Revenue certainty is a good thing. We've discussed a few examples where stocks appear undervalued and where investors can rest easy because companies have backlogs or have signed contracts that provide some assurances. Such revenue certainty allows companies visibility into the future, which translates into an ability to set their costs such that a profit will be made. But investors must take care to ascertain whether the agreements will indeed be honoured.
Consider Global Ship Lease (GSL), a lessor of container ships. The company leased away its fleet of ships in 2007 and 2008 over long-term periods, locking in future revenue rates. As a result, despite the fact that the shipping industry has been hit hard and shipping rates have fallen industry-wide, GSL continues to turn in profits. This should continue, as no leases are set to expire until December of 2012, and even then only 2 of the company's 16 ships will need new contracts. The following chart illustrates how long the company's ships have been leased out for at guaranteed rates:
Despite this, the company trades for $110 million while it brings in operating income of almost $15 million per quarter. So what gives...is this a screaming buy? Unfortunately, GSL's entire fleet is leased to a single customer, it's former parent company. The customer is a private company, so very little data is available, apart from the fact that the company experienced "substantial losses" in 2009. This is not surprising, as the shipping industry has been particularly decimated by the recession, as overcapacity has put downward pressure on prices. As a result, shipping companies are having trouble making ends meet, and so many of GSL's contracts may cause extreme hardship for their customer.
Adding to the risk of GSL's situation is the fact that it has over $600 million in debt, and has two more ships due to be delivered this year, which will require further financing. This doesn't leave a lot of room for error; if GSL needs to renegotiate its leases so that its customer can survive, it could have serious difficulties meeting its obligations.
A contract guarantee is only as good as the guarantor's ability to meet that guarantee. Considering that information regarding GSL's customer is limited, and that GSL has significant obligations to meet, an investment in this company appears to be rather speculative, with considerable downside risk.