Israeli shipping company, ZIM Integrated Shipping Services Ltd. (NYSE: ZIM) has been a market leader since listing in the United States. Its historic profitability is a consequence of major industry trends that are bearable on the coming years. With a free cash flow yield of over 130%, there is a huge margin of safety for an investor.
Share price performance
Since listing on the New York Stock Exchange (NYSE) in early 2021, ZIM shares have appreciated 174.17% at the time of writing, compared to a performance of -12.82% for the Russell 2000 Index (RUT ). During this period, the company’s peers also outperformed the market, with Scorpio Tankers Inc (STNG) gaining 266.72%, Matson Inc (MATX) gaining 11.47%, Kirby Company (KEX) gains 36.17% and Atlas Corp. (ATCO) gained 30.22%.
However, year-to-date, the company’s shares have fallen 44.45%. Existing shareholders who bought the company at the start of the year need an 80% gain in price just to break even. For these shareholders, it may be time to sell, but for investors who do not own shares in the company, the situation is different. The risk for one is an opportunity for the other.
Historical profitability of ZIM
ZIM’s run in the market is the result of the company’s historic profitability in the wake of the global pandemic. The company is at the peak of its profitability, improving its financial performance by every metric. This profitability was not temporary.
ZIM grew its revenue by more than 29% between 2017 and 2021, growing from nearly $2.98 billion in 2015 to nearly $10.73 billion in 2021. According to Swiss credit‘s Base Rate Book, only 1.9% of teams achieve a 5-year compound annual revenue growth rate (CAGR) of this magnitude. Over the past twelve months (TTM), the company has earned nearly $13.75 billion. The 5-year gross profit CAGR for this period was nearly 85%, with gross profit growing from over $280 million to over $6 billion. Gross profitability has risen from nearly 0.16 in 2017 to nearly 0.62 in 2021, well above the 0.33 threshold for attractive stocks as determined by Robert Novy-Marx. During the TTM period, gross profitability increased further, to almost 0.72, reflecting the improvement in the company’s ability to earn money. Operating profit grew by over 112% annually, from over $135 million in 2017 to over $5.8 billion in 2021. During the TTM period, operating profit was nearly $7.98 billion. The operating profit margin increased from 4.5% in 2017 to 54.2% in 2021, increasing to 58% during the TTM period. The shipping industry’s operating profit margin was 56% in 2021, compared to 3.7% in 2019. Net profit increased from $6.24 million in 2017 to $4.64 billion in 2021, representing a 5-year net profit CAGR of over 275%. During the TTM period, net profit is $6.2 billion. Free cash flow (FCF) grew from over $206 million in 2017 to $4.98 billion in 2021, for a 5-year FCF CAGR of over 89%. During the TTM period, the FCF was over $6.6 billion. The FCF margin increased from 6.9% in 2017 to 46.4% in 2021, rising to 48% over the TTM period. The return on invested capital (ROIC) increased from -1.4% in 2018 to more than 67.5% in 2021, reaching 193.8% over the TTM period.
The shipping industry conforms to Nicholas Kaldor’s spider web model, in which the time lag between production decisions and price changes is very large, leading to boom and bust cycles due to underestimates and overestimates of future demand. In the absence of a firm with real pricing power, capital spending follows demand, rising during booms, until capacity exceeds demand, after which rates fall. collapse until excess capacity is removed. Along the way, capital flows out, along with bankruptcies and consolidations, making the profitability of the industry more sustainable. Therefore, to understand if ZIM can sustain its future profitability, we need to ask what the industry outlook is for the future.
Sustainable industry-wide profitability
The shipping industry has never been so profitable, thanks to the increase in demand for shipping in the aftermath of the pandemic, and port congestion and wider global supply chain disruption, forcing customers to approve high priced contracts. In 2021, the global container shipping industry earned a record operating profit of around $110 billion, compared to $37.5 billion for the entire previous decade.
Freight rates have decreases in recent months as the US and global economy begins to teeter on the brink of a recession. With world spot rates downwards, there is a strong dose of pessimism about the sustainability of this profitability. Nevertheless, it is clear that freight rates remain at historically high levels.
Rates will not return to these pandemic highs, but there is good reason to believe that future rates will be higher than before the pandemic. Although pandemic restrictions have eased considerably, China maintains a zero COVID policy, and although port congestions are expected continue to soothe during the rest of the year, the Russian-Ukrainian war and its impact on energy prices, is likely to push up in the long term bunker fuel pricemaintaining freight rates at a high level.
Although shipping lines have used their historical profitability to order new container shipsthis is unlikely to expand the existing fleet in the short term, given that it takes 18 months to build a ship and may take longer to deliver.
It is impossible to know whether expanding the size of the world fleet will match world needs, exceed them, or be too small for world needs. Therefore, there is generally an inverse relationship between asset growth and future returns. Neither ZIM nor its peers should, at this time, be seen as long-term investments, but, the delay in the actual delivery of ships, and the continuation of the zero-COVID policy in China, and the Russian-Ukrainian war , and the possibility of a Sino-American War on Taiwan over the next half-decade, could keep rates high.
In recent years, the shipping industry has become more cautious about its capital allocation policies. For example, between 1980 and 2015, container ship capacity increased from 11 million dry weight tonnes (DWT) to 228 million dwt, with a CAGR of 8.79%. Between 2016 and 2021, growth had fallen to 2.44% CAGR.
Increased capital discipline had allowed the shipping industry to become more profitable. Although there are questions about future growth and trade, for now there is consensus that it will continue to grow, with IHS Markit estimate that the real value of global trade will reach $30 trillion by 2035, up from $20 trillion in 2021, resulting in an increase in volume from 12.8 billion metric tons in 2021 to 20 billion metric tons in 2035.
With over $6.6 billion in FCF for the TTM period and an enterprise value of $5.03 billion, ZIM has an FCF return (FCF/enterprise value) of over 130%. Compare that with the FCF yield of the 2,000 largest listed companies in the United States, calculated at 1.5% by financial services company New Constructs, LLC. The company’s FCF performance indicates outstanding future stock and company performance.
ZIM has beaten the market and most of its peers since listing on the NYSE last year. The company’s historic profitability goes beyond the pandemic. Over the past 5 years, the company has improved its operational performance by every metric, becoming a highly profitable business. Capital discipline in recent years has supported this profitability. Additionally, while there are question marks as to whether the industry will outstrip or understate demand with its capital expenditures, it will be several years before this new supply hits the market, and meanwhile, there is good reason to believe that freight rates will remain high compared to pre-pandemic rates. With an FCF yield of over 130%, the margin of safety is more than enough for an investor.