. In the United States and European countries, inflation is the main reason for lower demand for goods and a higher inventory-to-sale ratio in 2023. The annual inflation rate in the United States decreased to 6% in February and decreased further to 5% in March 2023, the lowest since September 2021. However, the U.S. consumer inflation expectations that decreased to 4.2% in February 2022, increased to 4.7% in March 2023. It was the first increase in inflation expectations in the past five months. It is important to know that excluding February 2023, consumer inflation expectations are still the lowest since May 2021. Furthermore, import prices in the United States decreased further in March 2023 (see Figure 3). As a result of the continuing tight monetary policies of central banks, inflation in 2024 may decrease further, fueling the demand for seaborne container trade.
In 2023, the world container trade volumes can be higher than in 2022, driven by higher demand in the second half of the year. According to WTO, the world merchandise trade volume is projected to grow by 1.7% in 2023 and 3.2% in 2024 (Figure 4). DAC estimates that the world container trade volume can increase from 213 million TEUs in 2022 to 218 million TEUs in 2023, up 2.2% YoY. Based on the current market and economic conditions, I expect the demand for seaborne trade in 2H 2023 to be better than in 1H 2023, and improve further in 1H 2024. Thus, container freight rates may increase.
Figure 3 - Inflation rate, consumer inflation expectation, and import prices in the United States
Figure 4 - World merchandise trade volume and GDP growth
Risks
Inflation rates are now lower than in 2022, implying that the tight monetary policies of monetary authorities are working. Also, due to very mild temperatures during the last winter, energy prices dropped significantly, reducing the inflationary pressures. However, as I mentioned before, the inflationary expectations in the United States in March were higher than in February. It means that the Fed needs to keep the interest rates high to combat further inflationary pressures. Keeping the interest rates high for a long time can cause financial instability, and hurt economic growth considerably. Thus, charter hire rates for containerships may experience volatility or decline again. Furthermore, despite the company's high contracted operating days charter coverage, DAC may have difficulty securing profitable employment for its vessels. As of 7 March 2023, 10 of DAC's vessels (the company has 68 vessels) were employed on time charters expiring in 2023, and 27 of its vessels were employed on time charters expiring in 2024. Also, the company has 6 newbuilding containerships scheduled for delivery in 2024. Based on the containership market condition, the company may not be able to secure employment for these vessels.
Besides, in 2022, DAC received 72% of its revenues from 6 of its customers. It means that losing any of these customers could hurt DAC's revenue significantly. These customers may not be able to operate well and may not be able to cover their obligations under the charters for DAC's vessels. Subsequently, if DAC loses a time charter, it may not be able to re-deploy the related vessels at attractive rates or re-deploy them at all.
DAC performance outlook
I analyzed the company's free cash flow trend over the past quarters. After a massive increase in the company's cash operation to $501 million in the second quarter of 2022 compared with $119.5 million in the first quarter, the operating cash flow declined back to around $169 million and $145 million in the third and fourth quarter of 2022, respectively. However, it is still 10% higher year over year compared with $132 million in 4Q 2021. Moreover, DAC dropped its capital expenditures to $11 million in the third quarter of 2022 as compared with the previous quarter of $82 million, then increased back to $104 million at the end of 2022. When all was said and done, the company's free cash flow falls to $41.5 million in 4Q 2022 as compared with considerable amounts OF $419 million and $157 million in the second and fourth quarters of 2022, respectively. As a result, the company could prepay a mass amount of its debt and thus improve its leverage condition (see Figure 5).
Figure 5 - DAC's cash structure (in millions)
Moreover, I investigated the leverage condition of Danaos Corporation. Leverage ratios are insightful to show how the company is financing its assets and business operations. In other words, does it use debt or equity financing for most of its operations? I used some common leverage ratios that have significant comparability to its debt. The ratios are calculated in comparison with previous quarters to be more helpful.
The net debt-to-assets ratio is a crucial metric used to assess a company's debt capacity. It measures the proportion of assets that are financed with debt, and a higher ratio indicates greater leverage and financial risk. It is observable that the ratio has been on a decreasing path during 2022. In the fourth quarter of 2022, its ratio hit its lowest amount of 0.07x as compared to previous quarters.
Additionally, the company's net debt-to-EBITDA ratio, which determines the likelihood of defaulting on debt, has been decreasing considerably in recent quarters as the company declined its net debt level of $234 million at the end of 2022 versus $783 million at the same time in 2021. Thus, the net debt-to-EBITDA ratio dropped to 1.4x in 4Q 2022 year over year compared to 6.1x in 4Q 2021.
The asset-to-equity ratio also decreased from its level of 1.74x in 4Q 2021 to 1.33x by the end of 2022, indicating that the company is using less debt to finance its assets. These leverage ratios are critical indicators of Danaos Corporation's solvency and ability to meet its current and future obligations (see Figure 6).
Figure 6 - DAC's leverage ratios
Summary
DAC's prepayment of its debt improved the company's leverage condition considerably. Its net debt-to-asset ratio dropped to 7% in 4Q compared with 22% in 4Q 2021. Also, an increase in EBITDA level combined with a lower debt level led to a drop in net debt-to-EBITDA of 6.11x at the end of 2021 to 1.4x in 4Q 2022. Thus, the company is financially healthy. Also, the containership market condition improved in the past few weeks and Danaos can benefit from higher charter rates.
SM Investor
SM Investor focuses on medium to long-term investments, analyzing companies' financial metrics such as cash flow, growth, and valuation. As financial analysts with real market education and experience, we cover diversified portfolios including growth and value equities, and dividend stocks (including IREITs and RICs). Our approach involves using diversified value investing strategies to identify profitable companies with strong financials and low risks at bargain prices. About the analyst: Sara Vaez, experienced financial analyst with a Master's degree in Financial Economics from Illinois State University, USA.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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