Seaspan Corp. (SSW)

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Look beyond the shipping forewarnings

By John Dizard

Published: September 20 2009 09:07 | Last updated: September 20 2009 09:07

Shipping operators have, historically, had two alternating assumptions about their world: 1) we’re all going to be multi-billionaires; 2) we’re all going to die horribly.

The institutional and retail investors who have financed much of their expansion in recent years have their own less-than-fully-rational investment philosophy: whatever the Baltic Dry Index has done between yesterday and today tells us what will happen to our stocks over the foreseeable investment horizon.

That goes not only for how you time investments in shipping, but how to make sense of the market indicators, such as that Baltic Index.

The Index is calculated by the eponymous London exchange, which canvasses shipbrokers to find out the shipping rates for three categories of dry-cargo ships along 26 routes around the world.

It reflects demand for transport of such commodities as iron ore, coal, and grains along those routes, as well as the supply of ships to carry them.

In the months before the Lehman crash, it had started to turn down from its high above 11,700, finally plunging by 94 per cent between May and December of last year. Then it headed up again, presaging the other risk markets’ recovery.

Lately, ominously, it has declined to just under 2,400 from its summer high of 4,290. Does this mean that we, along with the shipowners, are going to die horribly after all?

Pankaj Khanna, the chief operating officer of DryShips Inc, the largest publicly traded participant in these markets, says: “I would look at something like the BDI’s three-month moving average, rather than the daily or weekly numbers, which are distorted by port congestion or the Chinese building steel inventory. Personally, I don’t look at the BDI; I look at component indices and component routes.”

Just as 170,000 tonne Capesize dry cargo ships can take over a mile to come to a stop, so the supply of new vessels takes a while to slow after demand withers.

However, the choking off of bank financing has supported the economics of the existing fleet. Originally, more than 70m tonnes of new dry cargo ships were scheduled for delivery in 2009.

With only some 22m tonnes delivered now, only 40m tonnes at the most will be supplied this year, offset by some 10m tonnes of scrapping. Next year, Mr Khanna believes, over half the outstanding dry cargo order book will be cancelled.

For now, he is optimistic about the other force tugging on the BDI level, and DryShips’ profits: demand. For all those routes and sizes, as you might have guessed, this year has been about Chinese imports of iron and coal.

Was it all just a speculative build-up of inventories? “The coal and iron were all turned into steel, and that led to inventory build-up. So steel prices went up to $600 a tonne, then back down to $500, where they are now recovering and stabilising. In another month or two the Chinese will be back in the market. The final demand for the steel products is still there, thanks to their stimulus plan, which will have an effect for another six to 12 months.”

This coincides with my sense of how long this recovery spurt will last in the US. First half of next year good, second . . . not so good. Mr Khanna doesn’t see a strong recovery in shipping, or ship financing, arriving until 2011 and later.

DryShips’ contracting is consistent with this outlook. It is de-risking the business model. Almost all its dry cargo capacity is contracted through the end of next year, with some slack in capacity for 2011 that could take advantage of a recovery in spot rates.

Over the longer term, DryShips is making an ever bigger commitment to huge semi-submersible oil rigs designed to exploit reserves in very deep waters. That’s the energy cycle, which seems more certain than the shipping cycle.

But is there a way to invest, rather than gamble, on the value of ships?

Babis Ziogas thinks so. I’ve been speaking with him for years about the shipping market. A Greek shipping investor with a graduate degree from the Ocean Engineering Department of MIT, he has an interesting ship valuation methodology.

“It’s a filter model,” he explains over the phone from Athens, “and it’s about investment decision making rather than macroeconomics.”

Simplifying, he says: “You take newbuilding prices and prices for ships on the secondary market, and compare the inflation-adjusted, depreciated value of those to the newbuilds.”

This contrasts with even most sophisticated investors, who attempt to discount the revenue stream based on chartering rates.

“This doesn’t have the risk element inside it, including credit risk.”

What does the model tell him now?

“There is not yet a bottom in secondhand ship prices, or in newbuilding. But I am raising money now, because I think the first half of 2010 will be a good time to buy.” By the way, he sold most of the ships his company had owned back in 2007. “Prices lost any connection to the value of underlying assets.”

So don’t jump at every wiggle in the Baltic Dry Index. Think longer term.

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