Archive for the ‘Shipping Sector’ Category

The Decline in the BDI Doesn’t Mean Much…

June 15th, 2010 Michael McDonough Comments off

The Baltic Dry Index (BDI) has fallen 28% from its recent high on May 26th, indicating to some weakness in the global economy.  The BDI tracks the prices of bulk carriers which are the life-blood of global trade carrying everything from iron ore to grain.  While the 28% decline may seem ominous, the BDI is being influenced by two outside factors that have very little to do with global economic health.  The first factor is that during shipping’s boom period, prior to the recession, a record amount of new ships were ordered that are only now being delivered creating a supply glut in the sector, while demand remains tepid at best.  Secondly, China’s unprecedented stimulus package, stoking the country’s demand for raw materials through new lending and infrastructure projects, gave the country enormous sway over the index as they were receiving the vast majority of dry bulk goods.  Further tightening in China without substantial offsetting demand increments from the remainder of the world—which are returning, but at a gradual pace—along with an armada of vessels coming online over the next several month will likely place continued pressure on the BDI, but not necessarily indicate a slowdown in the global economy. 

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One Month’s Not a Trend, But January’s Trade Data Could Point To A Slowdown in Global Trade

March 11th, 2010 Michael McDonough Comments off

Trade, the life blood of the global economy, has begun rebounding nicely since the trough of the global economic crisis.  But, January’s US trade data unexpectedly displayed a decline in both exports–the first decline in nine months–and imports, leading to a smaller US trade deficit, but also implying a potential slowdown in global trade.  As I said, one month does not indicate the start of a trend, but this is something that should be monitored moving forward.  The chart below illustrates the relationship between the U.S. trade deficit and the Baltic Exchange’s Baltic Dry Index (BDI).  As you can see the sharp decline in the US trade deficit during the economic crisis–indicative of a slowdown in global trade–coincided with a collapse in shipping rates as measured by the BDI.

US Trade Deficit (White Line) vs. the BDI (orange Line):


Cantor Upgrades DryShips (DRYS) To ‘Buy’ From ‘Hold’

January 25th, 2010 Michael McDonough Comments off

From Cantor Report:

Cantor/DRYS: We Upgrade DRYS To BUY (From HOLD) On Valuation, Rig Exposure

* We raise our price target to $8 (from $7) based on our 7.0x
EV/EBITDA multiple to our new 2010 EBITDA forecast of $558 million
(from $544 million). Given the discrepancy between our target and
the current stock price, we upgrade DRYS to a BUY (from HOLD). Our
price target is also supported by our charter-adjusted NAV of
$7.80 per share.

* With nearly all of its dry bulk fleet fixed under period charter
contracts, we suggest the primary upside catalyst for the stock
over the near-term will be securing employment and financing for
the 5th and 6th drilling rigs.

* We raise our 4Q:09 EPS estimate to $0.27 (from $0.26). For 2010,
we now look for DRYS to report EPS and EBITDA of $1.05 and $558
million (from $1.00 and $544 million), respectively. Finally, we
introduce our 2011 EPS and EBITDA forecasts of $1.22 and $743
million, respectively.

* Our new estimates are based upon our revised dry bulk rate
forecast (see “The Ship’s Log – 4Q:09 Review and 2010 Outlook”)
published concurrently with this note.

* Management has stated its intention of growing the dry bulk fleet
through potential distressed transactions over the near-term, with
a focus on the Panamax and, to a lesser extent, Capesize vessel
classes. However, we believe the primary focus will be on fixing
drilling rigs 5 and 6 under charter contracts, as those charters
will likely be necessary before bank financing can be secured.


Cantor Raises Price Target for DSX

January 8th, 2010 Michael McDonough Comments off

Cantor Fitzgerald raised the price target for Diana Shipping (DSX) to $18 from $16 based on higher rechartering assumptions.  Cantors presently holds a ‘Buy’ rating on DSX.  DSX is one of the few shippers within the dry bulk space on which I hold a relatively constructive view.  Compared to other shippers the company has a healthy balance sheet, and is well position to take advantage of distressed asset prices.  In fact the company recently initiated a two year expansion program with its purchase of a new vessel.

Source: Bloomberg & Capital Link

Shipping rates over the near-term will likely remain volatile. Why? China.  China still holds a disproportional influence over shipping rates, and when a single player holds that much sway, volatility is inevitable, especially when that player is China. Therefore, anyone closely following the shipping sector needs to be very aware of what is happening in China. The secondary driver is of course a tug-of-war between a growing supply of ships and gradual increments in global demand for the service. Over the long-term, shipping rates should remain volatile through-out the year, but on average remain relatively subdued.


Be On The Lookout….

November 12th, 2009 Michael McDonough Comments off

Tomorrow I will be publishing an interesting piece on’s Real Money section titled “Coal in your stocking: hypocrisy, senility, or common sense?“  The piece discusses Mr. Buffett’s recent acquisition of BNSF, and highlights his indirect bet on coal.  The piece also highlights some trading ideas in the coal and railroad sectors that you may find interesting if you agree with Mr. Buffett’s implied investment thesis.


Finding a Complement to the BDI May Lie in the Rails…

September 24th, 2009 Michael McDonough Comments off

Carrying over from a theme I mentioned earlier this week in my column on, I began contemplating what frequent transportation index, if any,  would be a good complement the BDI as a forward looking indicator toward the global economy. My goal was to find something that could perhaps help factor out the impact of some of supply glut in dry bulk shipping sector.  What I mean is I wanted to find something that if moving up in conjunction with the BDI would almost certainly be good news for the global economy.  Concurrently, if the BDI was to remain static while the complementary index rallied, we might get some insight into the over supply of ship’s impact on the BDI.    After a few moments of thought I believe I found that index.

The major rail companies in North America release a weekly metric on railroad performance, which among other things measures the total number of rail cars on line.  I briefly mentioned this index in a piece I published several weeks ago, showing the strong correlation between CSX’s cars online and the BDI (see chart).

CSX vs. BDISource: Bloomberg, Capital Link, CSX

However, to get a true gauge of potential economic performance we would need to include more than just CSX, hence I created an aggregate index with car on line data from the following companies:  BNSF Railway Company, Canadian Pacific, CSX Transportation, Kansas City Southern, Norfolk Southern, and Union Pacific Railroad.  Once you factor in these additional companies the relationship becomes far less apparent (see chart).

Rail Volumes vs. BDISource: Bloomberg, Capital Link, Railroad Companies

The reason behind this will be fodder for another article, but it is possible that CSX has a higher exposure to the commodities, which were in high demand from China.  Nevertheless, what has been a horrible year in terms of aggregate rail volumes looks to be bottoming.  I recently heard from executives running most of the companies within this aggregate index, and in general their outlooks confirmed a possible bottom, but by no means a rapid recovery.  They were are also optimistic regarding the effects a potential record US harvest could have on rail volumes, a view echoed by participants in the panamax sector.  Finally, this is more or less in-line with my view that the US and developed nations will return to growth, albeit at a measured pace, with developing nations outpacing the developed world.  Now, lets see if the BDI and rail car volumes will agree…


Is a Falling Greenback Leading to Smooth Sailing for Shippers?

September 18th, 2009 Michael McDonough Comments off

I have received several inquiries regarding the recent divergence between the BDI and my dry bulk shipping index (DBSI), and thought I should touch on the subject.  First and foremost I believe that a large portion of the divergence can be explained as a US dollar story.  Also, recent weakness has been mostly isolated to larger capesize vessels, which means shippers with low or no exposure to that sector have been somewhat buffered.  Prior to the global financial crisis, a weakening dollar helped lead to an unprecedented surge in commodity prices and shipping rates, this had a direct positive impact on shippers’ asset values and rates.  As the crisis hit investors around the globe became more risk averse and flocked into US government debt.  This liquidation of risky assets caused a massive retrenchment in commodity prices and a significant rally in the US$.  Now however, as investors again grow less risk adverse, the value of the greenback has begun to depreciate, and with it we are again seeing a rally in commodity prices and flows back into riskier assets.  However, unlike the prior example we have not seen, and are unlikely to see, any significant appreciation in shipping rates over the near-term, more on this later.  But, speculation over what some believe may be a V-shaped recovery have potentially over-valued some assets that could experience a possible sell-off, leading to a interim increase in risk aversion and an appreciation in the dollar.  Don’t get me wrong, I do believe the overall global economy is improving, however, I feel it will be at a more measured pace with some volatility, and in this context I believe some debt spreads and equity markets could be overvalued.  This is especially true in the shipping sector.

Source: Bloomberg & Capital Link

Source: Bloomberg & Capital Link

The chart below overlays my DBSI with the inverted US$ index, and as you can see the correlation over the last few months has been very significant.  This relationship also explains why the DBSI has largely been ignoring declines in the shipping rates.  At least over near-term, it appears that a bet on the sector essentially equates to a bet against the US$.  As I mentioned yesterday, another reason the temporaneous breakdown in the relationship between shipping rates and the DBSI is shippers’ higher proportions of fixed long-term contracts, reducing the sensitivity to the BDI, however, this also limits upside.  In conclusion, an appreciating greenback will only move shippers’ stocks up so far, without a corresponding increase in shipping rates, which is not on the horizon.  Therefore, with the bleak outlook for shipping rates combined with the potential for what I believe could be another market correction before growth returns on a more measured pace, I would be hesitant to place any long positions on the sector at current values.

Source: Bloomberg & My Calculations

Source: Bloomberg & My Calculations

As an aside:  FBR Capital Markets, this morning published a bearish report on the dry bulk sector due what they believe will be relatively few order book cancellations.  The company said, “After our recent meeting with the largest and most advanced shipbuilder in China, China Shipbuilding Industry Corporation (CSIC), in Beijing, China, we reiterate our Underweight position on the dry bulk industry. CSIC confirmed our thesis that there will be fewer-than-expected order book cancellations.”  My DBSI returned some recent gains yesterday falling -1.1%.  The index is still realizing a weekly return of 9.1%


Potentially Good News For Smaller Ships

September 17th, 2009 Michael McDonough Comments off

A potential record US harvest could help buoy rates for small to mid-size ship rates.   What was a relatively mild and wet spring and summer has created conditions for what is setting up to be one of the nation’s biggest harvests.   The U.S. Department of Agriculture is projecting a total corn crop of 12.954bn bushels, which would be the second highest on record, and a record soy bean crop of 3.245bn bushels.  Some industry analysts believe these estimates could even be conservative, without a September frost.  The weather conditions that have led to this potential harvest haven’t come without some risks; cool temperatures have pushed back harvest time by up to two to three weeks, which increases the chances of a September frost in the mid-west farm belt. As an aside, changes in the near-term weather forecast for the mid-west could have a large impact on grain prices.  Optimal conditions would be sunny 80 degree days, whereas any frost forecasts before the completion of harvest could place some upward pressure on prices.

Soy Exports

Source: USDA

So what does this have to do with shipping?  While the US experienced optimal crop conditions, other countries, like China, have faced sub-par conditions and have reduced production of soy beans.    Overall the US supplies 45% of the world’s soy bean exports.  In 2008 China imported 37.44mn tons of soy beans, which according to my calculations is roughly 1.3bn bushels, with nearly 99% coming from the US, Brazil, and Argentina.  In fact, in 1Q09 80% of China’s record soy bean imports were from the US.  Early indications on the US Gulf Coast, where most domestic grain is shipped to China have been positive.  Lloyds List, a leading maritime and transport news terminal, quoted one regional broker saying, “The US Gulf has come alive with a bit more inquiry for October, and going forward, a number of sales have been done.” He went on to say, “The Chinese have bought quite a lot of grain out of the US Gulf, and those inquiries have either been with the Chinese or the grain houses.”  This should be especially positive news for panamax rates, which are facing pressure from both decreased iron ore and coal demand.  Capesize rates are unlikely to benefit much, if at all, from this demand as they are not typically involved in grain trade.


Norton Rose Shipping Industry Survey Paints Bleak Picture

September 14th, 2009 Michael McDonough Comments off

Lloyds List, a leading maritime and transport news terminal, reported the results of the first major shipping industry sentiment survey since the beginning of the economic downturn that was conducted by Norton Rose.  The survey “has painted a bleak picture of the sector with the vast majority of companies predicting that economic conditions will get worse before they get better. “  The results showed that 81% of those surveyed expects that it will be at least one year before the number of banks lending to the sector increases.  Additionally, 79% do not anticipate that lending will return to its pre-crisis levels within three years.  Possibly more concerning was this, “Of the shipping companies polled, 63% expected to see major bank enforcement of problem shipping loans, while 43% thought that this process would peak within the next six to nine months.”  It is important to note that this survey was not specific to the dry bulk sector.  The piece concluded with this comment from Harry Theochari, Norton Rose head of transport, “Notwithstanding the large number of cancellations of new orders, there is still a huge number of newbuildings, in all sectors, to be delivered between now and the end of the year. Unless there is a marked pick up in the world economy it is my view that ship market values and shipping stock prices will continue to decline until at least the end of the year.”  The shipping industry survey helps support my view that the industry is in the midst of a protracted downturn with limited upside potential over the short-term.  The DBSI is presently trading -2.6% below the level when it was introduced on May 22nd 2009.

Source: Bloomberg, Capital Link, & My Calculations

Source: Bloomberg, Capital Link, & My Calculations


Lehman’s Impact on the BDI & Shipping (Then & Now)

September 14th, 2009 Michael McDonough Comments off

In retrospect, the widespread panic that engulfed the world’s financial markets after the fall of Lehman Brothers may have been somewhat overblown considering the actual long-term impact of the event, which was significantly mitigated through innovative monetary policy.  But at the time, this did not prevent an almost immediate shut-down of credit markets around the world affecting most, if not all, facets of the global economy.    The shipping sector was no exception.  Within shipping there is an essential financial instrument called a ‘Letter of Credit’ (LOC).   LOCs facilitate the bulk of global trade by guaranteeing the buyer’s funds will be delivered to the seller upon delivery of the goods.  These instruments are issued mostly by financial institutions.

As I mentioned, Lehman’s demise led to an immediate lockup in global credit markets, including LOCs.  To help quantify this I created the chart below, which plots the TED spread against the BDI from 2006. For this application I slightly modified the traditional TED spread and used 3M LIBOR Basis Swap against the Fed Funds rate; this measure acts as a yard stick on implied counterparty risk as LIBOR is the rate at which banks are willing to lend to each other.  You will notice that the unprecedented jump in the TED spread coincides with an extraordinary drop in the BDI from a peak of nearly 12,000 to a low of 663 in only a matter of months.  To help put this into perspective, an article by “The Independent” noted that in June 2008 a shipment of coal from Brazil to China would have totaled US$15mn per voyage compared to US$1.5mn by October, and rates moved even lower from there.

Source: Bloomberg & Capital Link

Source: Bloomberg & Capital Link

Without LOCs, the shipping sector came to what was essentially a standstill. Even where demand still existed, buyers were unable to get the credit to guarantee payments.  A quote from an article in the Financial Post published in October of last year put it best, “There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit,” said Bill Gary, president of Commodity Information Systems in Oklahoma City. “The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy.”

How times have changed.  In the year since Lehman’s collapse, credit conditions have improved considerably, as demonstrated by the TED spread, which has begun reverting back toward its historical average.  Better credit conditions have provided increased liquidity allowing buyers around the globe easier access to LOCs.  This alone however does not mean smooth sailing for the shipping sector, but what it does mean is that the sector is highly unlikely to re-test the lows experienced during the end of 2008 and early 2009.