Shipping Sector
Published on Saturday, January 24th, 2009 at 1:06 PMAuthor: Munish Rao (11 Articles)
“A bleak outlook on the Shipping sector”
Author: Munish Rao Dated: 19th Jan’2009
Sea trade remains the primary means of international transportation and moves approximately 90% of global cargo and 100% of hydrocarbons. The growth potential of the shipping industry has a direct link to growth in world output, in economic terms; GDP. During the last two decades, world GDP has grown at an average of 3%. Due to increased globalization, world trade has registered an average growth of 3.6%, slightly outpacing the GDP growth by 60 bps. A higher level of economic growth generally leads to higher demand for industrial raw materials, which in turn boosts import and export activities worldwide. In the recent economic environment, the world has witnessed one of the worst financial crises in history. Along with this, the latest IMF forecast on global growth that has been plunged down to 2% for 2009 was another sign towards tanking global trade. So, how much should be its impact on the shipping industry??
The shipping market is cyclical in nature and freight rates generally tend to be volatile. The current financial crisis has brought the shipping activity to an unexpected halt, as is evident from the below table -
All data as on 16th Jan’09
|
Index level |
Peak Month |
Peak level |
|
Current level |
% change |
|
World Equities |
Oct’07 |
412.2 |
|
209.1 |
-49.3 |
|
Emerging Markets |
Oct’07 |
1338.5 |
|
526.6 |
-60.7 |
|
Crude Oil |
May’08 |
147.0 |
|
36.0 |
-75.5 |
|
Baltic Dry Cargo |
May’08 |
11793.0 |
|
911.0 |
-92.3 |
|
CRB Spot |
Jun’08 |
476.7 |
|
315.1 |
-33.9 |
|
CRB Metals |
Apr’08 |
950.9 |
|
402.6 |
-57.7 |
|
|
|
|
|
|
|
|
Exchange Rate (vs US$) |
Peak Month |
Peak level |
|
Current level |
% change |
|
Euro |
Apr’08 |
1.576 |
|
1.345 |
14.6 |
|
British Pound |
Nov’07 |
0.483 |
|
0.676 |
39.8 |
|
Indian Rupee |
Jan’08 |
39.270 |
|
48.608 |
23.8 |
|
|
|
|
|
|
|
|
Company (local currency) |
Peak Month |
Peak level |
|
Current level |
% change |
|
Teekay Shipping |
May’08 |
53.5 |
|
18.0 |
-66.4 |
|
Frontline |
Jun’08 |
72.4 |
|
31.5 |
-56.5 |
|
General Maritime |
May’08 |
31.0 |
|
10.1 |
-67.5 |
|
Shipping Corp. of India |
Jan’08 |
331.8 |
|
80.9 |
-75.6 |
|
GE Shipping |
Jan’08 |
571.5 |
|
178.4 |
-68.8 |
|
Mercator Lines |
Jan’08 |
186.4 |
|
31.4 |
-83.2 |
|
|
|
|
|
|
|
|
Day Rates ($/day) |
Peak Quarter |
Peak level |
|
Current level |
% change |
|
Tankers (VLCC spot) |
2Q’08 |
129998 |
|
52983 |
-59.2 |
|
Dry Bulk (Capesize spot) |
2Q’08 |
164202 |
|
7947 |
-95.2 |
|
Containers (Panamax spot) |
2Q’08 |
66372 |
|
3592 |
-94.6 |
|
|
|
|
|
|
|
Source: MSCI Barra, Bloomberg, CRB Trader, Yahoo Finance, Imarex, Pacific Exchange, Industry Reports
|
Baltic Dry Cargo Index (BDI); a standard Index for ore, coal and grain shipments
|
Deep understanding of the data presented above suggests that most of the markets peaked during 2Q’08, the time when crude oil & BDI peaked. Since then the oil has declined by more than 75% and the worst hit being BDI, that plunged by 92%. The decline was primarily led by the strength of the Dollar and also because of the shrinking global trade due to slowdown in economic growth. Oil demand contributes a major portion of container demand. Demand for oil remained muted as in US (major consumer of oil) because of rising oil inventories. The oil inventories stood at 835.2mn barrels growing at 3% y-o-y. This is above the 5yr average inventory level of 818.5mn barrels. Similar is the case for iron ore, where China has a huge build up of inventories. But the impact was felt more on the Dry bulk and Container day rates (declining more than 90%) than on Tankers (that carry Crude oil, chemicals, pet products, LNG, Fresh water) rates that fell around 59%.
This time it’s not just the trade related activities that led to a decline in freight and charter rates but the consequences of the financial crisis are also being felt in the shipping industry.
Credit woos … and shipping industry
Bank credit plays a vital role towards the rampant growth of the shipping activity and also for the foreign trade by issuing letters of credit (LOC) – a payment guarantee issued to the exporters for cargoes preventing them from counterparty risks. According to the data released by World Trade Organization (WTO), $13.6 trillion worth of goods are traded each year across the globe and importantly 90% rely on LOC’s. Post the bankruptcy filled by Lehman Brothers during Sep’08, the confidence towards the counterparties and their respective banks began to shatter. The poor liquidity conditions forced the banks to start refusing to issue credit. Massive dependence on credits thus led to collapse in the shipping of raw materials in some regions of the world. Almost 40% of the container fleets in the world are owned by German’s and majority of these were underwritten during last three years i.e. close to peak of the cycle. Now whether these German underwriters will be able to survive this crisis seams to be questionable. Even in India, orders for about 35 ships (out of total orders of 250 ships) that were to be built in shipyards around the country face cancellation, compounding woes for a sector that is already facing a financing crunch as banks stop lending to the sector.
The liquidity has added impact on the industry as almost 25% of the ships under construction worldwide (worth around $500bn) either lack sound financing or have no financing at all. More bad news hits the industry as some shipping companies or lenders have chosen to forfeit the advance payments of up to 40% of the ship’s cost again because of either non-availability of balance credit or minimizing current losses as the orders were placed at the peak of the cycle, thus the cost for the ships was relatively very high.
It’s possible that some big shipping companies might face defaults, and few others might shut down business. All this will be result of declining spot rates, lower demand, and discontinuation of the guaranteed charter business. One such company, US Shipping Partners, is on the brink of collapse after it revealed that it has defaulted on its senior credit facility of over $332.6mn in outstanding debt under a so-called “forbearance agreement”.
|
The forbearance agreement obliges lenders to refrain from taking action on the company’s failure to make the December 31, 2008 principal and interest payments under the senior credit agreement. |
Asia and its role in the global shipping industry
Asia is a hub of one of the world’s busiest ports. These include ports of Singapore, Shanghai, and Hong Kong, to name a few. As per the data provided by Institute of Shipping Economics and Logistics (ISL), Asia clearly dominates the world container traffic in terms of traffic by route. In the last few years, the shipping industry has witnessed a radical shift towards the inter-Asian trade routes, thanks to increased demand from BRIC countries. Also thanks to the new political regime headed by President Ma, towards improving relations between Taiwan and China (regions largest economy). During 2007, Inter-Asia route contributed 23.1% of the total world trade and 50% if the routes between Asia – North America and Far East and Europe are combined.
Proportion of global container transport by route (% of total, 2007)
Source: ISL, 2008
Economic worries of US, Eastern Europe and Japan being already in recession, along with economies like China and India witnessing slowdown in the growth have put immense pressure on the shipping industry. Besides US facing a credit bubble, China is facing over-supply and investment bubbles. Now as the exports are waning, there’s a double whammy. The impact could be felt by the decreasing traffic at Chinese ports and increased number of ships sitting idle. Shanghai, one of the world’s busiest ports has cut its container traffic target for 2008 by 5% blaming the global financial crisis as the cause. “Avoid” Chinese shipping stocks for at least couple of years unless China initiates some considerable trade policies thereby reducing its concentration risk by exporting majority of the products to US & Europe thereby diversifying trade with other Asian economies.
Demand-Supply, an anxiety over next two years
The market is anxious to understand the demand supply dynamics for the shipping industry for next few years. As global demand for products made in China (toys, electronics, steel), Germany (cars, iron & steel products) and Japan (cars, electronics, and computers) is shrinking, more vessels are lying idle. Moreover, running the ships at current prices could barely cover their costs. For example, shipping charge from Shanghai to Europe has fallen from $1000 per container during Jan’08 to the present charge of $200 per container. This scenario is quite scary, but chances are that this will remain a problem for at least next few quarters and the ship owners will be forced to bear the pain of low day rates.
During last few years, the boom in the industry led to increased orders for new ships and demand for big container ships (capacity > 10,000 TEU’s) skyrocketed during this period. For instance, at the Singapore port in last few years, though the number of vessel arrivals has declined by around 2% annually, the tonnage has grown by around 8.5% on an annual average basis. This suggests that more number of big vessels have been arriving at the port, shift of focus towards bigger container ships.
Sea Cargo Statistics at Singapore Port
Source: Yearbook of Statistics Singapore, 2008
The average age for the current available ships in the market is around 19 years, in addition to this majority of the shipment supplies are expected in 2009 & 2010. Most of the ship orders were placed in 2006 & 2007, few during early 2008 and usually it takes 2-3 years to build a ship. So, are we looking at a massive over-supply in next few years?? And what about the demand, is it expected to remain muted?? The latest report of World Bank expects the global trade to fall by 2.1% in 2009; IMF has projected the trade growth to slow by 4.1% for the same period. Economic problems in regions like US, Europe and some part of Asia have grown rapidly and till date we have not seen any hopes of recovery at least in couple of years. This suggests the demand is expected to be suppressed for some more time. The demand for short routes between Asian countries should continue to rise in all conditions.
During Dec’08, the cumulative order book stood at 597mn dwt and more than 90% of the orders came from Asia alone. The break-up of order book is South Korea 36.5%, China 35.9%, Japan 18.7%, and ROW 8.9%. Most of these new ships are expected to join the existing fleet over next two years against the demand that is expected to decline due to global slowdown. Importantly, more than 55% of the orders are for dry bulk carriers, moreover the demand for the products like iron ore, grains and steel for which these carriers are used is expected to decline by 5%, 3% and 1% respectively during 2009. This would put additional pressures on this segment.
Supply Scenario in dry bulk segment
Source: Industry Reports Source: Industry Reports
The above argument states that the demand supply scenario would go against the sector as demand is declining against huge supply expected in next two years. According to a recent report from China International Capital Corporation Limited (CICC), the Chinese shipyards experienced 34% drop in the new ship orders (existing contracts) in the first 3 quarters of 2008, as compared to the global average of 27%. Based on the available markets estimates and adjusting according to the current market environment, below is the demand supply table till 2010 –
Dry Bulk Supply / Demand Balance (million Dwt)
|
Year |
Demand |
Supply |
Gap |
Utilization (%) |
|
2005 |
297.1 |
333.8 |
36.7 |
89.0 |
|
2006 |
321.2 |
356.9 |
35.7 |
90.0 |
|
2007 |
361.4 |
380.5 |
19.1 |
95.0 |
|
2008E |
366.2 |
382.8 |
16.5 |
95.7 |
|
2009E |
355.2 |
415.3 |
60.1 |
85.5 |
|
2010E |
373.0 |
453.0 |
80.0 |
82.3 |
Source: Morgan Stanley Estimates, Own calculations
Assumptions –
|
Year |
Demand growth |
Cancellations |
|
2008E |
-5% |
5% |
|
2009E |
-3% |
5% |
|
2010E |
5% |
5% |
Thus, with the contraction in demand for shipping capacities and increasing supply of new vessels, the day freight rates are expected to be low and muted. Some recovery can be seen as these rates have been really hammered (decline of above 90%) when compared to decline in other industries. On a rebound, the Baltic Index might move up above 1000 levels; but forget a rapid recovery in index and the day rates. The target on BDI for 2009 is 750 and for 2010 its 1150. With most of vessels lying idle, the impact of dry docking will be felt on the revenues of the shipping firms. The business fundamentals are against the sector at least for 2009.
Spot rates vis-à-vis BDI Index
Source: Bloomberg
Scrapping Activity to increase
Another interesting relation that the shipping markets have seen during the last few years is that higher freight rates lead to less scrapping activity, building up an inverse relationship. Considering the current macro economic environment and already collapsed day rates, the sector is expected to witness increased scrapping of old ships due to high costs of maintenance. As mentioned earlier, at the current rates, the ship owners are barely able to cover their costs. In such an environment its better to keep the ships idle rather than incurring losses by moving them. If the current situation remains existent for another couple of months, the scrapping activity might become far more active. The movement of the BDI will provide a clear direction for such an activity. Imarex, an exchange for freight derivatives, the future contracts on BDI have been actively trading but the Bid Ask spreads are huge. The Imarex BDI Index Futures contract (BDIFuts) is aimed squarely at the cash equity and equity derivatives trading community as well as portfolio managers looking to increase their exposure to movements in the dry bulk shipping markets.
The most latest available BDI Future prices (as on 16th Jan’09) –
|
Contract |
Bid |
Ask |
Spread |
CLOSE |
|
BDI SPOT |
|
|
|
881 |
|
BDI JAN09 |
800 |
950 |
-150 |
875 |
|
BDI Q109 |
850 |
1200 |
-350 |
975 |
|
BDI Q209 |
1250 |
1600 |
-350 |
1 300 |
|
BDI Q309 |
1450 |
1900 |
-450 |
1 625 |
|
BDI CAL09 |
1275 |
1650 |
-375 |
1 406 |
|
BDI CAL10 |
1800 |
2200 |
-400 |
1 925 |
Source: Imarex
Day rates to push company’s NAV’s downwards
Despite, more than 90% decline in the BDI as well as day rates, the future for the shipping industry remains bleak. However, the shipping stocks have been hammered by more than 70% further downside is expected on the back of weak earnings outlook for next two years. The sector should be kept out of the investment themes for 2009 at least despite of this severe correction. So, it is expected that due to the growing gap demand and supply will raise negative sentiments towards the sector and freight rates should not bounce back more than the normal profit levels and remain weak over the next two years. Thus, considering the replacement value and weak future cash flows due to low day rates, the NAV’s for the shipping companies have gone down dramatically.
The current crisis probably will hit shipping companies more than the harbours. Presently mostly, the governments or public authorities build and operate the harbours. Thus, investing in harbours could be an attractive area for shipping companies by entering into public private partnerships. This will also help them to diversify their invested portfolio. Well, long term outlook towards the sector, post things get back to normal, remains positive. Globalization might again lead to buying interest in the sector post 2010 once the outlook on global growth begins to turn positive. Once the accelerator is there on the global trade, the industry might again witness increasing day rates.
DISCLAIMER
The information and opinions expressed in this report are compiled by the Author from the sources as are available and which the Author believes to be reliable. But the Author shall not be responsible for its completeness and accuracy. This report is for your private information only and the Author is not soliciting any action based upon it. Opinions and views expressed and statements made herein are of the Author as of the date appearing in this report only and its opinion may change. This report and any recommendations contained herein may not be applicable to specific investment objectives; financial situation or particular needs of recipients of this report and should not be used in substitution for the exercise of independent judgment. If any person takes any action based upon this report, the Author shall not be responsible for any loss incurred by such person.
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