TAL International – Income And Growth

All the talk of China slowing and sluggish growth in developed markets might lead you to believe that the global economy is facing a dire situation over the next few years. Don’t believe it. Expected growth from just China and the United States alone will add $1.08 trillion to the global economy and that is before a recovering European market that could surprise estimates. The International Monetary Fund estimates the global economy to increase by 3.7% this year and 3.9% in 2015.

Just as during the glory days of the gold rush, the smart money may not be behind companies trying to strike it rich in the new globalized world. Centuries ago, those that got rich enough to create legacies were the ones selling picks and shovels. They sold the tools and infrastructure on which the boom depended.

Now in an interconnected world of commerce, you might want to follow the same strategy and put your money in the companies making trade possible. Nearly every company has grand plans to increase sales in China and throughout the emerging world. Not all will succeed but all will need to ship their products.

Picks and Shovels to Ships and Containers

Before you rush to buy the shares of all transportation companies, not all will benefit from increased shipping. The size of container ships have increased dramatically just in the last 30 years, from about 4,500 TEU of capacity to the new Triple E class vessel that can ship up to 18,000 TEU of cargo. Shipping firm Maersk estimates that container shipping demand will continue to increase at about a 5% to 6% pace over the next several years, behind the projected 9.5% growth in shipping capacity.

The result, pricing power for the vessel operators may come under pressure while those leasing containers may be relatively safe.

TAL International Group (TAL)

manages just over 2.1 million TEU (Twenty Foot Equivalent Unit) of containers and is one of the world’s largest intermodal leasing companies. Revenue has jumped at an annualized pace of 20% since 2010 to $643 million last year and costs are extremely well-managed with a 51% operating margin. Shares pay an attractive 6.9% dividend yield and have returned an annualized 16.4% return since 2005, well over the total return on stocks in the S&P 500. Beyond the strong cash yield, nearly 11% of the annualized return has been from price appreciation.

While the yield on the shares is attractive, the dividend payment is relatively volatile as management does not smooth its payout policy as is done at most companies. Dividends per share may increase or decrease in any given quarter but have been increased on a consistent annual basis. Strong growth in container traffic should provide the company with plenty of cash flow to keep increasing the total annual payout each year.

As of December of last year, the average remaining duration on long-term and finance leases was 44 months. With approximately 70% of assets leased long-term, that translates to more than three years of stable cash flow. At 97%, the company has one of the highest utilization rates in the industry and

The container leasing industry is closely tied to global economic growth and still faces some headwinds on slowing China growth. Growth in Europe and the United States should help pick up the slack for shipping demand and the company should continue to provide a strong total return to shareholders. TAL International announced in February the closing of $291 million in “A” and “BBB” rated fixed-rate secured notes. The rate on the notes, both ten-year maturities with rates of 3.5% on $271 million and 4.1% on $20 million, are a good sign of credit quality and the company should have no problem meeting further financing needs without a dilutive share issuance.

Shares trade at an extremely attractive 10.3 times trailing earnings, though expectation is for earnings to be relatively flat at $4.08 per share this year. The industry average multiple is 21.0 times earnings and the company has traded at an average of 10.7 times earnings over the last five years. Earnings are expected to increase to $4.43 next year on 6.7% higher sales.

After almost no growth over the last several years, GDP growth in Europe has a good chance of surprising to the upside and supporting strong growth in shipping. This should boost revenue for container companies and improve sentiment in TAL International. On an upside to $4.25 in earnings and improved sentiment, shares could go to $48.00 a share for 12.7% on top of the 6.9% dividend yield.

Full Disclosure: I am long TAL.  See my portfolio here.