ZIM Integrated (NYSE:ZIM) has seen its stock dip as of late, in spite of roaring fundamental results and an unusually high dividend yield. The problem is that while the stock might look cheap based on current year earnings, investors should not forget that ZIM is in a highly cyclical shipping sector with a heavy reliance on freight rates. Dividend investors might be attracted to this name based on the high yield and strong recent growth, but this is unlikely to behave like a typical long term dividend stock. I expect great volatility in the dividend payout and stock price ahead.
ZIM Stock Price
After coming public in early 2021 at $15 per share, ZIM peaked at $91.23 per share and now trades around $37 per share.
The stock is still more than 100% higher than its IPO price, and I note that the company has paid out $29.10 per share in dividends, bringing its total return to around 340% since coming public. I last covered ZIM in April where I warned on the potential for multiple compression.
ZIM Stock Key Metrics
ZIM posted strong results in 2021, but 2022 is shaping up to be an even stronger year. ZIM saw net income grow by 50% in the latest quarter to $1.34 billion. For reference, the market cap is around $4.4 billion – the company generated 30% of its market cap in net income in just one quarter.
ZIM benefited from continued growth in freight rates which helped to offset a decline in carried volume. Free cash flow of $1.6 billion outpaced net income.
ZIM ended the quarter with $946.8 million of cash, $3 billion of bank deposits versus $4.3 billion in lease liabilities. If we ignore lease liabilities, and include the bank deposits, then that $3.9 billion net cash position represents 90% of the current market cap. Due to the outsized earnings and paydown of debt in past quarters, ZIM’s leverage ratio is virtually nonexistent.
ZIM generated so much cash in the quarter that even after paying out $2.4 billion in dividends, it still retained $743 million of cash that it used to pay down debt.
ZIM reaffirmed full-year guidance which called for up to $6.7 billion in EBIT. That implies that ZIM will earn more net income than its current market cap.
Yet the stock is down nearly 30% since reporting earnings. That might be due to fears of normalization. On the earnings call, management noted that it anticipated “some decline rates for the remainder of the year” but expects the “normalization to be gradual.” It appears that inflation may be taking its toll on demand which in conjunction with the inevitable build-out of new vessels will eventually lead to a steep decline in freight rates. While management appears unfazed, Wall Street is skeptical and has already begun pricing the stock based on multi-year projections.
Is ZIM’s Dividend Good?
I suspect that most investors are drawn to ZIM due to the high dividend yield. The company recently announced a $4.75 per share payout for shareholders as of August 26th – equal to 13% of today’s prices. The company has paid out very generous dividends in the past.
The company’s current dividend policy is to pay around 30% of quarterly net income, with a potential bonus end-of-the-year payout to bring the total payout to as high as 50%.
Consensus estimates call for $42 in earnings per share for the full year, implying around $17 in second half earnings per share. Assuming a 30% to 50% payout for the full year, investors might see anywhere from $5.10 to $13.40 in dividends per share for the remainder of the year.
But dividend investors typically look for consistency – one of the key benefits of paying out dividends has typically been lower volatility. While ZIM may offer an outsized dividend payout, it might miss on those fronts.
Is ZIM Stock A Good Value?
ZIM is trading at less than 1x this year’s earnings. For a company with a net cash position, that is an insane valuation. As stated earlier, the current valuation may be pricing in the potential for a steep dropoff in earnings. Consensus estimates call for revenues to decline rapidly starting next year.
That is expected to lead to earnings declining by nearly 90% by 2024.
With the stock trading at 7x consensus estimates for 2024 earnings, suddenly the multiple does not look so cheap for what should still be considered a stock in a cyclical sector.
Is ZIM Stock A Buy, Sell, or Hold?
Yet between now and 2024, ZIM is likely to make some sizable dividend payments. That could help bring down the cost basis enough to make the valuation more reasonable even in the event that earnings really do implode. If we assume $5.10 in dividends per share for the rest of 2022 and $6 per share next year, then the cost basis would drop to around $25. That places the stock at just 4.5x earnings and below the net cash calculation discussed earlier.
There is a saying that undervaluation can reduce risk. This statement might not apply so well here. As I wrote in my previous article on the company, ZIM struggled to generate meaningful net income prior to the pandemic. Operating leverage sent profit margins soaring as freight rates rose, but can work the other way as rates fall. What’s more, because ZIM does not own its ships but instead employs leases, it may see its operating expenses increase as the lessors seek to earn a greater share of profits. Management noted that it had 28 vessels coming up for renewal in 2023 and another 34 in 2024 (the company operates 149 in total). If the economic conditions worsen by then, management has stated that it could decide to not renew those charters. That helps reduce the risk of having to operate charters at unprofitable rates (for example if charter rates increase but spot prices later decrease) but would still negatively impact the bottom line.
Whether or not this stock is a buy depends heavily on one’s opinion regarding the ability of freight rates to stay high for longer. As we can see below, the Global Container Freight Index (US$ per 40ft) has been declining rapidly over the past year.
We also need to determine what is an appropriate earnings multiple once freight rates fall. Is it 5x earnings? Is it 2x earnings? I’d expect the stock to trade more around 2x to 4x earnings rather than 7x to 10x earnings. That implies that the stock might deliver negative returns even accounting for the projected dividend payouts.
Perhaps the critical metric at play here is whether the company can or will use the $3 billion in bank deposits to reward shareholders. Management has not emphasized this potential and even disclosed its net debt position as being $630 million as of the latest quarter, implying no credit to the bank deposits. For that reason, investors might not want to so quickly assume that this 90% net cash position is available to distribute to shareholders through dividends or share repurchases (though from my glance at retail sentiment, that has been a foregone conclusion).
Perhaps the most important takeaway is that one should heavily scrutinize the apparent undervaluation here, as the low earnings multiple is offset by the potential for declining freight rates and the net cash position is not as obvious as it seems. For those reasons, it may make sense to avoid making this a high conviction position. I rate the stock a buy and own a very small position and emphasize the high risk nature of this call.