Red Sea Normalization Will Boost Shipping Yet Expose Tariff Vulnerabilities

Key Takeaways

• Ocean Transportation income relies on trade normalization, with potential revenue impacts from fluctuating freight rates and geopolitical factors.
  
• Substantial capital expenditures from delayed vessel constructions may strain cash flow, affecting dividends and shareholder returns.
  
• Decreased Hawaii container volume, geopolitical uncertainties, and delays in vessel construction pose risks to Matson's revenues and future earnings stability.

Catalysts

Engages in the provision of ocean transportation and logistics services.

• Matson expects Ocean Transportation operating income to be driven by trade flow normalization in the Red Sea and geopolitical factors. If the trade disruptions persist, freight rates could stay elevated, benefitting revenue, but normalization could lead to reduced rates and lower revenue growth.
  
• The China service has seen elevated freight rates due to a strong U.S. economy and tight supply chain conditions, but any future tariff changes or economic downturns might decrease demand, affecting revenue and net margins adversely.
  
• The Logistics segment anticipates challenging business conditions, potentially yielding slightly lower operating income due to reduced contributions from supply chain management, thereby impacting overall earnings.
  
• The SSAT terminal joint venture has been impacted by an impairment charge and surplus capacity issues, which could weaken net margins and earnings if lift volumes and terminal operations do not improve.
  
• Capital expenditures are projected to be substantial due to delayed vessel constructions in the Philadelphia shipyard, which might strain cash flow and limit dividend payouts or share repurchases, impacting shareholder returns and future earnings.

Matson Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Matson compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Matson's revenue will grow by 1.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 13.9% today to 11.5% in 3 years time.
• The bearish analysts expect earnings to reach $405.6 million (and earnings per share of $9.81) by about May 2028, down from $476.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 11.5x on those 2028 earnings, up from 7.6x today. This future PE is greater than the current PE for the US Shipping industry at 4.0x.
• Analysts expect the number of shares outstanding to decline by 3.82% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.65%, as per the Simply Wall St company report.

Matson Future Earnings Per Share Growth

Risks

• The Hawaii container volume decreased year-over-year due to lower general demand and modest economic growth, which could impact future revenues.
  
• Challenges in population growth and lower discretionary income from higher inflation and interest rates in Hawaii could deter consumer spending and negatively affect revenue streams.
  
• The Red Sea disruption and geopolitical uncertainties may lead to fluctuating freight rates and unpredictable supply chain activities, impacting net margins and earnings.
  
• An impairment charge related to the SSAT joint venture impacted net income and diluted earnings per share, indicating potential risks in joint venture operations and future profit margins.
  
• Delays in the construction of new Aloha Class vessels at Hanwha Philly Shipyard could lead to additional costs and delay increased capacity, potentially affecting future earnings.

Valuation

• The assumed bearish price target for Matson is $132.38, which represents one standard deviation below the consensus price target of $153.33. This valuation is based on what can be assumed as the expectations of Matson's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $175.0, and the most bearish reporting a price target of just $125.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $3.5 billion, earnings will come to $405.6 million, and it would be trading on a PE ratio of 11.5x, assuming you use a discount rate of 6.7%.
  
• Given the current share price of $110.17, the bearish analyst price target of $132.38 is 16.8% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.