Long Term Asset Value

The Long Term Asset Value method, short LTAV method is a method of ship valuation . The long-term earnings potential of the ship (including scrapping after the end of the mission) is converted into today's cash value using the discounted cash flow method (DCF method for short).

Basics

Taking into account only financial goals, the value of a ship is determined by its ability to generate future financial surpluses. The calculation of the LTAV is based on the established DCF method based on the concept of weighted average cost of capital ( WACC approach ). Accordingly, the LTAV of a ship results from discounting the expected financial surpluses ( cash flow , English free cash flow ) with a weighted capital cost rate (k _WACC ):

{\ displaystyle LTAV = \ sum _ {t = 1} ^ {T} {\ frac {C_ {t} -B_ {t}} {(1 + k _ {\ text {WACC}}) ^ {t}}} + {\ frac {{RW} _ {T}} {(1 + k _ {\ text {WACC}}) ^ {T}}}}

The forecast free cash flows can be derived from the future achievable charter income C _t minus the expected ship operating costs B _t and a residual value RW _T at the end of the ship's useful life.

Determination of free cash flows

Charter income

For the forecast of the charter income C _t , assumptions have to be made about the future achievable charter rates (gross charter income), the shipping costs and freight charges incurred, as well as the occupancy (days of use per year).

Since the development of the financial surpluses for the near future can be forecast with a higher degree of certainty than for more distant years, at least the first three years should be planned in detail. If there is a charter agreement, it should be used to forecast the charter income in the detailed planning period - provided that the charterer has sufficient creditworthiness to consider compliance with the contractually agreed charter rate to be very likely. If there is no charter agreement or if the ship is to be valued without an existing charter agreement, (time) charter rates currently observable on the market can be used, as well as market analyzes of future fleet development (market supply) and the development of global demand for goods (market demand). In addition, market forecasts about the future development of charter rates and an analysis of the difference between freight rates and freight date rates can provide further indications for the future development of charter rates in the detailed planning period.

Following the detailed planning phase, it is difficult to make forecasts due to the high volatility of the charter rates over time. Long-term historical averages of charter rates provide orientation. When forecasting charter income, inflation-related price increases should always be taken into account.

With increasing age, ships usually only achieve lower charter rates due to efficiency disadvantages. This can be taken into account in the forecast of charter income, especially for older ships, by means of an age discount.

When chartering, there are freighting commissions and ship management fees, which must be taken into account in the evaluation calculation.

With regard to the days of operation of a ship, a distinction must be made between normal operating years and years in which the ship is docked for class renewal (usually every 5 years). In addition to the regular shipyard times, the forecast days of use should also take into account other periods of unemployment ( off hire ), for example due to a possible technical failure.

operating cost

The operating costs B _t essentially include costs for personnel, insurance, lubricants and auxiliary materials, spare parts, maintenance, repairs, docking and class renewals as well as for (tonnage) taxes.

Due to the trend of rising operating costs observed in the past and also expected in the future, in contrast to the long-term forecast of charter income, an orientation to past values is critical when forecasting future operating costs. Taking into account the current framework conditions and the development of operating costs in recent years, the current operating costs should be used as the basis for future prognosis. It must be taken into account that the operating costs are naturally higher in class years. Analogous to the forecast of future charter income, future inflation-related cost increases should also be taken into account for operating costs.

residual value

To determine the residual value RW _T , it is advisable to use the scrap value at the end of the economic useful life (usually 20 to 25 years) taking into account disposal costs. To determine the scrap value, the empty weight of the ship ( light displacement ) must be multiplied by the expected scrap price at the end of its useful life. Analogous to the procedure for forecasting future charter income and operating costs, the expected scrap value should also reflect inflation-related price increases.

Determination of the discount rate

For the valuation of a ship on the basis of the LTAV method, the expected financial surpluses must be discounted to the valuation date using a suitable capitalization rate . This interest rate should represent the return on an alternative investment that is adequate to the investment in the ship to be valued and must be equivalent to the cash flow to be capitalized in terms of maturity, risk, currency and taxation.

Since the LTAV method is based on the WACC approach, the free cash flows must be discounted to the valuation date with a weighted cost of capital that depends on the cost of equity and debt. The advantage of the tax deductibility of the interest on borrowed capital can usually be dispensed with, since the shipowners mostly opt for income-independent tonnage taxation. The weighted cost of capital is summarized as follows:

{\ displaystyle k _ {\ text {WACC}} = k _ {\ text {EK}} \ cdot {\ frac {EK} {GK}} + k _ {\ text {FK}} \ cdot {\ frac {FK} { GK}}}

Cost of equity

An established method of determining the cost of capital (k _EK ) is the Kapitalgutpreismodell (English capital asset pricing model , CAPM). According to CAPM, the cost of equity can be broken down into a risk-free base rate (r _f ) and a risk premium demanded by the owners due to the assumption of entrepreneurial risk, which for ship valuation purposes is derived from the multiplication of a general market risk premium (MRP) by a risk factor specific to the ship type (the so-called beta factor β) results, decompose:

{\ displaystyle k _ {\ text {EK}} = r_ {f} + {\ text {MRP}} \ cdot \ beta}

When deriving the cost of equity rate based on the CAPM, empirically observable capital market parameters are used.

Borrowing cost rate

Ship financing is often based on variable interest rate agreements linked to interbank interest rates (e.g. LIBOR ) plus a risk surcharge ( credit spread ). Because of this, interest rate swaps can be used as a starting point for determining the cost of debt (k _FK ). The amount of the credit spread depends not only on the usability of the ship in the event of insolvency, but also on other influencing factors such as the performance of the shipowner and the existence of long-term charter agreements.

Capital structure

Usually ships are financed to 50 to 70 percent with outside capital. For the level of the weighted cost of capital, however, the capital structure is generally only of subordinate relevance, since a higher level of indebtedness leads to a higher beta factor and thus to a higher cost of equity, and the relative weight of the cost of equity (EK / GK) is lower.

Suitability of the LTAV process

Due to the existence of so-called pig cycles , due to a delayed adjustment of the supply, the ship markets show strong price fluctuations with regularly overheated and disrupted market phases. The market prices that form in these phases are particularly influenced by short-term transactions (e.g. fire sales) and are characterized by high volatility.

The LTAV process, by focusing on the long-term earnings potential of a ship, can compensate for these market imperfections to a certain extent and thus represents a reliable basis for decision-making for rational, long-term investors, even in phases of market exaggeration. It assumes rational investors who act with Long-term positive prospects (achieving risk-adequate returns on capital) and, if necessary, undertake subsequent financing.

The LTAV procedure can thus be used to evaluate ships in all market phases. In this respect, it represents a necessary addition to the market price-oriented valuation method.

literature

Daniel Mayr, Claus Brandt: Ship Evaluation on a New Basis , International Transport, Issue 4, 2012.
Daniel Mayr: Ship valuations based on the Long Term Asset Value method , HANSA International Maritime Journal, Issue 12, 2013.
Daniel Mayr: Valuing Vessels , HSBA Handbook on Ship Finance, pp 141-163, 2015.