Containers Falling Cargo Ship

Shipping is sinking (again). Two of the three main shipping sector indices are heading lower again, and the other one has gone nowhere for years. Oversupply of ships has met tepid demand to float stuff across the world’s oceans. With everything so low in the water line, is an investment in shipping the ultimate contrarian trade?

Bulky raw materials and finished goods have to be moved around the world from the people that produce them to the people that need or want them. Ocean going ships play a huge part in this bulk global trade.

Trains, trucks and pipelines take up the rest of the slack, where markets have land links. Planes are generally only any good for low bulk, high value items.

Shipping falls into three broad sectors:

  • Dry bulk cargoes, meaning non-liquid things loaded directly into hulls such as iron ore, coal and grains like wheat, soybeans and so on.
  • Containers, meaning things that fit into big metal boxes that can be stacked neatly.
  • Tankers, meaning liquid commodities such as oil and liquid natural gas (LNG).

The supply-demand curve for shipping is pretty steep. What that means is that the prices paid to ship goods and materials around the world are highly volatile. Big rises and big falls, in short order, are the name of the game.

The supply of ships changes slowly, as it takes years to get financing, put in orders to shipyards, weld a mass of steel together and receive delivery.

When customer demand in the sector is booming, and prices are high, shipping companies tend to ramp up their orders for new ships. Very often loads of those new ships come into service just as demand softens. This sends prices crashing, and it then takes many years for the oversupply to work its way out of the system.

That’s when orders for new ships collapse. Older ships are decommissioned and often scrapped entirely. Then, just when things are coming back into balance, demand picks up – even ever so slightly – and shipping prices rocket again. There simply aren’t enough functioning ships to go around.

In the middle of all this sit the ship brokers. They “fix” ships, in the lingo, meaning they bring together ship owners with people that need to move cargoes, negotiate prices, and live off the commissions for doing so. For historical reasons, the biggest brokers are headquartered in London. They certainly used to be a pretty boozy bunch – like old school stock brokers – although that may well have changed these days (but probably hasn’t).

When it comes to dry bulk shipping, the benchmark price index is the Baltic Dry. Here it is for the 30 years from 1985 to 2015.

Baltic Dry index - the long run

And here it is more recently, up until today.

 

Baltic Dry index - past five years

You can see in the first chart the huge bubble in prices that started in 2003, collapsed, and reinflated to massive proportions by 2007. That was when we had a “commodity supercycle” as buying of bulk commodities was booming, especially in China.

Then came the global financial crisis (2007 to 2009), the shipping bust, and the collapse. Followed by a nice bounce into 2010, another collapse in 2011 and then a slow drift to ever lower levels.

In fact the Baltic Dry index plumbed record lows in February 2016. Then it rose a bit, and has recently been falling sharply again. That’s consistent with the fears of a slowdown in global trade if the USA plunges into protectionism and trade wars – most significantly with China (perhaps). But, of course, these are real market prices we’re talking about – not speculation.

Next up is the HARPEX, an index of prices to ship containers produced by shipping broker Harper Petersen & Co.

HARPEX container ship index since 2001

It’s not exactly the same pattern as the Baltic Dry, but there are clear parallels. There was a huge spike in prices to ship containers running into 2004 and 2005. That was followed by a mini-bust, another mini-bubble into 2007/2008, financial crisis bust, recovery, and then mostly sideways. It’s now nearly at it’s lowest point again.

Finally there are the tankers. This next chart shows the Baltic Tanker Clean Index (in blue) and the Baltic Tanker Dirty Index (in green). It only goes back to 2011, as I couldn’t find a longer time series. “Dirty” refers to tankers that ship dirtier products, such as crude oil. “Clean” refers to ones used to ship refined products that don’t leave so much residue.

Baltic Tanker indices (clean and dirty) - August 2011 to January 2017

Tanker prices haven’t been as weak as bulk and container prices, but neither have they been especially strong. Although I note the prices have risen in recent months.

Overall, three of the main shipping price indices are really down in the dumps, and the other is just “so so”. Since this is such a cyclical and volatile industry, when it comes to pricing, it could spell a great opportunity for those prepared to go against the grain. Namely, anyone looking for a bargain to buy into.

This could be the ultimate contrarian trade at the moment, as everyone is so concerned about a potential collapse in global commerce. Buying struggling shipping stocks could be a way to make a lot of money in the next few years.

But it comes with a health warning. More than one actually.

First, just because things are bad, doesn’t mean they can’t get worse. Second, investing in this sector is only for the brave – meaning people with a high tolerance for big price swings, and the patience to see it through.

I have a senior contact in the ship broking industry who I’ve known for about 25 years. Based in Singapore, he runs the Asian dry bulk operations for one of the very biggest (possibly the biggest) London ship brokers, and has been in Asia for 20 years.

I’m going to try to see if I can find out more, although he can be difficult to get hold of. He’s on the other side of the world, always busy, not a big one for emails (and certainly not Facebook) and in a 24 hour a day job. The last time we met in person was about two years ago, in England.

Back in 1998 I stayed with him and his wife, a university friend, when they lived in Hong Kong. Every dinner or late night drink was interrupted with a call from a customer (anywhere in the world) or ship owner (very often Greeks and Iranians).

In the meantime, you should see this all as more of an observation than a recommendation. But if you’re interested in putting some money into play in this beaten down sector then there’s a handy ETF that covers all the sectors.

It’s called the Guggenheim Shipping ETF (NYSE:SEA), and at the current price of US$12.90 it’s trading not too far above its late 2008 / early 2009 lows. At that time it very briefly dipped below US$8 on two occasions, but was mostly above ten bucks during the thick of the financial turmoil.

Based on last year’s distributions SEA yields 5.8%, net of fees – and despite the weak sector. Dividends in 2016 were half of the previous year and 13% up on 2014. But of course there’s always room for a further fall.

According to the fund manager, SEA had a price-to-book ratio (P/B) of 0.7 at the end of September (it seems they haven’t updated the quarterly figures yet). P/B is a useful measure for companies that are heavy on fixed assets, like these.

The price is up 9% since end September, which implies a P/B today that’s still less than 0.8. That means the companies trade below liquidation value on average, assuming the balance sheets are vaguely accurate. (Liquidation value is when P/B equals one. In other words all the assets less all the liabilities are the same as the traded market capitalisation of all the shares.)

Just one more thing to note. The biggest holding, AP Moller Maersk, is 21% of the fund. That’s a huge Danish container company with a market capitalisation of US$34.4 billion – even at these lows.

So there’s concentration, but with a massive market leader from a mostly sane country (and the original source of my family name, I might add). The rest of the holdings are spread across 26 other companies.

Buying into shipping right now – in the midst of deep pessimism and low prices – could be the ultimate contrarian trade. Just remember that it’s high risk and not for the faint hearted.

On the other hand, “fortune favours the brave”, so they say. But the brave can also wind up in bad shape, or in the ground. So if you do go into this beaten up sector, make sure you do it with your eyes wide open.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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