No, it's not the storm you're thinking of. I'm talking about a financial storm.
Shipping companies, ranging from dry bulk shippers that ship dry goods, to oil tankers that ship oil, are some of the most volatile stocks around. They are extremely risky--even more riskier than bond insurers in my eyes--and very sensitive to commodities and global trade. If you can tolerate high risk and ever want to place macro bet on improved global trade, these are some of the best companies around. They are a good proxy for commodities and Chinese growth.
Conversely, if economic growth slows or world trade falls apart, as it has, shipping companies are some of the worst ones to own. Many of their stocks are down far more than the broad market. If economic growth doesn't pick up soon, it looks like these shipping companies may be looking at a perfect storm:
As a key player in the commodities sector, the shipping industry is regarded as a barometer of what's ahead, and right now shippers are in the eye of the storm.
Since June, the cost of moving material by sea has fallen by more than 80%, according to the Baltic Exchange Dry Index.
In December, it hit a 23-year low and despite a recent jump shippers are barely covering their costs.
Nearly 400 ships used to carry containers have been laid up worldwide as owners scramble to reduce capacity. In a bid to recover some of their costs, some companies are copying oil tanker owners by offering their excess ships as floating storage facilities to manufacturers looking for a place to store their empty freight containers.
A bigger problem is the looming arrival of hundreds of new ships. During the boom years when demand for bulk carriers and oil tankers was at its height, many shippers put in big orders for new vessels they hoped would allow them to stay competitive, never imagining economic conditions would turn so quickly. They now face the prospect of having to pay for thousands of new ships for which there is no demand.
The London-based ship broker Howe Robinson recently warned of an impending "disaster" as the industry tries to cope over the next three years with the arrival of 3,000 bulk carriers ordered by 479 ship owners.
The company warns that the shipping industry is at the centre of the commodity storm and now faces its most serious crisis in 60 years.
It's difficult to say what the future may hold. If the world economy recovers--some are already placing big bets on supposedly imminent Chinese recovery--these companies should recover, although anyone owning shares will never recoup even half their losses. Otherwise, the shipping companies will face serious problems.
Stock prices of shipping companies are already discounting an extremely pessimistic scenario. Nearly all of them are down far more than the broad market, as you can see from the following chart:
I should note that many of them tend to pay out most of their earnings as dividends so their returns will be somewhat better than what is shown in this price-only chart.
It is possible that most of the negative issues, including the increased capacity coming on-stream, are priced into the stocks.
Sometimes people wonder how investments would differ between a macro investor and a value investor. Well, the shipping companies are a good example of investments that a macro investor would make but nearly all value investors would avoid (except in some special cases.) Shipping companies are good for macro investors because they are a pure-play bet on world trade, China, commodities, or whatever else one deems critical. The fact that they pay out most of their earnings right away means that you can realize profits easily. In contrast, if you bet on, say a copper mining company, it is possible that the company may waste profits (assuming your macro case is right) on buying out other companies, investing in dubious other schemes, and so on. In the latter case, the only way you can make money is if the market bids up the price of your stock.
A value investor would be hard pressed to buy these companies. Nearly all of them are commodity businesses that have zero pricing power. All it takes is for some dumb competitor to increase capacity (i.e. buy too many ships at the wrong time) and you can go bankrupt when the tide turns. These are also companies that likely have asset values that can decline precipitously right when you want to get rid of ships. When there is too much capacity, no one wants a ship--even at cheap prices (you literally have to scrap them.) In contrast, most other industries can recoup some value for their factories, equipment, or real estate even during recessions.
There are some cases where value investors have invested in these companies. Mohnish Pabrai invested in Frontline 5 or so years ago. The shipping industry was, like now, struggling back then and Pabrai bet that Frontline will survive while others go bankrupt. I haven't read Pabrai's books so I'm not sure what gave him the confidence but I suspect it was the potential liquidation value. Right now, however, it would be extremely difficult to pull off the same tactic. Back then, the shipping companies weren't coming off a boom where thousands of ships entered the market.
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About This Blog
- Sivaram Velauthapillai
No, it's not the storm you're thinking of. I'm talking about a financial storm.