09 May 2012

Dry-Bulk Shippers Still in Troubled Waters: Companies likely to restructure in 2012 as they navigate dire straits.

Oversupply has kept dry-bulk shippers in the brig, and it will take some time before they are squared away. Strong demand for the dry-bulk trade continues to be fully offset by available capacity in the existing world fleet. Despite record-breaking scrapping rates and elevated slippage rates, oversupply is expected to keep a lid on freight rates for all of 2012. When the Baltic Dry Index--which measures shipping demand versus supply--reached a 25-year low Feb. 3, some industry participants called for a bottom. However, we think headwinds will weigh heavily for some time, and we would delay investment in this market until the order book trims down and the rate of new orders weakens. We think this is likely to occur in late 2012, at the earliest, or early 2013.

Despite the near-term pains anticipated in dry-bulk shipping, we think many of the companies we cover are fairly valued to slightly undervalued. Initial first-quarter earnings reports have reaffirmed our view that 2012 will be difficult for ship owners and, as a result, our dry-bulk shippers have traded lower. We think Eagle Bulk Shipping and Genco Shipping & Trading are the most exposed to a prolonged weak period in shipping. Conversely, Diana Shipping and Navios Maritime Holdings are our two favorite picks to weather an extended downturn.

China Still Fueling Demand, but So Is India

Chinese demand for iron ore and coal continues to be the biggest driver in the dry-bulk trade. According to the World Steel Association, Chinese steel production increased 8.9% to 694.5 million tons in 2011, increasing its share of world steel production to 45.5% in 2011 from 44.7% in 2010. Despite the recent slowdown, we're optimistic that China's appetite for iron ore and coal remains firm longer term, with a growing population leading to increased housing and infrastructure projects. In 2011, the emerging economy imported 687 million metric tons of iron ore, up 11% year over year, and increased coal imports used in steelmaking and power generation by an estimated 13% year over year. China accounts for 60% of iron ore consumption worldwide and is responsible for 35% of the global dry-bulk shipping trade.

India has also become a major dry-bulk consumer since it has taken initial steps to industrialize and urbanize. To keep pace with expanding steel and electricity production, India coal imports have increased 25% compounded annually since 2006. According to the Central Electricity Authority of India, elevated demand levels should continue, since 65% of new power generation is projected to be coal-fired. The country now imports more coal per year than the United Kingdom, Italy, France, and Germany combined.

We expect China will remain the dominant steel producer and consumer worldwide, with India the fourth-largest (behind the United States and Japan), and we expect these countries will fuel demand growth over the long run. The global steel and iron ore trade reached a record 1.1 billion metric tons in 2011, increasing imports for the 10th consecutive year, and we think the demand for dry-bulk commodities will remain healthy in 2012 despite a slowing Chinese economy.

2012 Deliveries Signal Oversupply

Ship scrapping is on pace to reach an all-time high for the second consecutive year, and slippage rates are expected to remain elevated in 2012. While these trends are positive for ship owners, we think higher scrapping and slippage rates are not enough to mitigate oversupply.

We think the 100 million deadweight tons, net of delivery delays and order cancellations, that are still scheduled to enter the global dry-bulk fleet in 2012 will carry forward the oversupply issues that have plagued the industry. While we're encouraged to see the global order book materially trim down to 28% of the existing world fleet (fleet stood at 627 million DWT as of February 2012), compared with 45% a year ago (fleet as of February 2011 was 545 million DWT), we're still concerned about the scheduled 19% supply growth rate. However, we like that scrapping rates are on pace to mint an all-time high for the second consecutive year. As of February, the market had scrapped 4.0 million DWT compared with 2.4 million DWT in the comparable prior-year period and 22.3 million DWT for 2011. Scrapping in 2010 amounted to 5.9 million DWT. After accounting for new highs in scrapping, we estimate the vessel supply growth to be around 15%. Still, given our expectations of 6%-8% growth in demand for dry-bulk trade, we estimate net oversupply of 7%-9% will keep a lid on freight rates for all of 2012.

Source: By Paul Choi. 9 May 2012

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