The Ship, the Sea, and...the Value Opportunity?(Part one)

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

At the moment, a typical investor would stay far away from shipping stocks. Weak global demand has led to an unprecedented oversupply within the industry. In turn, over the past five years, ship owners have been struggling with declining chartering rates and diminished profits. On the other hand, a contrarian investor would probably think to dig deeper into the market's trends seeking a possible value opportunity. As Baron Rothschild wisely advised centuries ago,

“Buy when there is blood in the street, even if the blood is your own.”

When we refer to Greek shippers, there are certainly plenty of reasons to anticipate fruitful returns once the industry has recovered. Greek shippers carry a legacy of strong performance in the space backed by carefully planned growth strategies. Moreover, despite the current turbulent market environment, most of them have managed to stay on float. When the industry starts to show the first signs of improvement, the Greeks will be the ones leading the way.

Market Trends

In order to get an overview of demand and supply trends in the shipping industry, analysts usually examine the Baltic Dry Index. The index provides useful insights by measuring changes in the cost to transport fossil fuels, metals, and grains by sea. It covers Supramax, Panamax, Handysize, and Capesize carriers and takes into account the price levels for 23 different shipping routes, product to transport, as well as the time for delivery.

Since the sub-prime crisis occurred, the BDI has been performing poorly. Tight demand for seaborne commodities, as a result of slow global economic growth, and record deliveries of new buildings from shipyards in Asia, crashed vessel earnings. Thus, after reaching the peak of 4,660 points in 2009, the index fell off the cliff. For 2012, the BDI's average performance was the lowest in over two decades.

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^BDIY data by YCharts

However, lately, some good news from the industry gave ship owners a breath of fresh air. Since the beginning of the year, the Index has gained about 7.4%. This accelerating trend was attributed to a 5.5% increase in average daily rates for Capesize vessels, and a 37-point climb in the BPI (Baltic Panamax Index), a sub-index of the BDI. For 2013, the Panamax market, which has the largest order book, is expected to remain under pressure due to the prevailing imbalance between demand and supply of vessels.

On the plus side, according to analysts' median estimation, daily rates for Panamaxes will average $9,500 this year, marking an increase of 23% compared to last year. Even though, the estimated daily rate is lower than the required break-even point of $11,000, still this upward trail signals a break out of a long-term downtrend. Thus, investor sentiment is highly likely to be positively affected.

The reasoning behind this overall restrained optimism lies largely on expectations for strong Chinese imports. China may be dealing with slow growth rates, but its appetite for raw materials remains robust. Throughout 2012, augmented steel production in the country led to an 8.4% boost in iron ore imports. Chinese iron ore imports are expected to follow an upward pace in 2013 as the country continues to focus on urbanization activities. Imports of crude oil were also elevated and posted an almost 7% growth on a year-over-year basis. 

Moreover, over the past three years, China has been steadily becoming a net importer of coal. Even though, domestic production is relatively high, low international coal prices and decreased shipping costs created incentives for increasing coal imports. In the first 11 months of 2012, China imported about 245 million tons of coal indicating a 34.9% year-over-year growth. For 2013, this trend is projected to continue.

Potential winners

Following the recent pickup in the BDI, shipping stocks ended the first week of 2013 with advanced returns. Greek shipping companies stood among the industry's winners and recorded significant gains. DryShips (NASDAQ: DRYS) went up by more than 25%. Diana Shipping (NYSE: DSX) gained about 15%. Eagle Bulk Shipping (NASDAQ: EGLE) also went up by about 20%.

DryShips used to be a big name in the space. However, over the past five years, the stock has witnessed immense deterioration. At the moment, DryShips is certainly not investors' favorite primarily due to its growing debt pile. Most of the shipping companies are burdened with short-term and long-term liabilities. Both tanker and dry bulk spot charter rates have been below cash break-even rate for quite some time, resulting in declining operating cash flows. DryShips, though, has much to worry about as most of its charters are expiring. The company has contract coverage of approximately 33% and 22% of total calendar days for 2013, and 2014, respectively.

Nonetheless, DryShips has managed to sustain a leading position for two reasons. First, it has one of the biggest fleets in the industry. It operates a fleet of 59 vessels, including dry bulk carriers and tankers, with its fleet utilization reaching 100%. Secondly, it has a 65% ownership stake in OceanRig UDW (NASDAQ: ORIG), an offshore drilling contractor. OceanRig acts as a safety cushion for DryShips. It provides a more diversified cash flow stream and allows DryShips to take advantage of the comparably positive conditions in the offshore drilling business. At the moment, all odds are against DryShips. Once the industry starts to rebound, the firm could benefit from its strategic position and long experience in the space.

Diana Shipping started the year with two new contracts. Recently, the firm employed two of its Panamax vessels for a period of minimum 18 months. As of Sept. 30, 2012, fleet utilization stood at 99.3%. Diana could be an intriguing investment compared to its peers. Its balance sheet shows remarkable financial discipline. The company ended the third quarter of 2012 with $452 million in cash and cash equivalents. Its current liabilities, including current portion of long-term debt, stood at $58 million. Diana's solid cash position has allowed the company to invest in expanding its fleet. This aggressive strategy suggests anticipation for enhanced operating cash flows in the future.

Another strong player in the space is Navios Maritime Partners L.P. (NYSE: NMM). Navios Partners was formed in 2007 by Navios Maritime Holdings. Since then, the partnership has been enjoying a firm sales growth supported by long-term time charters with an average remaining term of four years. These long-term charters acted as a barrier against the market's volatility. Consequently, for the past five years, Navios Partners has been able to reward its shareholders with juicy dividends. At the moment, the stock offers a double-digit dividend yield, which is impressive considering the current tough market environment. Based on analysts' median target price of $15.86, it has at least 13% appreciation potential.

Bottom line

At the moment, I would not advise investors to rush into starting a position in shipping stocks. However, all of the above mentioned stocks are trading with considerably attractive valuations and possibly limited downside. In other words, they are as cheap as it gets. Overall, I do suggest that they are worth watching for upside potentials.

The industry as a whole has been depressed for over four years now. The recent surge in the BDI does not necessarily translate into a sustainable long-term improvement. The main market indicator, which allows some optimism for the future prospects of the shipping industry, is the rising pace of Chinese imports. The oversupply within the industry will remain a major concern for at least another six months. I plan to analyze in depth this issue in a follow-up article.

FaniKel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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