Costamare Series E undervalued despite mean reversion (CMRE.PE)
The favorites of the E Costamare series (NYSE: CMRE.PE) are the ones we covered a few years ago. Technically they have outperformed since then, but we think the preferred shares trading below par are now a bit useless as it gives substantial margin on the rise in benchmark rates. Given the state of the business, although experiencing some mean reversion, CMRE.PE remains quite attractive from a valuation and implied credit risk perspective. We won’t be playing commodity-exposed markets for the time being, but still stress the potential of this stock.
Let’s quickly review some of the Q2 updates. The first thing to notice is that the pressure is higher on dry bulk, which is more exposed to commodity trends which have since reversed. While some commodities are still highly valuable, especially as the Russian invasion has tightened supply dynamics, China’s weakening demand for things like steel and iron ore , but also other building products, has put pressure on some key commodities. The dynamics behind this situation have wreaked havoc on the charter market for these vessels.
As tighter liquidity conditions and demand side pressures harass the dry bulk charter rate due to exposure to heavier and more cyclical industry, container ship charter rates remain stable at peak levels, and this is the majority of CMRE’s fleet. In general, we have seen demand performance for goods and consumer staples as we shift from supply chain pressures to demand side pressures. We highlight pressure in some markets that matter to container ships like electronics, where inventories are now rising and not falling and point to another glut of semiconductors to come. In addition, downturns in consumer durables are now beginning as higher rates put pressure on car purchases, and this will impact the transportation of auto parts, a major container ship cargo. In general, the purchasing speed of consumer goods will suffer, in particular due to the COVID-19-related recovery in the services sector, but also due to recessionary pressures due to the rising cost of living.
Net income is still up, up 37% year-on-year, but also because compensation is still a bit easier and liquidity is increasing, with net debt decreasing ever so slightly due to some additional funding. Some of this funding is for a fairly aggressive share buyback program. About 30% of preferred stock is being redeemed, which will significantly reduce the company’s dividend burden, and about 4% of common stock is being redeemed, which also reduces the overall dividend burden on shareholders, although preferred shares have a priority dividend. on the stock dividend.
Reducing the burden of preferred and common stock is effectively a type of deleveraging, and the credit profile, particularly because more preferred stock is retired relative to common stock, should reflect this as an improvement.
Additionally, charter life rates remain high at 4 years, and any reversal still occurs at very high charter rates for container ships, and well above break-even for dry bulk carriers. Idle rates have some inertia at these low levels.
Using the current dividend yield on the Series E Preferred Shares as the discount rate, we can relate the premium to the risk-free rate, which we consider to be 5%, to find the implied credit rating.
Caa puts it at the top of the C category, but in the lower half of what are already speculative-grade investments. About 50% of assets at market value are claimed by debt. In a recovery and liquidation scenario, it could be much more. Then the next 15% is for the privileged, with Series E being the least senior. That leaves another 35% discount to asset values from current market values before the rally becomes a problem for preferred stocks. This is a good margin given that liquidation is unlikely, but it reflects that the leverage for CMRE is quite high.
The bottom line is that liquidation remains unlikely. If we are at the end of the current cycle, then there are 4 years of high rate charters to skate on. Things will gradually decline but preferred stocks will be late to lose their dividends.
However, we note interest rate risks. Rates have risen about 300 basis points in the current phase of the rate hike cycle. This puts approximately $18 million of net income pressure on net income, or about 20% of 2019 net income and less than 5% of 2021 net income. We could see another 300 point increase in basis in the worst case. This would represent a 40% impact on 2019 net income levels, which would perhaps better reflect a recessionary environment in addition to sustained general demand for commodity and commodity stockpiling reasons. Moreover, the recession we are preparing for is likely to be quite varied.
Overall, a low rating seems unreasonable for CMRE, despite macroeconomic pressures and IR risk on the net of existing debt. Nevertheless, things could become more volatile in the markets in general. Although a 9% return allows you to anticipate inflation erosion and rate erosion, we would not like to hold these assets when severe declines occur.