Rough Seas Ahead For Shipping Stocks

By Eugene Bukoveczky | August 30, 2009 AAA

Is it just a pause that refreshes, or is one of the world's largest economies now showing definite signs of indigestion after having recently gorged itself on a steady diet of stimulus spending?

IN PICTURES:
Seven Ways To Position Yourself For Recovery

Recent signals emanating from central planners Beijing suggest that the party may be coming to an end as the government now considers throwing the credit lever into reverse. Over the first six months of this year, a record $1.1 trillion has been lent by Chinese banks to local industry, prompting a massive expansion of capacity in heavy industry sectors like steel, coal, cement and power.

That, in turn, prompted a commodity buying frenzy that was largely responsible for the parabolic rise in the price of such key commodities as copper, oil and iron ore over the last few months. Data for July already reveals a marked deceleration in Chinese demand for those commodities. (Thinking of putting money into China? Read Investing In China for an overview of this growing economy.)

Lease Rates Now Expected To Tumble
For the purveyors of bulk shipping services, this frenzy of commodity buying by China helped kick-off a mini-boom in demand for their services that saw the Baltic Dry Index, a key measure of spot lease rates for shipping, stage a quick snap-back during the first half of 2009 following a catastrophic 99% plunge the previous year as the recession virtually brought global trade to a halt.

After hitting what increasingly looks like a recovery peak in early June, the Baltic has been trending lower; a bad sign for the global economy and an even worse sign for the shippers. Recently released survey data revealed that analysts and fund managers who follow the sector now expect lease rates to fall by 50% from current levels to about $18,000 a day before the end of the year.

Shippers Bracing For Perfect Storm
If this second downturn in as many years does materialize, it could constitute a perfect storm for the industry. It would come at a time when shipping capacity is poised to explode as new build ships come down the slipway in record numbers. For bulk carriers alone, the construction backlog now amounts to about one-third of the existing fleet, prompting some industry observers to conclude that in the near term, supply could exceed demand by 50 to 70%.

Battening Down The Hatches
But while a return to rougher seas now looks likely, earlier moves by many of the shippers to lock in lease rates under long-term time charter contracts, moves that had earlier been panned by pundits as too conservative as spot rates soared, are now looking particularly prescient.

Across the industry, time charter contract coverage levels are now at 77%, with operators like Diana Shipping (NYSE:DSX) at the high end with 95% of their lease rates under contract coverage, while more risk-prone players like Excel Maritime (NYSE:EXM) and Dryships (Nasdaq:DRYS) still holding spot market exposures of 35 and 32% respectively. Recent time charter contracts have been done at the $18,000-a-day level, a rate at which most operators will turn a profit.

Curiously, investor sentiment as to the efficacy of this strategy still remains mixed. In a recent online survey conducted by The Street, nearly half of investors favored Dryships, despite its relatively high spot market exposure, and only one quarter favored well-hedged Diana. Less well liked was Genco (NYSE:GNK).

The Bottom Line
The bulk shipping stocks have been conspicuous under-performers so far this year as investors appeared to look past the China-driven price spike in rates to give greater attention to the bearish overcapacity issue confronting the industry. Now that lease rates are poised to head lower, this under-performance is likely to accelerate during the second half of the year.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

You May Also Like

Related Analysis
  1. Chart Advisor

    Profit From Holiday Spending With This ETF

  2. Chart Advisor

    How To Trade The Biggest U.S. Companies In 2015

  3. Chart Advisor

    'Tis The Season For Food And Beverage Stocks

  4. Chart Advisor

    Commodities Set Up For A Continued Move Lower

  5. Chart Advisor

    Are These Uptrending Stocks About To Move Higher?

Trading Center