Expecting A Bust In The Shipbuilding Industry

Includes: AKS, HII, MT, NUE, X
by: Paulo Santos

As the Baltic Dry Index plunges ever lower, taking out the 2008 lows, we've already concluded that many dry ship bulkers will go under the bankruptcy waves in this cycle. However, there are other obvious consequences of this pricing environment.

We know that one of the clear reasons why freight rates are imploding is simply too many ships being delivered. And such an influx of ships was the result of the bubble in freight rates that took place during 2007 and early 2008, together with long delivery periods. Thus, today's incredibly low rates will lead to the opposite - precious few ships will be ordered and made in the next 2 years or so.

So certainly, the shipbuilders are going to hit a dry spell here. Unfortunately, shipbuilding is something that's long gone from the U.S. economy and markets, and other than Huntington Ingalls Industries (NYSE:HII), I can't even locate any other shipbuilder. Naturally, HII doesn't fit this thesis, since it does mostly military work.

Certainly, we can follow the events through a worldwide shipbuilding index published by Bloomberg, but that won't cut it as far as trading goes, since the shipbuilding companies are mostly Korean, like Hyundai and Daewoo as well as Chinese, such as Yangzijiang Shipbuilding.

There is, however, another consequence of a bust in shipbuilding. It's something that adds to other factors I've already written about, regarding the Chinese Economy slowdown, namely the drop in auto production that's already occurring, and the predicted drop in residential construction, given that residential prices are already falling. What is this consequence? Well, those large ships take a lot of steel. If you don't make ships, you don't use steel.

So this is one more reason why the steel sector will face substantial headwinds during 2012, with United States Steel (NYSE:X), AK Steel Holding Corporation Co (NYSE:AKS), Arcelor Mittal (NYSE:MT) and Nucor (NYSE:NUE) being potentially exposed to these developments.

Right now, these steel shares are being bought under the general theory that slightly better economic numbers in the U.S. will lead to higher steel consumption and prices, yet these effects I've been describing, from auto and residential production in China, to shipbuilding, are much more important than any increased demand on U.S. soil. It's thus not a surprise that, as I have written earlier, steel prices are already falling.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.