Euroseas Ltd.: Come sail away
Investors will expend copious amounts of time and energy looking for the next “new thing” when often the better alternative is to parse the old and the pedestrian. Consider the greatest investor of our time, Warren Buffett. Buffett has accumulated an expansive fortune by investing in companies that have either been around for centuries — The Coca-Cola Company (NYSE: KO), Wells Fargo & Company (NYSE: WFC) — or simply do simple things well — See's Candies, Inc., Wal-Mart Stores, Inc. (NYSE: WMT).
One could argue that shipping falls within Buffett's investing purview. Since man discovered the benefits of division of labor, he has persistently moved goods across the open seas because (1) it's the only means to get the goods from point A to point B, and (2) it's profitable. Case in point, Athens-based Euroseas Ltd. (Nasdaq: ESEA), an international seaborne transportation services company that specializes in shipping various drybulk cargoes — iron ore, coal, grain, bauxite, phosphate and fertilizers — across the ocean.
Not only does Euroseas move commodity goods across the open waters, it moves them profitably. In the third-quarter ended Sept. 30, the company reported net income of $9.5 million, or $0.39 per share, on revenues of $21.5 million, representing a 76.6% and 141.1% increase, respectively, over net income of $5.4 million and revenues of $8.9 million in the third quarter of 2006. The stock closed at $12.66 on Friday, with shares ranging between $6.60 and $21.52 over the last 52 weeks.
Euroseas earned its keep deploying an average of 12.13 vessels during the quarter. The utilization rate was a remarkable 99.9%, a rate likely to remain as efficient a level through 2008. Forty-six percent of Euroseas' ship capacity days in 2008 are already fixed under time charter contracts or protected from market fluctuations. Management believes that its contracting strategy provides a solid revenue base and more predictable cash flows and downside protection, while still allowing the company to participate in the spot-market during periods of rising rates.
More impressive, Euroseas expects to maintain full capacity with a growing fleet. In November, the company closed a 5.8 million share follow-on public offering at $17 per share. Net proceeds, after underwriting discounts and offering expenses, were approximately $93.4 million. Management intends to use the net proceeds to acquire additional drybulk and container vessels. In fact, $28.6 million had already been earmarked for the November purchase of the panamax drybulk carrier M/V loanna P before the offering was completed.
At current count, Euroseas' fleet comprises three panamax drybulk carriers (60,000 to 80,000 dead-weight ton capacity each), two handysize drybulk carriers (40,000 DWT), two intermediate container ships (29,000 DWT), five handysize container ships (40,000 DWT), two feeder container ships (18,000 DWT) and one multipurpose dry-cargo vessel (22,000 DWT).
The Marine shipping waters can be choppy at times; the industry is highly sensitive to global trade, so it tends to cycle. But since 2004, the cycle has been mostly up. The S&P Marine Index has showed robust growth compared to the overall market. Synchronized global growth, increased global trade, rate increases, high utilization rates and strong profit margins all aided the strong performance. What's more, demand remains strong today and is expected to remain strong through 2008.
At least that's what the pros who monitor Euroseas think. In November, Wachovia Securities initiated coverage with an “outperform” rating and a $22 to $24 share- price range, stating that it “expects container ship and dry bulk fundamentals to remain strong throughout 2008.” Oppenheimer seconded the sentiment by raising its share-price target to $21 from $17, opining that “Euroseas balanced fleet mix of drybulk and container vessels should enable the company to participate in the currently strong drybulk rate environment while, at the same time, increasingly capitalizing on the rapidly growing inter-Asian container trade, which appears to be well suited for the company's small container fleet.”
More important, management believes demand should remain strong. The sentiment is manifest in Euroseas' dividend policy, which, remarkably, has been hiked every quarter since September 2006 and is currently being paid at an annual rate of $1.16 per share to produce a 9% yield. Management reasons that the dividend is sustainable and “represents only a fraction of our net income.” (True, but based on fiscal-year 2008 EPS estimates for $1.49 that fraction is 78%, which is still below the peer-payout average.)
Though dividends are often pooh-poohed by many small-cap investors, they shouldn't be. Dividends are an important return component. According to Ibbotson Associates, dividends accounted for 4.3% of the 10.4% annualized return for large-cap stocks from 1926 through 2003; for small-cap stocks, it was 3.8% out of 11.7%; and for micro-cap stocks, it was 2.6% out of 12.7%. In other words, dividends matter.
And contrary to popular belief, dividends and earnings growth needn't be mutually exclusive. Research by Robert Arnott, chairman of Research Affiliates, and Clifford Asness, managing principal at AQR Capital Management, found dividend growth and earnings growth are correlated. The duo found that expected future earnings growth is fastest when current payout ratios are high and slowest when payout ratios are low. Their research suggests managers possess private information that allows them to pay out a large share of earnings when they are optimistic about their company's prospects. In other words, management is presaging better days ahead when it raises the payout rates.
If Arnott's and Asness' research holds, then Euroseas (ESEA) is presaging warm, calm waters through 2008.
