An incidental story appeared in the Financial Times in mid-January that appeared to make little sense. The arcane sounding Baltic Exchange Dry Index-the spot day rates that shippers charge-had collapsed to levels not seen since the height of the financial crisis. Indeed, since late October, day rates for the largest drybulk vessels had fallen from $46,284 to $8,894 as of early April.
These rates were less than operating costs, which, according to industry observers, run around $15,000 a day for the largest dry bulk vessels, called capesize ships. More head-scratching is prompted by the fact that shipping is generally considered a proxy for global growth. These rates should not be plummeting if the world is supposedly in the midst of economic recovery.
This has translated into poor equity results. While the S&P 500 was up 15.7% over the past year through early April, the Capital Link Drybulk Equity Index [shipping.capitallink.com], which is comprised of 17 U.S.-based drybulk companies, was off by 10.3%.
Whether this suggests an investing opportunity or a bear trap depends on the answers to several basic questions.
Has shipping supply and demand fallen out of whack, compromising pricing power and equities?
Is the global recovery weaker than many economists suggest it is?
Are shipping industry finances more complex than spot rates convey, involving forces more dynamic than one would think would be associated with such capital-intensive operations? Getting a handle on the shipping business is an essential first step to deciphering the sector.
Shares tend to be small-cap stocks and often pay attractive dividends that range from 3% to 8%. Though the industry is perceived to be a longer-term macro play driven by economic growth and global trade, ocean shipping rates and equity prices are volatile. The sector is diversified, with rates and profitability varying depending on the vessels, mainly dry bulk, tankers and container ships. They collectively represent 84% of tonnage capacity, according to Douglas Mavrinac, head of the Maritime Group of the global investment bank Jefferies.
Shipping firms typically manage just one type of vessel. Each type carries distinct products whose markets behave very differently from one another. For example, while demand for finished Chinese goods could mean a boon for container shippers, a slowdown in crude oil demand could cut into tanker rates.
But there is another factor that's unique to the sector that affects pricing and profitability. Unusual spot rate volatility (see graphs below) appears to be based on geography-where last-minute marginal demand is coming from and where empty ships are.
It's as if, according to Mavrinac, day rates are a matter of the tail wagging the dog. Interestingly, the recent move to slow down ship speeds to improve fuel efficiency has in essence decreased mile-tonnage availability (i.e., supply), which improves pricing power while enabling companies to better choreograph ship movement.