Tufton Oceanic Assets (LON: SHIP) is a $280m (£200m) investment trust which owns and leases 22 container ships. I participated in its $14.7m tap issue (ie an issue of a bond not placed immediately with investors) in March 2021 at $0.98, personally and on behalf of Tyndall Investment Management clients.
I was introduced to SHIP in 2018, around the time of its launch, armed with all the scepticism I could muster. Surely shipping must be equivalent to air freight, prone to regulatory whim, high operating costs and low margins?
Weighing up risk
The experience and knowledge of the management team rapidly dispelled my prejudices. The crucial difference is that SHIP leases its containerships, so the operating risks associated with fuel costs, the vagaries of cargo and portside regulation are borne by the lessees rather than the lessors, the shareholders.
Defraying the operating risks lessens the assets’ return potential but significantly reduces the volatility, meaning shareholders can focus on crucial risks: whether the value of the ships will go up or down; if the fleet is fully ‘let’; the leasing environment, driven by supply/demand (im)balance for global shipping; and the value of the US dollar.
It is important to recognise these are US dollar assets and returns to sterling investors will have the added volatility of the USD/GBP exchange rate.
I used this trust as a diversifier in client portfolios, so had to decide whether this added volatility was worth the returns on offer. In 2018, and subsequently at the share placing in 2019, my fear of a stronger sterling price against the US dollar outweighed my greed, and I only bought a few shares on behalf of US dollar-based clients.
The leasing environment, I have learned from SHIP’s management, is all-important. In the depths of the Covid-19 crisis, SHIP was leasing its assets on short-term charters for low single-digit returns, such was the pessimism on global trade.
A year later, leasing returns of 25% +/- are possible, on far longer charters. Lease rates are fixed at the time of charter, so it is up to the skill of the manager to negotiate the best terms available.
The costs of ‘vacancies’ for property investors or landlords will be well known, and these are compounded for ships at sea: any gaps between charters can decimate profitability. This comes down to the company’s charter management track record, which is extremely good. New entrants will have to earn their stripes.
Finally, I was surprised if not shocked to learn that containerships worldwide are valued daily by an international standard methodology relating to the type of ship and engine, scrap metal prices and the value of the charters in place.
As of SHIP’s Q1 ’21 investor update webinar, the portfolio held a negative charter value of $44.6m. This means if the 22-ship fleet was free to re-charter today, the NAV would jump $44.6m or 15.7% on a Q1 NAV of $284.4m. Fact is that the fleet must work through the lower value charters secured in 2020 and prior before they can be re-let at current rates.
Shipping charter demand outstrips supply
All of which brings us to what charter rates will do in the future.
The manager’s strongly held view is that there are not enough ships to satisfy the level of demand, and that this problem will be exacerbated by emissions reduction targets. Older less- efficient ships will be retired early, and the easiest way to meet emissions targets is to slow down.
Add in supportive macro – never a given – and the case is compelling. The portfolio currently produces gross returns of around 13.5% (or perhaps a net 8.5% post-depreciation and fees), before factoring in the ‘pull to par’ as boats chug towards the end of their charters, supporting the 7% dividend yield today.
Management points out that lease rates typically perform well in inflationary environments as both the value of cargo increases and the scrappage metal value of the ships rises. That being said, the inverse is also true, so this will never be an ‘uncorrelated’ asset.
I place a high bar on ‘diversifiers’ within my portfolios, particularly where there is such a clear connection to global growth. Taking into account the return profile, management record and macro drivers, I believe Tufton Oceanic Assets currently meets this bar.