Readers of the Financial Times could not be blamed if they missed a small story in January that spoke of the collapse of the Baltic Exchange Dry Index – a shipping benchmark that sounds as arcane as it does dull.
However, nothing could be further from the truth about the index – that is if one is compelled by the idea of a global economy. The index tracks the day rates shippers charge for transporting coal, iron ore and like commodities, otherwise known as dry bulk – a term also in need of a good publicist. And dry bulk, along with tankers and container ships, make up more than 80 per cent of the tonnage that gets shipped around the globe, according to Douglas Mavrinac, head of the maritime group of the global investment bank Jefferies.
So despite strong evidence of global economic recovery, dry rates are now back at Great Recession levels, having fallen from $46,284 in late October 2010 to below $11,000 in January. And as of early April, they were down an additional $1,300. Since markets generally tell us something about the state of business to come, this collapse could give pause. But it seems, instead, to highlight the riskiness of the shipping business for both owners and investors.
According to Michael Webber, senior shipping analyst at Wells Fargo, the sector has been impacted by rapid fleet expansion that collided with the recession. “It has simply been a situation where there have been too many ships compared to cargo over the past several years, which has particularly weighed down dry bulk and tanker rates,” observes Mr Webber. Mr Mavrinac points to another factor unique to shipping. “While global shipping demands don’t change overnight, isolated events such as the flooding in Australia, weather- related disruption in Canada’s St Lawrence Seaway and the triple disaster that has befallen Japan, can drag down day rates.” He sees day rates as a sort of tail wagging the dog. Thus, as a sector indicator, it could be misleading.
Still, the effect of market imbalances and disruptive events has been evident in equity performance. While the S&P 500 was up 15.56 per cent over the past year through mid-April, the Capital Link Maritime Equity Index, which is composed of 49 US-listed small-cap shipping stocks, was flat. Its 15-ship Tanker sub-index was off by more than 12 per cent, and its 17-stock Dry Bulk sub-index was off by nearly 19 per cent (shipping.capitallink.com). However, the 8-stock Container sub-index has enjoyed a recent revival, having risen by one-third – most of the move occurring since the beginning of March. This is not a surprise to industry observers. FBR Capital Markets shipping analyst Doug Garber sees demand for container ships having recovered since the recession, absorbing excess capacity and reactivating laid-up vessels. He sees this priming the industry’s next growth phase. With worldwide container ship trade currently at record levels, Mr Garber expects the market to tighten further over the next several years, possibly finding itself undersupplied by 2013. He is anticipating day rates for intermediate size vessels to surge 30 per cent in 2011. Mr Webber sees container shipping firms benefiting from better supply control. “Order books have dropped by more than half from their peak of 60 per cent in 2008 to 27 per cent in early 2011,” he says. He finds container shipping capacity has been further cut by firms deliberately slowing ship speeds.
Scott Clark, a managing director of California-based Fairview Capital, a $500m investment advisory firm, is less sanguine about the sector. In being both cyclical and capital intensive, he finds shipping inherently risky. He is, however, intrigued by a particular container shipowner, Seaspan, which he likens to a floating real estate investment trust. “The company purchases ships then leases them out long-term,” says Mr Clark, “which protects the firm from volatile spot rates while helping it generate a predictable cash flow, a good chunk of which is then paid out in dividends.” Fairview is the fourth largest shareholder of Seaspan, owning 2.7 per cent of the shipowner. Mr Clark is also impressed by management, which he feels has consistently articulated its goals and the ways in which it intends to achieve them. He was, however, caught off guard by Seaspan’s decision to chop the dividend by 80 per cent during the financial crisis. Mr Clark surmised this was done to preserve investment capital and to avoid dilutive equity financing when the stock was severely depressed. After bottoming in the mid-single digits, shares have more than tripled. And Seaspan has reiterated its commitment to a progressive dividend policy. “As its fleet grows and free cash flow expands, the firm intends to raise its dividend,” says Mr Clark. And it did just that in March, when it announced a 50 per cent rise in the dividend to $0.75, which at the time implied an annual yield of 4.5 per cent. Wells Fargo’s Mr Webber believes revenue and profit are poised to grow by 25-30 per cent over each of the next two years. However, he is concerned about $2.6bn in long-term debt and a long-term debt-to- total capital ratio of nearly 64 per cent. But these figures are not extraordinary for this highly capital-intensive sector, he says. With the industry’s order book having fallen sharply from 50 per cent of the fleet size as of the fourth quarter of 2008 to 26 per cent in the first quarter of 2011, tanker shares look set to rally. Rates and equity prices have been in a protracted down trend, says Mr Webber, but he thinks they are bottoming. Going forward, he sees potential rewards outweighing risks for longer term investors. “Some pricing power could begin to return once the current supply overhang is alleviated, and expanding crude demand from emerging and developed economies as well as a falling vessel order book could position tankers for a multi-year rally,” he says. Mr Mavrinac believes Frontline and Overseas Shipholding Group are two tanker stocks that are well positioned to benefit from this shift, offering attractive yields of 7.68 per cent and 5.57 per cent, respectively. After having significantly sold off during the recession, these shares have so far realised only modest gains during the past two years of recovery. Many shipping shares are still trading not far off their recession lows, offering attractive yields. And with day rates over the medium term more likely to rebound than to fall much further, shipping may now be a timely play. Certainly Carlyle Group and JPMorgan Asset Management think so. They are both in the process of setting up shipping ventures that will own their own fleets, betting that over the longer term this unique asset class will generate outsized total returns.