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.
Ship Financing Remains
Scarce
In 2012, we've seen several companies
restructure or seek restructuring with depressed shipping rates, forcing owners
to examine their liquidity position. It appears that ship financing has become
more difficult with banks attempting to minimize their shipping loan
portfolios. Western European banks, the traditional financiers to the shipping
market, face very difficult market conditions. We think the sovereign debt
crisis, stagnant economies, and increasing default rates have led to scarcity
of funds for financing vessel acquisitions and tougher covenants. Still, we
think lenders are willing to work with better-capitalized ship owners that have
the balance sheet strength or solidly locked-in charter coverage for additional
financing opportunities. Moreover, we think 2012 will entail several more
restructurings and some industry consolidation, as independent ship owners
struggle to deal with depressed shipping rates.
Baltic Dry Index
The BDI gives a pretty accurate
picture of the dry-bulk market's dire straits. We saw market weakness intensify
in the beginning of 2012 on the back of a flood of new-build deliveries hitting
the water in January. Owners with orders nearing delivery at year-end were
motivated to take the ships the following year; this "January effect"
allows owners to market their ships as being younger by one year. Deliveries in
January this year totaled 12 million DWT, a monthly record. With the additional
impact of the Asian New Year, which commenced two weeks earlier than usual, and
weather-related issues in Brazil temporarily reducing iron ore exports, the BDI
reached a 25-year low of 647 points on Feb. 3 as very little business was
conducted between Christmas and the end of the Asian New Year. We think the
index attracted some investor attention as a result, but industry fundamentals
show continued muted pricing, in our opinion. The BDI has slightly recovered
since, thanks to a pickup in iron ore fixtures and the South American grain
season getting under way.
Little Upside in the
Near Term
We anticipate both emerging and
advanced economies will drive decent demand growth for dry-bulk cargo, but we
see very little upside for the dry-bulk shippers we cover during the next 12
months. We think the industry is lacking a material catalyst for dry-bulk shipping
stocks, and we don't expect an improvement in rates anytime soon. This is
largely in part because the order book still represents 28% of the existing
fleet, and we believe the overhang will take at least two years to alleviate.
Though the BDI remains at historically low levels, we doubt any improvement in
rates will be enough to generate meaningful cash flow generation from any of
our ship owners. By our estimates, dry-bulk trade growth for 2012 is projected
at 6%, but fleet growth, although past its peak, is expected to remain
elevated. We believe 2012 will be another challenging year for the dry-bulk
market, with supply/demand fundamentals coming more in balance from 2013
onward.
We reiterate our very high uncertainty
rating for the industry and require a wide margin of safety in our discounted
cash flow analysis before recommending investment. We project additional
pull-downs in freight rates from 2011 averages for all asset classes and
generally predict softer cash flow generation for most of these ship owners,
with declines in EBITDA margins and operating margins during the next two
years. Beginning in 2013, however, we predict high-single-digit growth rates as
we see freight rates returning to somewhat normalized levels; in fact, we think
capital expenditures will be needed to fuel growth from that point. We think
Diana Shipping (DSX) and Navios Maritime Holdings (NM) are best positioned to
handle additional weakness in the dry-bulk shipping because of their stronger
balance sheets, ample liquidity, and solidly locked-in contract base.
Conversely, we think Genco Shipping
& Trading (GNK) and Eagle Bulk Shipping (EGLE) are the most sensitive to
fluctuating freight rates, as many of their contracts have rolled off in 2011
and a larger portion of their fleets is now subject to the spot market.
Additionally, Eagle is operating under amended credit agreements and is in
discussions with its lenders on a longer-term restructuring solution, which we
think will be necessary to remain viable beyond 2013. After coming off a mixed
first quarter, Excel Maritime Carriers (EXM) is operating under a favorable
restructuring of its $1.4 billion syndicated credit facility that provides
flexibility in 2012. The company and its lenders reached a principal agreement
to defer up to $100 million of installments, which were scheduled for payment
during the next three quarters, and to amend a handful of covenants through
Dec. 31, 2013. Furthermore, Excel has secured 67% of its 2012 available days
(100% of its 2012 Capesize fleet) on fixed-rate charters, which we think
insulates it in 2012.
Source: By
Paul Choi. 9 May 2012
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