- Most shipping companies are down more than 90% and the short term outlook does not look bright.
- After 25 years of 10% global fleet gross tonnage growth, 2016 is a turning point with growth lower than 5%.
- Increased interest rates, fewer ships and constant global trade growth show that there are investment opportunities in the shipping world.
It seems strange to analyze the shipping sector in the current volatile markets, but sound sector analyses help to keep nerves firm and to clearly valuate the opportunities a bear market brings. The shipping sector is interesting due to the fact that it represents a perfect example for a bottomless investment theory and an excellent investment opportunity for those who can and know how to catch a falling knife.
Overview of the Shipping Sector
A combination of low interest rates and high shipping prices brought lots of investments in new ships which created a long lasting oversupply of ships. More ships means more shipping capacity which consequently means lower shipping prices. Such a situation brought the Baltic Dry Index—which represents the average price to ship raw materials around the world—to lows not seen in the last 30 years.
Figure 1: Baltic Dry Index. Source: Hofstra University.
In such a low pricing environment, it is difficult for fleet owners to be profitable. Therefore, the shipping ETF is also at 5 year lows.
Figure 2: Shipping ETF. Source: Bloomberg.
Global economic growth made ship owners believe that there would be constant demand for their services and therefore they invested heavily into building new ships.
Figure 3: Expected global demand for shipping in relation to GDP and population growth. Source: International Chamber of Shipping.
The amount of global transported goods is indeed growing but not at a rate that would bring balance to the shipping markets. At the end of 2014 there was a total of 85,094 merchant ships, while in 2005 the number was 61,227. This represents a growth of 40% and is already higher than the growth of world merchandise exports of 34% for the period.
Figure 4: World merchandise exports from 1995 to 2014. Source: World Trade Organization.
But on top of the increase in ship numbers, the ships are getting larger and larger in order to be more efficient. In 2005 the world fleet gross tonnage was 600 million tons while currently it is 1,166 million tons, representing an increase of 94% for the period. In such an environment all the marginal cost shipping companies should bankrupt on their debt, but the low interest rates enabled the shippers to survive and constantly add new shipping capacity in hopes of better times.
A small digression here, the shipping industry shows how artificially low interest rates keep a lot of businesses alive. Even if everything looks stable, the low interest rates highly increase the risk of being invested because a turnaround in investor perception toward risk would have an even worse effect on markets than the 2009 Great Recession.
Back to shipping. With low interest rates, ship owners continue to build new ships and low commodity prices continue to keep shipping prices depressed. Even with the current slowdown in gross tonnage growth, with 6.8% of the total global fleet idle it will take a few more years to restore the balance.
The outlook for shipping is not a rosy one, Moody sees combined earnings decline by at least 7% this year. The sector is expected to continue to suffer from the above mentioned problem of too many ships and slow demand growth.
The global container shipping fleet grew by 8.6% in 2015 further increasing the already high gross tonnage. Things are starting to slowly change as the growth in new ships in 2016 is expected to be the slowest since 1990, but still the 2015 increase combined with low commodity prices and stable demand will keep the oversupply in the shipping sector for a longer time.
Now, if things are so bad why would anyone even look at this sector as an investment opportunity? Well, the best investments come by looking in the darkest places because they give you the opportunity to buy cheap and enjoy the ride when a turnaround comes.
The figure below gives an overview for five major shipping companies: Diana Shipping (NYSE: DSX), DryShips (NASDAQ: DRYS), Genco Shipping (NYSE: GNK), Golden Ocean Group (NASDAQ: GOGL) and Star Bulk Carriers (NASDAQ: SBLK). Almost all of them are more than 90% down from their five year highs.
Figure 5: Shipping stocks performance comparison. Source: Yahoo Finance.
With such declines an investor must, above all his analysis skills, be brave as all the above mentioned companies are losing money and might be bankrupt soon. But the terrible chart from above creates great opportunities. For an example, Star Bulk Carriers (NASDAQ: SBLK) was at $2 in February 2016 only to jump to $5.30 at the end of April 2016 and is currently down to $2.95.
Figure 6: SBLK 6-month price movement. Source: Yahoo Finance.
For the short term, the shipping industry gives great trading opportunities, while in the long term the companies that will survive will also bring great returns, but the difficulty is in finding those companies. The goal should be to find the most efficient companies with low debt and wait for a turnaround in shipping prices. It might be too late to wait for a pickup in shipping prices as when that happens shipping companies will be up more than 100%, as was the case for SBLK from February to April.