Pierre Aury has some advice for would be shipping investors.
An old topic for a new year. I’ve already made my opinion quite clear about the fact that shipping companies trading in competitive spot markets should not be listed. In this column we will acknowledge how wrong it is that a number of these companies are listed and that investors are looking for the best way to select which of these companies to invest in. A number of investors are hard bent on using the so-called price to net asset value (NAV) ratio. The rationale is simple and is that if the share price multiplied by the number of shares is below the NAV of a company then the shares of that company are a good purchase. I am of the opinion that relying heavily, or worse solely, on this metric is flawed.
NAV represents the book value of a company’s assets minus its liabilities. It is by definition a static and backward-looking metric. It is looking at a company from a breaking it up point of view as it fails to account for forward-looking factors such as market trends, revenue growth potential, or upcoming changes in asset values. For instance, in shipping, where asset values can fluctuate dramatically due to market conditions, NAV will not give any clue regarding future economic developments. A shipping company with a ‘great’ P/NAV ratio might look undervalued but if freight rates are in a long lasting downturn, its fleet’s market value could deteriorate rapidly, rendering the use of the P/NAV ratio misleading. The share price of a given company can be discounted to its NAV all the way down leading to a big loss in the end.
NAV is impacted by accounting policies. Valuation of vessels often involves assumptions, estimates or models. Companies might overstate their asset values creating an inflated NAV that leads to misleading P/NAV ratios. The P/NAV ratio provides no insight into a company’s profitability or cash flow generation capacity. A low P/NAV could signal undervaluation, but if the company consistently underperforms the discount could be justified.
Market sentiment can create a disconnect between share price and NAV. A low P/NAV could indicate investors concerns about governance, liquidity or market conditions. Illiquid stocks often trade at steep discounts to NAV due to the lack of buyers, even when fundamentals are sound and most shipping stocks compared to stocks in other markets, are illiquid.
NAV calculations often fail to fully account for financial risk. Some companies with significant leverage might show an attractive P/NAV ratio, but their debt levels can pose substantial risks, especially in volatile markets like shipping. Investors focusing solely on P/NAV might miss these underlying potential problems.
NAV being essentially backward looking will not account for strategic elements like potential mergers, acquisitions, or synergies. A company’s true value might come from its market position or competitive advantage, which are not captured in NAV. The P/NAV ratio fails to consider these qualitative factors that could significantly influence long-term valuation.
But the main problem is that using the P/NAV ratio implies that the price of the shares of a shipping company is driven by shipping which is only partly true. The share price of a company is driven by the overall world financial market, the local financial market where the shares are listed, the market in which the company operates and the specific circumstances of that shipping company. Would be investors in shipping should use this P/NAV metric in conjunction with other valuation tools, such as price-to-earnings (P/E) ratios, discounted cash flow (DCF) models, and qualitative analysis of market trends and competitive positioning.
