The Baltic Index has been falling mercilessly. The index, which once used to be above the 4,000 mark in 2010, is currently below 800. The Baltic Index represents the current progress of the dry bulker business and has fallen by 30% in the last month.
The dry bulk business is one of those that move with the global economy, given the fact that the business involves the transportation of steel, coal, timber and iron ore. Dry bulk cargo also includes grains, the supply of which is heavily dependent on suitable weather conditions. With tempered GDP growth rates of big economies, and the worst-ever drought in the last half a century in the U.S. and in areas between Europe and Australia, dry bulkers are facing a soft demand.
The shipping business has also been plagued by overcapacity of ships, which has led to declining freight rates amidst intense competition. The current freight rates for Capesize are below the breakeven mark. The negative YTD performances of five of the six NASDAQ listed dry bulkers clearly depict the industry's poor condition. Out of those, all four that have reported second quarter earnings have shown negative YoY revenue growth.
On a positive note, Chinese imports for steel and iron ore are expected to grow this year, as domestic production has slowed down due to lower profitability and higher extraction costs. Also, order books have sharply declined, which will mean lesser overcapacity issues in the future.
Therefore, dry bulkers will heavily depend upon an improvement in the global economic growth for any favorable movement in their own growth.
Baltic Exchange (BDIY)
BDIY rebounded in April-May this year by reaching 1,200 points, after falling below 700 in early February. However, BDIY has fallen once again, below the 800 mark, displaying the seasonal behavior of the index. The -50% YTD performance can be attributed to falling commodity prices, as well as rising overcapacity at ports. BDIY has also come down due to cargo disruption to the monsoon-hit Indo-Australia region, and heavy rainfall in Brazil. Within BDIY, Supramax and Handysize freight rates outperformed the Capesize and Panamax freight rates. This again shows the lack of demand for commodities, which led to improved utilization rates for the smaller Supramax and Handysize, as compared to larger Panamax and Capesizes that can carry more tonnage.
Grain and Drought
The U.S. has been hit by the worst drought since 1956. Grain cargo is expected to contract to a 19-year low. The U.S. Department of Agriculture has predicted that global grain trade will fall by 4.6% in 2012-13. The amount of corn loaded at U.S. ports has declined by 14%, whereas wheat has declined by 21%. The production rates for soybeans, sorghum and barley have also declined. The U.S. Development Authority (USDA) has cut the estimate of global grain export by 2.7 percent for the year, the biggest decline since 1993-94. Supramax is the most common form of vessel used to transport grain. Its rates will be affected as a result.
Western Australia, the main region for wheat production, also experienced dry weather, leading to low production rates. Consequently, the International Grains Council cut the global grain production estimate by 3.1%.
All these developments are adding to the woes of the already suffering dry bulkers businesses, especially those companies that rely heavily on Supramax for their revenues.
Falling Freight Rates and Supply-Side Concerns
The order book has reduced sharply by 13%, after dry bulkers canceled orders in lieu of the rising overcapacity problems. However, the order book still accounts for 30% of the total current fleet. The following shows the year's U.S. dry bulkers' order book:
Therefore, future prospects are positive, as the growth in vessels is declining. However, the current influx of vessels is not relieving the pressure off freight rates. This was inevitable, given the large number of orders given by dry bulkers in 2008-2009, when they expected demand to soar high amidst the rising BDYI. Vessel suppliers take two-three years from order times to supply a vessel.
The Chinese economy has a very important role to play in the recovery of this sector, given the fact that it is one of the largest importers of commodities. However, the slower-than-expected growth in the economy is not a good signal for dry bulk businesses. The following shows the growth rate pattern for the Chinese economy:
Deflation has been the main cause of the slowdown in the economy. However, regulators are cutting borrowing rates and implementing expansionary policies, which is a good sign for all businesses, including bulkers, that depend on the Chinese economy for growth.
Chinese demand for thermal coal rose by 8.4% this year, which is the lowest growth rate since 2008. Coal has an important role to play, given that it forms 80% of the total cargo transported by Panamax. Chinese demand for coal can see a rise, as the Chinese government plans to increase electricity generation in the country. Currently, 26 coal-fired plants are being constructed in China - which account for 6% of the total capacity. However, the Chinese have been stock piling coal for some time. They do this in the fourth quarter, as freezing temperatures at ports in the coming three months disrupt supplies. Therefore, there may not be an increase in demand at all. Also, the Chinese are resorting to alternative sources of fuels like natural gas and hydropower for power plants, which will lead to low coal demand in future.
China is responsible for 65% of the total iron ore transported through seas. Past trends show that China imports more iron ore in the second half of the year than the first one, because of the temperature factor already mentioned above. Current prices of iron ore are declining in China, which have led suppliers to curb their production. The decline in supplies will force steel mills to import iron ore from outside. However, currently, a lot of movement in imports is not expected, as iron ore inventories have reached their highest level in two years. Capesize are mostly used to transport iron ore.
After discussing the macro factors that will decide the future of the industry, we will now discuss individual stocks:
DryShips Inc. (DRYS)
DryShips Inc.'s exposure to the drilling business has helped it insulate itself from the declining dry bulk business. DRYS currently owns 65% of Ocean Rig's (ORIG) shares. Lately, dry bulkers have found it difficult to handle their debt-related issues, which has led to breaching of loan covenants. However, DRYS sold off 11.5 million shares of ORIG to fund its CAPEX and pay off some part of its debt. The 65% remaining shares will likely provide a cushion to the company in stressful times. The following shows the worth of stake that DRYS has in ORIG:
This shows that DRYS's ownership of ORIG is worth more than the market cap for DRYS itself. This means that when an investor is buying DRYS, he is getting the dry bulk business for free.
DRYS doesnt want to be stuck in a long-term contracts with low shipping rates in case the demand for the Dry Bulk Industry rebounds. However, this has led to a 44% utilization rate for the company.
Another important factor in deciding the fate of the stock is the decision regarding CEO George Economou. Economou has a repute of destroying shareholders value. In his presence, it is highly probable that DRYS will keep selling off its ORIG stake, and thus increasing vulnerability to the current headwinds that the Dry Bulk Industry is facing as a whole.
Despite missing analyst estimates, low utilization rates, and the slump in the dry bulk business, the 'ORIG deal' promotes DRYS as a buy, as it will help the company survive the current crisis. An important boost for the stock will be the change of CEO.
Diana Shipping, Inc. (DSX)
Like DRYS, Diana Shipping, Inc. has a shipping container business that has helped it tackle headwinds from the slowdown in the dry bulk business. The shipping business turned profitable in the latest quarter. DSX also beat earnings and revenue estimates. The company has very intelligently managed its debt and cash levels, and therefore enjoys the lowest LT debt/EBIT ratio amongst its competitors. The company has the youngest fleet, which has helped it keep its operating costs lower than its competitors.
Eagle Bulk Shipping Inc. (EGLE)
Eagle Bulk Shipping Inc. had some fresh air to breathe after it secured a credit line with the Royal Bank of Scotland (RBS), which has ensured it to be a going concern till 2017. The company acquired an instant $20 million to address its liquidity-related issues. The company recently announced its earnings, which came out short of estimates. However, the company managed to exceed revenue expectations, clearly showing that dry bulkers are facing erosion in profits due to overcapacity.
Currently, except for DryShips, investors should not take any position in these stocks as the dry bulk sector is facing a serious crisis where sustainability of any company cannot be guaranteed in the near future. However, all those companies that have the financial muscle to live through the crisis will rise high as transportation of dry bulk is expected to continue forever. The important catalyst to look out for is:
- Recovery in global economy, especially Chinese GDP growth rate.
Investors should wait for global trade/transportation to rebound before buying stakes in other dry bulkers. Any positive news on attaining additional liquidity by these companies will cause big upward moves in these stocks. These companies will be great buys as freight rates start to recover. Till then, just limit yourself to DryShips Inc.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.