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My Notes on Dry Bulk Shipping

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August 09, 2010 – Comments (9) | RELATED TICKERS: DSX , GNK

As I learn more about the dry bulk shipping industry, I thought I'd post my thoughts so that others may learn with me.  I figure there's still very little interest in dry bulk shippers, but I figure anyone who owns GNK with me or any of the other shippers would be interested in reading and maybe sharing their thoughts and suggestions.

As of now, I'm concentrating on dry bulk shipping.  I may look into containerships and tankers later on, but I figure I should learn all I can about dry bulk shipping before moving onto a completely different set of shippers.


Dry Bulk Vessel Types

There are standard types of ships.

Capesize: These are large vessels that cannot pass through canals and must travel around capes.  These are typically around 175,000 dwt (dead weight tons).  These are the big kahunas.  There are larger vessels, but the Capesize is the common large vessel.

Panamax: These are vessels designed to pass through the Panama Canal.  The dimensions of the ships are modified accordingly.  These are typically around 75,000 dwt. 

Kamsarmax: Kamsarmax ships are about as big as Panamax ships, but they're a bit longer and designed for Port Kamsar.  These are typically around 82,000 dwt.  As you can see, ship types are often named after the ports or canals through which they travel.

Handymax (or Supramax): These are roughly 40,000 to 60,000 dwt.

Handysize: These are roughly 10,000 to 40,000 dwt.

The bulk of ships seem to belong to the Panamax, Handymax, and Handysize designations.  There are other special types besides the Kamsarmax, but you really only need to know Capesize, Panamax, Handymax, and Handysize. 


The Baltic Dry Index

This index tracks the price of moving dry bulk goods by sea.  The major goods seem to be coal, iron ore, and grain.  The relevance of the BDI as a forward-looking indicator is debatable, as the fluctuations are sometimes off the charts and not very predictive of future economic conditions.  Ship supply is a major factor in the swings, among other factors.  It seems to me that shipping rates remain fairly subdued except in times of major commodity demand, as in 2007 and 2008. 

Warren Buffett once stated in one of his annual letters to shareholders that capital-intensive companies are likely to earn only a small amount above cost except in times of extreme demand.  He was obviously talking about the now discontinued textile mills of Berkshire Hathaway, but it seems to me that the dry bulk shipping industry isn't much different. 

The BDI started to gain steam in 2007 and stayed very high for 2H 2007 and 1H 2008 before starting to crash down in 2H 2008.  4Q 2008 saw an immense drop in the BDI to extremely low levels.  The index improved some in 2009 and has remained relatively flat since 4Q 2009, up until the recent collapse.


The Demand Side

As I stated above, the major dry bulk shipping goods seem to be grains, coal, and iron ore.

Grains: Obviously, this is the agricultural component.  I don't really follow agriculture stocks very much, but I'm guessing the consumption across the world is relatively stable, since we must always eat.  Events such as fires in Russia disrupt the supply side, which may lead to higher grain prices over the world.

Coal: I suspect that most electric utilities over the world still use coal-fired plants.  Much of the electicity usage is most likely stable.  Besides the steady state component, the unstable component is tied to economic production.  When factories ramp up and fully utilize production capacity, utilities actually benefit quite nicely.  This leads to higher consumption of coal.  I work at a steel plant and I can tell you that steel capacity at least in the US is far from being fully utilized.

There is also metallurgical coal, or coke.  For steel companies that utilize blast furnaces, coke is one of the ingredients used to make molten iron, which is then oxidized into molten steel.  Steel is used in construction, automobiles, and appliances the most.  Any major economic recovery would see a recovery in steel as well.

Iron Ore: Like with metallurgical coal, I believe the major use of iron ore is to make steel.  Steel companies with electric arc furnaces (think Nucor) actually melt down scrap steel, but I'd bet the majority of steel companies still use blast furnaces.  Again, iron ore consumption will ramp up in the face of economic recovery.  Cars, buildings, bridges, etc. would contribute to iron ore consumption.

As you can see, coal and iron ore demand are heavily dependent on economic growth.  How does this affect dry bulk shipping? With growth likely to be slow, dry bulk rates probably aren't going to spike anytime soon. 


The Supply Side

Much of this information was taken from Genco's Q1 Earnings Call Presentation here

Whenever people mention dry bulk shippers, oversupply is mentioned.  It's even mentioned by many of the shipping companies in their interactions with the press and investors.  Taken from GNK's annual report, the average ship age is 15 years.  I also see in their presentation that 27% of the dry bulk ships are 20+ years old.  Before 2009, the rate of scrapping vessels remained very low.  When you're making money hand over fist, you tend to utilize your vessels and wait till later to scrap them.

With the BDI slumping terribly in 2009, almost 260 vessels were scrapped last year.  In Q1 2010, just under 40 vessels were scrapped.  I've yet to see Q2 numbers myself.  Before 2009, vessels were scrapped at a much slower rate.  With the overall old age of the fleet, I expect more vessels to be scrapped over the next few years.  It simply costs more to maintain older equipment and I've heard on several occasions that newer vessels obtain more profitable charter rates.  It's also true that the accident rate of dry bulk ships increases tremendously as a ship's age advances past 20 years.

So there's an oversupply of ships and a lot of them are probably going to be scrapped.  That sounds good, but we've yet to consider the new ships that will be delivered over the next few years.  I read in EGLE's 2007 10-K that new ships being built at the time would increase supply by 57% over the next 3 years.  Since the 10-K likely came out in February 2008 or March 2008, it's safe to say that delivery of new ships is not over.  Almost all across the industry, long-term debt or shares outstanding have ballooned as companies figure out ways to pay for their new ships. 

Despite the number of ships that seem to need scrapping, it seems that the oversupply condition will not go away anytime soon.  I liken this to the steel industry.  The steel industry seems to be in a longtime condition of oversupply, with utilized capacity almost always below 100%.  Referring back to Warren Buffett's quote about the textile industry, the steel industry is not so different.  It's extremely capital-intensive and profits generally won't be outrageous except in times of extreme demand.  Dry bulk shippers seem to be in a similar situation as the steel companies of the world. 


Final Thoughts

Dry bulk shippers rely on the overall economy as many other companies do.  Steel companies will dictate a large portion of that growth, along with other manufacturers.  Anyone serious about dry bulk shippers would have to consider macroeconomic factors that spill over into many other industries.

With rising debt levels and an oversupply of ships, I'd stick to companies with newer fleets and good control of debt.  Last but not least, I'd look for companies that are making money consistently.  Companies making money quarter after quarter and year after year are likely to have newer fleets, good management, or a combination of both. 

9 Comments – Post Your Own

#1) On August 09, 2010 at 3:41 AM, Underdog122 (< 20) wrote:

For what it is worth, I used to act as an operations agent working closely with many dry bulk shipping lines and their clients. The ports I handled were all on Gulf Coast (Tampa, New Orleans, Mobile, and Houston). Companies like Vulcan Materials -VMC (Parent company of Vulica Shipping), Cemex - CM and Martin Marietta - MLM. These companies all are heavy into building materials such as limestone, granite, gypsum, and cement. If you track most of them, stocks were booming prior to the housing bubble bust, and I can say from experience, we had ship traffic non-stop during this time. Naturally, they have slid substantially since 2007. I would however say that if anyone has an inclination that the housing market will take an upturn, more specifically, in the new build area; these companies would be a steal at their current prices. 

Again, just a thought.

 

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#2) On August 09, 2010 at 9:43 AM, Teacherman1 (57.22) wrote:

Good post bullishbabo. A lot of good general information in it.

I agree that well run companies with newer fleets will do better.

A majority of the companies have gone either to all contract, with or without profit participation, or a combination of contract and spot charters.

Some of the dry bulk shippers also have tankers or container ships as part of their mix.

A surprising number of these companies are relatively new and have had to run leaner, more efficient operations almost since their inception.

In my opinion, NM is one of the best. They are, and have been adding a lot of Capesize vessels to their fleet, but because of the way they are run, have been able to buy at good prices. They have not borrowed excessively to finance individual ships, but have used a combination of financing and cash ( sometimes through affiliated companies that are structured differently), so that as they come on line, they are already under long term contracts (usually with profit participation), at prices sufficient to service the debt and still provide a profit.

They are set up to do "OK" in the current environment and if and when the global economy gets to a point of sustained recovery, will do much better than "OK".

The thing that attracts me to them is the relatively cheap price these stocks currently have.

Some will do better than others, and there might even be a loser or two in the mix, but overall, I like the shippers I own for the longer term.

Didn't get enough sleep last night, so this may be a little rambling, but just wanted to add my two cents. 

Have a good day and a great week ahead in this ever changing market.

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#3) On August 09, 2010 at 11:00 AM, Tastylunch (29.26) wrote:

great post Bullish always like your stuff! 

Grains: Obviously, this is the agricultural component.  I don't really follow agriculture stocks very much, but I'm guessing the consumption across the world is relatively stable,

I don't think this assumption is true

I don't have the numbers on me, but the developing world's populations primarily India and China are trading up into better food (or rather more per person) pretty rapidly  There is a lot of upward potential price pressure. E.g. look at China's rapidly developing obesity problem as they westernize their diet...

FWIW Jim Rigers is long term bullish on ag.

 

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#4) On August 09, 2010 at 12:48 PM, TMFBabo (100.00) wrote:

@Underdog122: Interesting story about ship traffic.  I guess the thing to do then is to buy stocks of companies that make decent money now.  An uptick in demand would then hopefully increase market prices beyond analysts' expectations and create a soaring stock.  With (usually) overly optimistic analysts, that might prove tough.

@Teacherman1: Thanks.  I agree, many shippers seem to be going more to long-term contracts.  I saw many of the "shared profits" charters in GNK's fleet utilization summary as well.  I have indeed seen some dry bulk shippers have containerships or tankers in their fleets as well.  I think that provides healthy fleet diversification that provides more steady revenue streams.

NM seems pretty solid.  Considering Capesize vessels' pathetic charter rates right now, I think it'd be pretty smart to buy Capesize vessels with the rates so low. 

I have mixed feelings about dry bulk shippers.  Like I said above, I like the shippers that have new fleets and are currently making money.  That rules out companies like ESEA and TBSI, which I was ironically rollercoastering all of last year.  Since these things tend to move together, it seems I was rollercoastering the wrong stocks last year; I should've been in the safer ones.

I'd consider the following for purchase: DSX, EXM, GNK, NM, PRGN (DSX and GNK are my favorites)

@Tastylunch: You make an excellent point about agriculture.  After going on and on about the demand side and supply side of dry bulk shippers, I go on to generalize about agriculture, lump it all together, and oversimplify it by saying "we all eat" just because I didn't know about the topic.  I didn't discuss wheat, corn, and all the other different commodities and the different supply/demand characteristics.

It's interesting to note that of all the (excellently timed) calls UltraLong made in March 2009, his double long agriculture ETF is one of the few underwater picks from that time.  Based on the terrible relative underperformance over the past year and a half, I'd say agriculture might be a decent bet just based on that tidbit of info.  More research is obviously warranted.

It's an interesting dynamic you note about people in developing countries and their changing diets.  I also know that Jim Rogers is no slouch and he must have some very good reasons for his agriculture bet.

Thanks for your comment as usual.  I've actually learned a good deal from your random comments here and there.

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#5) On August 09, 2010 at 1:33 PM, ikkyu2 (99.32) wrote:

I have been watching bulk shipping since 2005, when I found a negative post here on CAPS about DRYS.  It was one of the first stocks I ever analyzed; I had a copy of 'Beating the Street' in one hand and I was going over the financial statements.  I decided that I didn't agree with the negative pitch, the financials looked good, and I put a small amount of money in my retirement account into DRYS.  And quite by accident, caught a ten-bagger.  (Since then, I've read quite a lot of negative things about Economou, the DRYS CEO, and have become less sanguine about the company's prospects.)

In the following years, I have been keeping an eye on DRYS, Diana, and a number of others and what I have noticed is that the stock prices are incredibly volatile compared to what you quite rightly note as the sort of boring, predictable nature of the business.  I guess that this phenomenon has to do with pricing power during times of peak demand.  But I don't see that we're going to be running the world economy at peak demand for quite some years to come.

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#6) On August 09, 2010 at 2:50 PM, rofgile (99.31) wrote:

I am currently invested in EGLE and NMM.  I plan to buy more dry shippers this year.

I am currently looking at PRGN, DSX, GSK as my next buys.

---

 EGLE is a nice buy, since they are mostly small boats.  EGLE has also been linked to being positively affected by the wheat pricing problems of late.  As they use mostly handymax boats, they might do better if there is wayyyy to many panamaxes being delivered compared to PRGN which is all panamaxes. (Each class of ships has a different shipping rate like a Baltic Dry Index).

 -Rof 

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#7) On August 09, 2010 at 11:08 PM, Tastylunch (29.26) wrote:

bullishbabo

Thanks for your comment as usual.  I've actually learned a good deal from your random comments here and there.

ditto I always pick up a new thing or two or three from your posts. This one was really great stuff. Really good basic overview of the industry.

I wish more people talked business/macro/stocks/markets on CAPS like you, Deej, Ultra, Binve and a few others do.

  I also know that Jim Rogers is no slouch and he must have some very good reasons for his agriculture bet.

Yeah check his opinions out on it, I think you'll find it interesting.  Ag is actually his generational mega play. More so than Gold or Oil or other commoditiues (I believe he just made a killing in Sugar). The way he puts it is (paraphrasing heavily here) that the wealthy of today are bankers, the wealthy of the next twenty-thirty yeras will be farmers.

Long term I'm very bullish on ag (primarily grains, sugar and cocoa) and water. The challenge is that there aren't as many slam dunk ways to play it as some other commodities.

But there are definite pitfalls in playing it. For one perishability of the goods means you have to spend more time trying to time correctly. If you are off by a season in ag you really feel it.

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#8) On August 10, 2010 at 1:48 AM, foolishdoog (< 20) wrote:

Nice post. Recently I took a position in DRYS as they traded below $4/shr and have traded in and out of them for a while with mixed results. As a reminder, they are very different than the average dry bulk company with more than half of their revenue coming from their drillship business. And that's with two drillships contracted.I can go on and on about DRYS but I'll stop with the risk reward seemed attractive below $4 as I value the dry bulk business at $4. Moreover, I'm only 21 so my portfolio beta is a little high.

Your oversupply issues were well covered. However, you need to touch up on spot pricing vs long term charters.

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#9) On August 10, 2010 at 3:09 AM, TMFBabo (100.00) wrote:

@ikkyu2: Congrats on the 10 bagger! I hope to have one myself some day.  I've found that many of the strongest opportunities have some sort of black mark that comes with them.  If that weren't the case, they wouldn't fall so much.  I guess we just have to do our our due diligence and trust ourselves when we make that call.

The overly volatile BDI creates some interesting short-term opportunities, so I'd probably be very tempted to sell my GNK if it were to suddently pop up to even the mid to high 20s in short order.

@rofgile: I agree on small boats being attractive right now.  Capesize rates seem very low at the moment.  I'll have to take a closer look at the other dry bulk shippers before writing them off.

@Tastylunch: I agree, there aren't enough investing posts here these days.  Blogging etiquette is flying out the window too, with some people triple posting when it could all fit in one post. 

As with oil and metals, I prefer to own stocks that deal in certain commodities rather than the commodities themselves.  Chosen correctly, I think the agriculture stocks could benefit me more than holding the actual commodities themselves.

@foolishdoog: I guess I should research DRYS before writing them off.  I have too many other companies I want to research first at this point, so it may unfortunately take me a while to get there.  I had heard though that DRYS was involved with drilling and such.

You make a great point about spot and time charters and how I didn't cover it at all.  I realized that only after I'd already posted.  It's an important aspect, as it determines how the companies decide to make money off their ships.

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