This report will look into the capital structure of Danaos Corporation, a shipping company based in Piraeus, Greece. Since its main activity is chartering its vessels to other companies, this report will look into the way in which it maintain a young fleet, the process of selling an old vessel and buying a new one, the way in which the company finances its investments and it will conclude with the ratio analysis of the company.
The main conclusions drawn by the research in Danaos are:
The residual life of the vessels was 195.8 million $ and 178.2 million $ for the years 2008 and 2007, respectively.
In 2007 the company funded its operation 50% by equity and 50% by debt.
In 2008 the company funded its operation 27% by equity and 73% by debt.
From 2007 to 2008 the WACC increased from 7.39% to 8.56% and thus the company requires investments with higher returns.
In 2007 the stock price was $35 and because of the financial crisis it dropped below $5.
ROA and ROC both decreased in the period examined by 6% and 6.5% respectively.
ROE increased by 10.5%
When compared to Diana, the TIE of the company is significantly lower than the competitors'.
Introduction
DANAOS Corporation is a leading international firm which owns more than 40 container ships and has an aim to add another 20 containerships in the direct future. Additionally, charters vessels to many liner companies such as MAERSK, COSCO and China shipping. The purpose of the company is to become the greatest and the most profitable charter company in the world. DANAOS has a central office in Piraeus, Greece but also has offices in several other countries like Germany and Ukraine. DANAOS Corporation is headquartered in the Republic of The Marshall Islands and is listed in the NYSE from October of 2006.
In 1972 Dimitrios Coustas, an investor with huge experience in the shipping sector founded DANAOS Corporation. From 1987 John Coustas, the son of the founder is the CEO of DANAOS to date. Nowadays, DANAOS has a reputation of operational support to liner companies and other charterers all over the world.
Fleet Replace and Acquisition
The firm in order to have a young fleet sells the old vessels and replaces them with new or second hand vessels but younger. The table below presents the sales of the firm that took place in 2008.
DATE
SALES
AGE
AMOUNT
GAIN OR (LOSS)
15/01/08
APL Belgium
6 years
44.5 million $
0.8 million $
25/01/08
Winterberg
30 years
11.2 million $
4.8 million $
20/05/08
Maersk Constantia
29 years
15.8 million $
9.3 million $
26/10/08
Asia Express
31 years
10.2 million $
3.5 million $
10/12/08
Sedeberg
30 years
4.9 million $
(1.5) million $
The following table shows the acquisitions of vessels of the firm in 2008
DATE
PURCHASES
NEW BUILDING OR SECONDHAND
AMOUNT
11/02/08
Hyundai Progress
Secondhand (10 years old)
30.4 million $
18/03/08
Hyundai Highway
Secondhand (10 years old)
31.0 million $
20/03/08
Hyundai Bridge
Secondhand (10 years old)
31.0 million $
04/07/08
Zim Rio
New building
63.8 million $
22/09/08
Zim Sao Paolo
New building
63.8 million $
03/11/08
Zim Kingston
New building
63.8 million $
Sources of Funding
The principal source of funds the firm uses is equity provided by stockholders, long term bank loans and operating cash flows. The firm usually uses its funds for capital expenditures. The company aims at creating wealth for its shareholders through its growth.
In 2008 the firm in order to finance the construction and the acquisitions of new vessels entered into credit facilities with several banks and for various amounts of dollars:
On 15/02/08 the firm entered into a credit facility with Emporiki Bank of Greece S.A for $156.8 million at LIBOR plus a margin due June of 2021.
On 09/05/08 the firm entered into a credit facility with Credit Suisse for $221.1 million at LIBOR plus a margin due December of 2019.
On 30/05/08 the firm entered into a credit facility with Deutsche Bank for $180.0 million at LIBOR plus a margin due October of 2018.
On 29/07/08 the firm entered into a credit facility with Fortis Bank, Lloyds TSB and National Bank of Greece for $253.2 million at LIBOR plus a margin due July of 2018.
Debt of the Company
A characteristic of the maritime industry is risk. Due to the fact that shipping companies are very susceptible to competition, cyclicality of the economy and capital intensity, it is common for the majority of companies to have a low credit rating. When a shipping company seeks to get a loan from a bank, the lending usually depends on a number of factors. Research (Grammenos et al, 1998) has shown that the most important factor that banks take into account when deciding whether to give a loan to a shipping company or not, is the reputation of the company. Moreover, banks take into account credit worthiness, securities given as collateral, cash flow projections and experience and time length in the market among others. As mentioned above about DANAOS, the majority of companies in the shipping industry finance their investments and operations through debt rather than equity.
Capital Structure of DANAOS
At this point we have to specify that the market value of equity is equal to the number of shares outstanding times the average price of the stock during the year. Moreover according to A. Damadaran (2005), we make the assumption that the book value of debt is equal to the market value of debt. At last the firm value is equal to sum of M.V of equity and the M.V. of debt.
2007
Market Value of equity = 26,45 * 54.600.000 = 1.444.635.514
Market Value of Debt = 1.446.900.000
Firm Value = 2.891.535.514
2008
Market Value of equity = 18,15 * 54.500.000 = 989.088.834
Market Value of Debt = 2.609.400.000
Firm Value = 3.598.488.834
The figures above depict the capital structure of the company in 2007 and in 2008. It is clear than the percentage of debt increased from 2007 in 2008 dramatically. In 2007 both the market value of debt and the market value of equity were 1.4 billion dollars. While in 2008 the market value of debt was 2.6 billion dollars and the market value of equity was almost 1 billion dollars.
Cost of Equity
'The cost of equity is the rate of return that investors require to invest in the equity of a firm.' (A. Damodaran, pp92). DANAOS cost of equity will be calculated using the Capital Asset Pricing Model (CAPM). The CAPM formula is the following:
K=Rf+β(Rm-Rf)
The Rf is the risk-free rate used in the 10 year us t-bond. In order to calculate the Rf we took the average monthly prices of the annualized yields for 10 years from Bloomberg.
The beta (β) used is the statistical measure of the volatility of the security's return in relation to market returns. The beta for 2007 was 0.82 and for 2008 was 1.95. Finally, the risk premium is the minimum difference between the risk free rate (Rf) and the market return (Rm) that an investor requires in order to bear the risk of the investment. At this point we have to underline that we took as granted that the risk premium is 5.5% for both years.
Cost of equity 2007
Ke = 4.64% + 0.82 * 5.5% = 9.15%
Cost of equity 2008
Ke = 4.52% + 1.95 * 5.5% = 15.25%
From this result there is evidence that an investor required at least 9.15% and 15.25% return in order to invest in DANAOS for 2007 and 2008 respectively.
Cost of Debt
The cost of debt measures the cost a firm has when borrowing funds in order to finance a project. In order to calculate DANAOS' cost of debt, one of Damodaran's spreadsheets for rating calculation was used. This spreadsheet uses the interest coverage ratio, the estimated bond rating and the estimated default spread in order to find the estimated cost of debt. In 2007 the firm had a credit rating of A. This essentially means that DANAOS had a strong capacity in repaying its debt in the short term but in the long term it can be affected by economic conditions. DANAOS default spread is 1% which means that an investor would require 1 % on top of the 10 year T-Bond's interest rate in order to invest in DANAOS bonds. From the results generated by Damodaran's spreadsheet, there is evidence that, in order to finance its projects, DANAOS borrowed funds at an average interest rate of 5.64% approximately. In 2008 because of the extra leverage the firm had a rating of BBB. This means that the company had adequate capacity to repay its debt, but it was risky. DANAOS default spread for 2008 was 1.5% thus an investor would require 1.5 % more than the 10 year T-Bond's interest rate in order to invest in DANAOS bonds. From the results generated by Damodaran's spreadsheet, there is evidence that, in order to finance its projects, DANAOS borrowed funds at an average interest rate of 15.25%.
Weighted Average Cost of Capital (WACC)
The cost of capital is a measure of the composite cost of raising money that a firm faces'(A.Damodaran, pp150). According to Damodaran (2005), the formula used to calculate the cost of capital of a firm is:
Cost of Capital = kE [E/(D+E+PS)] + kD[D/(D+E+PS)] + kPS[PS/D+E+PS)]
Where:
KE: Cost of Equity
KD: Cost of Debt
KPS: Cost of Preference Shares
E: Total Equity
D: Total Debt
PS: Number of Preference Shares
WACC 2007
WACC = (1444635514/2891535514) * 9.15% + (1446900000/2891535514) * 5.64% = 7.39%
The weighted average cost of capital can be defined as the return an investor expects if he were to invest in a portfolio that includes all the securities of a specific company. DANAOS is funded 50% by equity and 50% by debt.
WACC 2008
WACC = (989088834/3598488834) * 15.25% + (2609400000/3598488834) * 6.02% = 8.56%
In 2008 DANAOS is funded 27% by equity and 73% by debt. Thus, there is evidence that DANAOS is increasingly funded by debt instead of equity.
Danaos Stock in 2007-2008
The figure below depicts the price of the firm's stock for 2007 and 2008. It is clear that in 2007 when the world economy was booming the stock price was increasing and in 2008 because of the financial crisis the stock began to decrease. In July 2007 the stock had a price of approximately $35 and at the end of 2008 the price of the stock fellow below $5. As mentioned previously, this shows how sensitive the shipping companies are to economic cyclicality.
From the figures above it is clear that Diana, the competitor of DANAOS Corporation, has also lost value due to the credit crunch. The price of the stock in October 2007 was close to 35$ and at the end of 2008 the price was near to 10$.
Danaos Ratio Analysis
In our assignment we use the ratio analysis to provide the highlights of the financial statements. We define the most relevant ratios such as profitability and gearing ratios and we explain with their use the position of the firm compared to the previous year and to one of the firm's competitors.
The figures illustrated above show that there has been a decline in both ROA and ROC which means that the returns for every asset of the company are lower for 2008 when compared to the year before and in the case of the ROC there are lower returns for the capital invested. On the other hand there is an increase in ROE which means that the returns for every dollar invested from equity are higher than the previous year.
Profitability Ratios
2007
2008
ROA
11.47%
5.40%
ROE
34.45%
52.60%
ROC
10.3%
4.07%
EPS decreased over the year which means that each share paid out a lower return. In contrast, dividend yield increased due to a decrease in the share price. Finally the P/E ratio increased. This was due to the fact that the rate at which the share price decreased was lower than the rate at which the EPS decreased.
Investment Valuation Ratios
2007
2008
EPS
3.94
2.11
DIVIDEND YIELD
13%
20%
P/E
1.90
3.55
Due to the large loans that Danaos took out, the company's debt increased significantly and thus the D/E ratio recorded a sharp raise. In 2007, Danaos could repay its debt 9.61 times, but since the debt increased through loans this ratio decreased and in 2008 it was able to repay its debt only 3.05 times.
Debt Ratios
2007
2008
D/E
100%
263%
TIE
9.61
3.05
The current ratio shows the liquidity of the company decreased over the year because the current liabilities of the company increased significantly. Finally, the working capital ratio increased during the year which means that because the company has more capacity to repay its current liabilities.
Other Ratios
2007
2008
CA/CL
2.60
2.05
CA-CL
81900000
128000000
Comparison with competitors in 2008
When comparing Danaos to Diana, figures show that Diana has a higher ROA and ROC but lower ROE than Danaos. This means that Diana has higher returns for every asset the company owns and higher returns for the total capital invested. On the other hand the figures show that Danaos has higher returns for every dollar of equity invested.
Profitability Ratios
DANAOS
DIANA
ROA
5.40%
21.41%
ROE
52.60%
28.58%
ROC
4.07%
21.50%
Diana had higher EPS and P/E ratio but lower dividend yield than Danaos. These figures seems reasonable because the Diana's stock price didn't decrease at the same rate as it did for Danaos.
Investment Valuation Ratios
DANAOS
DIANA
EPS
2.11
2.95
DIVIDEND YIELD
20%
12.81%
P/E
3.55
7.16
The debt ratios clearly reflect the higher debt of Danaos compared to Diana. This is mainly due to Diana's policy of funding its investments through equity rather than debt. All these combined show that Diana has the significantly higher capacity to repay its debt.
Debt Ratios
DANAOS
DIANA
D/E
263%
16.25%
TIE
3.05
40.30
Finally, Diana had higher liquidity than Danaos and both companies have adequate capacity to repay their current liabilities.
Other Ratios
DANAOS
DIANA
CA/CL
2.05
3.43
CA-CL
128000000
48542000
