Is A Global Rally In This Beaten-Down Sector At Hand?
For the companies that own lease massive dry-freight cargo ships, it’s been another tough year.
Copper export woes in Indonesia, canceled orders in China for U.S. soybeans, and a few other events have taken away any optimism that the freight industry may have had at the start of the year. The Baltic Dry Index, which tracks the daily lease rates of a wide range of freighters, was rallying six months ago, but is again back in the doldrums.
#-ad_banner-#So you would have expected to hear of a dour mood when the industry’s leading players gathered this month at Posidonia, the biennial meeting in Greece to discuss industry conditions. Deutsche Bank analyst Taylor Mulhern, who attended the event, heard an entirely different tone.
His view of the event: “Optimism from management teams for fundamental improvement in the shipping sector continues to build after several years of prolonged fragility.”
For an industry that has been slumping since 2008, such optimism would seem to be misplaced.
At the height of the economic boom before the global downturn, freight operators placed orders for many new ships, and those ships hit the market right as global demand for them was tanking. By one estimate, global shipping capacity was increased by 33% in the three years ended 2013, even though demand barely budged.
How bad has the carnage been? The Baltic Dry Index (BDI) rose to 7,000 back in 2005 and then to above 11,000 in 2008 — and has since slipped more than 90%.
At current lease rates, shippers are barely making enough to pay off the interest on their loans, let alone the principal. A half-dozen dry bulk carriers have already gone bankrupt, and many more have embarked on deep financial restructurings just to stay afloat.
The reason for renewed optimism at the Posidonia event: Fewer new ships are being built, and a slow rise in demand is expected to finally lead to firmer daily lease rates for these ships in coming years. Indeed, a handful of hedge funds are already positioning for an industry rebound, as The Wall Street Journal recently reported. Pricing for so-called Capesize ships (which are built to withstand the rigors of the Cape of Good Hope and Cape Horn) is already rising, and pricing for other ships is expected to follow suit.
Analysts at MLV Capital share that view, predicting that industry capacity will grow just 5% this year and next: “We now believe that the worst is behind us and that we are entering into a new phase of the cycle where demand remains strong and supply has moderated, thus resulting in the potential for higher rates.”
For investors, the potential rebound creates a tricky setup. If lease rates rise by even a moderate amount, share prices for the key players have considerable upside. We don’t even need to see the Baltic Dry Index return to the manic days of 2008. If that index just moved up to 2,000 or 3,000 — far below prior peaks — then earnings estimates for the industry’s key operators would soar far higher.
But investors have been burned too many times before, and a head-fake in the BDI would simply lead to another round of lost money. If the BDI remains stuck at its current range, the most heavily indebted players would follow Genco Shipping, Excel Maritime and others right into bankruptcy.
Simply put, any dry bulk carrier that has more than $1 billion in net debt should be avoided. They carry too much bankruptcy risk.
Baltic Trading (NYSE: BALT) is in reasonably solid financial shape and leases ships in various sizes, which means it’s not too strongly tied to a particular commodity for success. Baltic has also avoided long-term contracts and would sharply benefit from a rise in spot lease rates.
I remain a big fan of Diana Shipping (NYSE: DSX) which has pursued generally conservative financing practices throughout the industry downturn and has more than $300 million in gross cash with which to acquire distressed assets on the cheap.
“Based on current asset prices, we estimate Diana could buy eight to 10 modern Panamaxes (doubling the size of its current fleet),” note analysts at MLV.
Risks to Consider: China drives much of the global commodity trading activity, and a slump in that economy would push down ship lease rates.
Action to Take –> The Baltic Dry Index, along with industry share prices, have yet to reflect a potential industry upturn, making this a good time to dig in to the changing industry dynamics, before the crowd appears.
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