Buy Shipping Stocks Now for Big Upside

by Susan J. Aluise | August 29, 2013 9:15 am

Buy Shipping Stocks Now for Big Upside

Shipping sector investors have been on a wild ride in recent weeks as higher demand and fewer new ship orders have begun to boost rates and buoy the fortunes of this troubled sector.

However, the rising tide isn’t lifting all ships — companies like Frontline (FRO[1]) with broad exposure to the traditional tanker niche are really feeling the pinch.

Frontline stock plummeted more than 11% on Wednesday after it reported a second-quarter loss of $1.54 a share — more than triple the 50-cent loss analysts had expected.  Revenue beat Wall Street estimates, but still fell by more than 33% year-over-year to a mere $121.2 million.

Also weighing on the company was a vessel impairment loss of $81.3 million in the first half of this year on three ships it leased from Ship Finance International (SFL[2]). FRO characterized the tanker marketplace as “massively oversupplied” and urged ship owners to scrap vessels more than 15 years old[3].

But the challenges facing tanker shippers extend beyond FRO’s specific woes.

The growth of shale oil production in North America has caused oil exporters to hold the line on prices by cutting production. Lower oil production translates into lower rates for shipping stocks — tanker day rates have slipped below their operating costs. This is bad news for owners of popular Suezmax and Very Large Crude Carrier (VLCC) tankers like FRO, Teekay Tankers (TNK[4]) and Nordic American Tanker (NAT[5]).

Dry bulk carriers are a different story, though. While they’re far from experiencing fair winds and following seas, their fortunes are more favorable than their tanker cousins.

Many dry bulk shipping stocks have prospered recently on two hopeful signs: strong growth in China’s iron ore imports and a slowdown in new ship construction. That tide of optimism helped lift shares in dry bulk carriers like Paragon Shipping (PRGN[6]) and Star Bulk Carriers (SBLK[7]), which have shot up by roughly 40% and 30%, respectively, in the past few days alone. Both companies recently reported second-quarter earnings that swung to the black (although PRGN’s profit was a mere $17,000, that beats losses in the year-ago period).

So what’s different about the dry bulk niche?

Perhaps the best measure of health for dry bulk shippers is the Baltic Dry Index (BDI), which reflects how much it costs to move raw materials by sea.

There are few better examples of volatility than the BDI. It began the year below 700, but skyrocketed in June to nearly 1,200. Shipping rates have swung wildly since then, moving down — then up — a total of 350 points since July 1 to reach current levels around 1,170.

Of course, back in the white-hot market of mid-2008, the BDI hit a record high of nearly 11,800, and that was a turning point for the industry.

While the BDI was so elevated, companies placed orders for fleets of newer bigger ships to accommodate all that business. But those ships emerged into a global economy that was vastly different than when the orders were placed. In the Great Recession, demand (and rates) plummeted — while shipping stocks were saddled with a lot of expensive new ships they could not afford to operate profitably.

It’s easy to see why shipping stocks have been struggling to stay afloat. Shipping is one of the purest supply-and-demand-driven sectors; too much supply with constrained demand makes for pitifully low rates — sometimes rates that don’t even cover the cost of operating the ship.

The good news: Fewer new ship orders will reduce capacity and boost rates (and profitability) — as long as demand continues to grow.

Bottom Line

Shipping rates won’t recover their 2008 levels anytime soon, and that will continue to hang on the sector. But at least dry bulk shipping stocks can take a lesson from airlines — by cutting capacity. Scrapping old vessels and exercising discipline when it comes to new construction will eventually tilt the supply/demand curve back in their favor.

Granted, you can’t overlook the sector’s vulnerability to slower growth in China and other trends, but you should give strong consideration to stocks like PRGN and SBLK. They’re well-managed, very cheap and there is a potential for significant upside.

But tanker-focused companies have a much tougher challenge — oversupply is more acute, and import-export activity in oil production is taking a hit from shale oil. FRO’s struggling under a mountain of debt and is very easy to pass up, but even Nordic American — one of the most solid tanker stocks — is tough to recommend right now.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities. 

Endnotes:
  1. FRO: http://studio-5.financialcontent.com/investplace/quote?Symbol=FRO
  2. SFL: http://studio-5.financialcontent.com/investplace/quote?Symbol=SFL
  3. scrap vessels more than 15 years old: http://www.bloomberg.com/news/2013-08-28/frontline-urges-scrapping-of-tankers-aged-over-15-amid-ship-glut.html?cmpid=yhoo.
  4. TNK: http://studio-5.financialcontent.com/investplace/quote?Symbol=TNK
  5. NAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=NAT
  6. PRGN: http://studio-5.financialcontent.com/investplace/quote?Symbol=PRGN
  7. SBLK: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBLK

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