ESEA Is In A Good Way

Over the past year, the broader equity markets have been resilient enough, delivering returns of 28%. But how about the performance of Euroseas Ltd. (NASDAQ:ESEA), a Greek shipping entity that operates in the containership space? During the same period, ESEA has ended up trouncing the total stock market by around 3.8x.

A spike in Houthi rebel attacks on ships passing through the Red Sea this year has put a spanner in the works of maritime traffic in the Suez Canal. Compared to last year, the average TEUm transported per week in 2024 has come off quite markedly, and the resultant rerouting effects have caused demand for ships to rise by an additional 10%. Because of this situation, investors should also note that the pace of recycling of ships too is expected to come down in FY24, boosting the age of the fleet. This should work very nicely for ESEA, more so given the subdued pace of new capacity additions in the sub 3000 TEU space through FY25 (more on that later). All in all, as per Clarksons’ forecast, containership trade demand for this year is expected to surge 9.2% as against previous projections of 5.5%.

Nonetheless, the shift in the demand/supply position has already galvanized time charter rates this year, with ESEA management pointing to a 73% increase in their rates since the Dec 21 lows.

Note that as of May 17, the sub one-year time charter rates for ESEA are currently trending well above the 10-year average, and ESEA looks well-placed to benefit from this momentum with 7 of their vessels due to see their time charters expire this year. Note that ESEA’s charter coverage for 2024, is now at a rather high threshold of 88% providing useful visibility.

While the world is expected to see GDP growth of 3.2% this year, cargo volumes are expected to grow at a slightly higher average rate of 3.5% from H1 growth in particular, benefitting from the low base of last year.

As things stand, there does not appear to be any resolution in sight with regard to the Red Sea crisis; in recent days, we’ve seen the UN’s maritime agency come out with some strong rhetoric to address the situation, but it is still questionable if anything tangible will develop.

If not for these Red Sea developments, there’s good reason to believe that containership rates were likely to stay stunted at lower levels, particularly on account of the increased supply that has been coming into the market. Through FY25, the containership fleet in the system is expected to rise by around 15%, hitting a total TEU of 32.1m by the end of next year.

However, what’s key to note is that ESEA is unlikely to face the same supply-side pressures as its larger peers, as its fleet only consists of feeder and intermediate ships (22 in total as of now) which mainly consists of ships with a capacity of less than 3K TEU. Note that the new expected capacity in this space (see image above) is hardly anything, with the bulk of capacity growth (75%) expected to come from ships with capacities of 12000 TEU and more — not a terrain where ESEA is involved.

If these Red Sea tensions do eventually abate over the next 12 months (and that’s still a big IF), the containership industry is likely to face an adverse supply-demand backdrop by FY25, particularly given the momentum with fleet expansion across the broader industry. For context, the order book as a % of the fleet is still at rather hefty levels of over 21%, whereas in the 1000-3000 TEU domain it is still quite minuscule at less than 7%. This should provide some support for charter rates, particularly as 50% of the fleet is already quite aged at over 15 years!

Closing Thoughts- Why ESEA Stock Isn’t A Good Buy Now

Despite our relatively favorable stance on ESEA’s prospects so far, we are not convinced it offers great value at these levels, particularly in light of the forward EBITDA outlook. According to YCharts, ESEA is currently priced at a forward EV/EBITDA of 3.72x, which represents a 56% premium over its long-term average.

Note that at 3.72x, it is now also priced at a level higher than the industry average. One wouldn’t be averse to shelling out a premium if we were getting a healthy degree of EBITDA growth through FY25, but that is not likely to happen when supply-demand dynamics across the industry are likely to tilt in FY25 (ESEA may be better placed than its peers due to the ships it focuses on, but rates are unlikely to be as resilient as they are now).

It appears the sell-side is currently quite mindful of this, reflected in their estimates through FY24 and FY25. After generating adjusted EBITDA of $123.6m, YCharts consensus for ESEA currently points to a 2-year CAGR decline of -13%, which is not a great pitch when a stock is priced at a premium of over 50%+

Meanwhile, on ESEA’s standalone weekly chart it appears that we have a rising wedge pattern, which runs the risk of reversal as we go higher. Even if you want to dismiss the prospect of a reversal, it does not look like the reward-to-risk picture is too appealing with the stock now trading a long way off the lower boundary of the wedge, and hardly around 7% off the upper boundary.

Finally, also note that the relative strength chart (which can be used to identify promising rotational opportunities within a given sector) which considers ESEA’s positioning relative to other transportation stocks, shows that the current ratio looks quite overextended to the upside, currently trading at well over double the level of its long-term average. This relatively overbought stance is likely to dampen rotational interest towards ESEA.