Getting On Board the Shippers

 | Mar 26, 2014 | 12:30 PM EDT  | Comments
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Last week, I had the opportunity to attend the eighth annual Invest in International Shipping Forum presented by Capital Link in New York. Nicolas Bornozis and his team do a great job of bringing the leading lights of the shipping industry together in one place.

The conference is peppered with Greek-accented English, but it is clear that shipping is a truly global industry. My interest in the shipping sector is focused on the dry bulk sector, which features ships that haul cargoes such as coal, iron ore and grains on long-haul routes such as Brazil-China, Australia-China, etc.

The first question on shipping, especially dry bulk, is, what's going on in China? The seaborne movement in coal and iron ore has been absolutely vital to the growth of China Inc. China's locally sourced iron ore tends to have relatively low ferrous content, and its domestic coal industry is at best inefficient, at worst deadly.

So the first takeaway: China looks OK. The consensus seemed to be that while Chinese growth may be slowing somewhat, there aren't any signs of bubble-bursting from the Middle Kingdom. At lunch, legendary investor Wilbur Ross tipped China to grow about 6% this year, below consensus forecasts, but still high enough to pique his interest and keep his firm invested in the sector.

In the dry bulk space, the key indicator is the Baltic Dry Index, which is a measure of time charter pricing for vessel voyages. Many observers, including TheStreet founder Jim Cramer, use the BDI as an insightful proxy for the global economy. The BDI was recently quoted at 1,600, after hitting a high of just over 2,300 in December. The index has recovered from its February swoon to the 1,400 level, which I believe had as much to do with normal seasonality (the Chinese shipping industry virtually shuts down for the New Year/Golden Week holiday) as any perceived emerging-market panic.

But where is the BDI heading next? The consensus among the management teams was that it is headed upward. A recurring theme among management presentations was a bias toward spot-market exposure ("going long") as opposed to signing longer-term time charters, which can be viewed as a short position.

The ship owners are expecting a pickup in rates as China gets back to business, but I am not 100% convinced, and I will be looking very closely at Chinese data for March as they are reported a few weeks from now.

I believe that China is experiencing a secular slowdown as the country matures from a high-growth/expanding-infrastructure economy to one that is more dependent on domestic consumption (like the U.S.). At the conference, for once, a billionaire actually agreed with me. Ross mentioned that his bullishness on China stems not from bullishness on its steel sector but on a pickup in domestic consumption. However, as an investor who has fond memories of the large profits I made buying call options on the dry bulk shippers in 2007 and 2008, that infrastructure-to-consumption scenario makes me less likely to buy stocks in that group now.  

Dry bulk rates tend to be driven by "capesize" rates, and these gigantic ships are best used to carry the heaviest cargoes, such as coal and iron ore. If the mix in shipping is changing to lighter cargoes such as grains and soybeans to feed that domestic consumption, I don't believe that's positive for dry bulk rates.

It's a megatrend, and obviously it could be counteracted in the short term by supply-demand trends, which for the first time in six years look favorable for shippers, but it bears watching.

So, if you agree with me, be careful in a sector which has already priced in a BDI bounce and stick with the best in breed: Navios Maritime Holdings (NM). Navios certainly has the strongest balance sheet in an industry riddled with debt and write-downs. For my Portfolio Guru model portfolio, I own Navios Maritime Partners (NMM), a master limited partnership that exists to pull ships on long charters from parent NM, and which has steady cash flows from those long-term deals.

If you disagree with me and are wildly bullish on the sector, the way to play is DryShips (DRYS). This stock has truly been the widow-maker in the dry bulk space, and I just have trouble buying a stock at $3.33 that I was selling in 2008 above $120. But it is really long in terms of its fleet's spot-market exposure, and if you are wildly bullish on dry bulk, that's the way to play. DryShips also owns 59.4% of Ocean Rig (ORIG), an ultra-deep-water drilling company, which is a very attractive asset in my estimation, but I would choose to play Ocean Rig directly rather than buying the parent. 

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