Friday, July 31, 2009 5 comments ++[ CLICK TO COMMENT ]++

Shipping industry crashes into the rocks

(source: Image by AFP/Getty Images. Pictured: The cargo ship smashed to pieces just minutes after 31-strong crew were plucked to safety, By Daily Mail Reporter. Last updated at 9:36 AM on 12th October 2008)

One of the most volatile industries out there is the shipping industry. The transportation companies, in particular, are very volatile and only a few brave souls will ever invest in them. The stock price charts are volatile enough to scare off most investors.

Given the collapse in world trade, it shouldn't be surprising how badly the industry has been hit. The Economist has a story updating us on the present state of affairs:

World trade in general remains in its worst slump for generations, although it too is no longer falling. Two of the biggest shipping banks (RBS and HBOS) are in state-backed rehab. The parlous state of the world economy could mean more shipping companies following Eastwind Maritime, which went bankrupt in June. On July 28th Hapag-Lloyd, Germany’s largest container-shipping company, secured a €330m ($468m) bail-out from its shareholders while it seeks up to €1.75 billion to keep it from sinking altogether.

Worse, there is a huge supply of new ships on order and due off the slipways over the next four years. For bulk carriers alone, the backlog is equivalent to more than two-thirds of existing capacity.

Although the situation looks dire there are some green shoots that can be seen:

Analysts at ICAP Shipping Research in London shrug off the idea that there will be a glut, since shipments of cheap Australian coal and iron ore to China have for years been constrained by a lack of big ships. More giant bulk carriers will lower the prices of ores delivered to China and stimulate trade growth, they say.

The outlook for tankers is less clear because of the volatility of crude-oil prices. Rates recovered strongly in June, according to ICAP, partly because large vessels were in demand for storage, as oil companies waited for crude prices to strengthen... But lower demand will be offset by a scheme to phase out single-hull ships on environmental and safety grounds in European and North Atlantic waters. The decline in production from mature oilfields in the North Sea and Alaska also means that replacement supplies will have to be hauled longer distances by sea to the refineries of Europe and North America.

The part of the shipping industry headed for the choppiest waters is the container trade, which had steamed ahead gloriously since the mid-1970s. The forging of global supply chains in the past 20 years, the rise in merchandise trade and the emergence of China as the workshop of the world created growing demand. Vessels became gigantic, with the latest capable of carrying 15,000 standard containers. Now the box trade, as it is called, is in the midst of its first decline. AXS Alphaliner, an information service that tracks the trade, has estimated that some 15% of capacity will be idle by October.

Even though I post a ton of stuff seemingly unrelated to any viable investment idea I have, I think it is useful for amateur investors to expand their knowledge base and keep up with events. By glancing over an article like this, one may get a basic understanding of the business. Even if you don't invest in a shipping company, at least you'll learn, like I did, how the dynamics for container shipping companies is very different from the dry bulk carriers or the crude tankers. The time may come when one may consider investing in this industry. Mohnish Pabri made a killing investing in Frontline (FRO) when it was out of favour and a pure value stock, around 5 years ago. Shipping companies—or anything to do with China, emerging markets, trade, credit, or real estate—were overvalued hyper-growth stocks in the last few years but they may become value investments at some point.


5 Response to Shipping industry crashes into the rocks

Plan Maestro
July 31, 2009 at 6:50 PM

And my friend, I am all in having invested in two of them and waiting for a better price in three others. Several opportunities in this industry and you as a contrarian will love it. I also read Pabrai's FRO example. I still think that the margin of safety was not as clear as he wrote: FRO was/is in the spot market and it is much better to invest in chattered companies specially in an uncertain worldwide trade environment. But you can not argue with a trade for a 100% in less than 3 months.
I am leaving leave you background information to one of this opportunities in the most distressed sector in this distressed industry: container shipping.

It is a pitty that it raised 15%+ today and also that you can not invest in its parent (CMA CGM is a private company). But it is still dirt cheap very close to its 52 week low that was one week ago. Sorry for being so promotional :)

Check that whole board to understand the problems that companies like Hapaag-Lloyd, Zim, CSAV, Maersk and the shipyards are having.

Sivaram Velauthapillai
August 1, 2009 at 12:11 PM

I have neither read Pabri's books nor have access to his hedge fund letters, but his Frontline investment from a few years back is completely different from what has been happening in the industry in the last few years. When Pabri was investing in FRO 5 or 6 years ago, the industry was out of favour and, most importantly, no new supply was coming onstream. So, my impression is that he invested as Benjamin Graham would, and looked at liquidation value and potential upside if the industry normalized.

When Pabri was investing, shipping was not booming. The China growth story wasn't a mainstream thing. You may have seen Jim Rogers or someone like that talkign about it, but it was a non-mainstream view.

My opinion--I don't follow this industry so my view is based more on general macro views (you will know a lot more)--is that the current situation is nothing like when Pabri was investing back in 2004 or whatever. So we should ignore Pabri's strategy back then.

Shipping entered a massive bubble in the last few years because China, emerging markets, global trade, commodities, and so on, were very popular. Shipping company valuations made no sense a few years ago. Companies like Dryships (DRYS) was trading at something like 20x P/E based on peak earnings--this, for a cyclical!

I think if you are a very good bottom-up analyst and can pick off the survivors in the industry, you probably have some good investments to consider. You basically need to pick the winners and be sure that they are going to survive.

I think shipping is very risky because there is massive overcapacity. As The Economist article points out, so many new ships were built that many are just sitting in harbour. This is why stock prices of many shipping companies are down 80% or 90%, rather than simply being down, say, 40% or 50%.

I think contrarians can consider an investment at current valuations if they are bullish on certain macro factors. In particular, if you think China's GDP will stay about 8% and/or US GDP will go above 3%, and world trade will go back to the 2007 levels, these companies look cheap. I hate to say it, but I'm more bearish and think any positive macro outcome is temporary. I don't think world trade is going to go back anywhere near the 2007 levels--not just this year or next but maybe the next 10 years.

Anyway, good luck with your investment. There is potential for spectacular gains in this industry but the risk is extremely high as well.

Plan Maestro
August 1, 2009 at 2:53 PM

I would not say completely different because the shipping industry has been historically a boom and bust industry, China had been growing doucle digits since 1978, and after the 2000 demand driven bust  there was also an adjustment of supply with scrapping of obsolete vessels, bunkruptcy of marginal players and cancelation of orders.

All of these things are happening right now in the container industry, as you can see in the links that I provided, and it is a process that takes couple of years. So you do not need China growing at 8%, you just need it growing.

My issue with Pabrai's margin of safety analysis is that it was based on the very existence of a market for used tankers. That is a very big asumption to make because in distressed situations this asset markets collapse very rapidly, with prices that sellers are not willing to take in a buyers market. And that is happening right now in the container industry. That is a reason that I prefer  charterers/leasers with a margin of safety based on the revenue stream. If you add that most of these are trading well below tangible book value, even better.

Plan Maestro
August 1, 2009 at 4:13 PM

BTW, I completely agree with this parragraph:

"I think if you are a very good bottom-up analyst and can pick off the survivors in the industry, you probably have some good investments to consider. You basically need to choose the winners and be sure that they are going to survive."

It is a bottom-up analysis opportunity and you have to pick up your spots. You have to be very careful not only on the financial health of the company you are investing in, but also of its clients and shipyards.

And finally, I recommend reading "The Box". Besides giving an historical perspective of the booms and busts, it is a surprising history of a very simple technology that REALLY changed the world. Not that many has made much money of it, remiding Buffett's comments on the airline industry, but its cyclical nature has given opportunities for contrarian investors.

Sivaram Velauthapillai
August 1, 2009 at 8:25 PM

The problem you have is that the boom was so massive that it's hard to say how much suffering will materialize. It's sort of like trying to buy a technology (or media or telecom) stock in 2001. The tech boom was so massive that it depressed the economics for everyone. Even after prices collapsed 90%, it was tough to separate out a Cisco from Nortel or Lucent or 3Com. Amazon or Ebay were great but there were countless others that would have made one lose everything.

Just make sure you do your financial analysis and be conservative. The company you mentioned, GSL, seem unclear to me. I'm not sure if it has a ton of debt or not (Yahoo Finance numbers don't seem to show up properly). If it has debt, it'll be risky...

You are more of an expert in shipping and would know a lot more about this but let me write a post about how big the trade boom was...

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