What Does the Future Hold for Shippers?

Colin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

“This is the best time since the Vikings,” said shipping king John Fredricksen of the shipping market on June 1, 2008. At that time, his oil tankers were making $100,000 per day, and some of his drybulk carriers were making even more. Of course, that comment came just as a red-hot 5-year bull market ended in a devastating collapse of the index. Though Fredricksen had been socking away fat dividends from his shipping businesses and diversifying his assets, other investors weren’t so lucky.

The shipping business is cyclical and is a function of simple economics: as supply goes up and demand goes down, prices fall. While the global economic meltdown caused demand for commodities, and therefore vessels, to fall, the supply of tankers and drybulk ships has been increasing ever since. This is because vessels that were ordered during boom times are still being delivered. The order book size (showing ships that have been ordered and are under construction, but aren’t in the water) has begun to decline--this makes sense as existing ships are cheap to buy and shipping companies are low on cash--but it is still at record highs and will continue to increase the supply of ships in the near future. On the supply side, things don’t look too good for shipping rates in the medium-term. 

Demand for drybulk ships is not projected to catch up with the rapidly increasing supply in the medium-term. This is due to a lackluster world economy, translating into a sluggish demand for commodities. It is predicted that this year, demand for drybulk vessels will increase a modest 3%, but supply will increase another 14%. In the words of Sverre Svenning, director of research at Fearnley Consultants AS, “The biggest problem is that the fleet is continuing to expand like there’s no tomorrow.” (Nasdaq)  So while the current glut has caused shipping prices to fall, the imbalance between supply and demand is only expected to get worse. 

While these projections are bad for companies’ fundamentals going forward, they are also causing big money to stay on the sidelines for the time being. Derek Prentis, an 86-year-old shipbroker and consultant who is the Baltic Exchange’s longest-serving member, has said “I can’t see much happening until March or April 2013.”  (Nasdaq) Nonetheless, the very John Fredricksen who cashed out of the market at the top recently created the privately-held shipping company Frontline 2012

This spinoff holds Frontline’s (NYSE: FRO) newest vessels, as well as much of its debt. However, this probably isn’t an indicator that the shipping industry will become profitable in the near future--the deal was made under special circumstances; Frontline was running out of cash, giving Fredricksen the opportunity to purchase new oil tankers efficient enough to still make a profit during these tough times while throwing a lifeline to the company in which he holds a 33.78% stake.

It must be noted that the ships in Frontline 2012’s fleet are an average of 3 years old, compared with an industry average in the double digits. This means that the ships are able to break-even in the depressed shipping market because of their low maintenance cost and that they won’t be in the scrapyard when the market finally recovers. Other companies, such as Freeseas (NASDAQ: FREE) and Eagle Bulk Shipping (NASDAQ: EGLE) that own old fleets, however, are currently losing money. It is likely that their fleets will be scrapped before the market recovers, meaning there is little reason to invest in these companies.

As old ships are sent to the scrapyard, supply will fall to meet demand and the market will eventually go through another cycle. Although things are probably going to get worse before they get better, the reality is that it is impossible to accurately predict the perfect time to buy. Well-capitalized shippers with newer fleets, such as Diana Shipping (NYSE: DSX), and Navios Maritime Holdings (NYSE: NM), are still able to eek out earnings during tough times and will be the companies that survive in the long-term. These companies still offer significant upside; they are at once value investments due to the current state of the Baltic Dry Index and growth investments as they strategically acquire deeply discounted vessels from struggling shippers.


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