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The Rising Tide Does Not Float All Boats: Long Dry Bulk Short Tankers

|Includes:DRYS, DSX, FRO, OSGB, TK

I recently did a study of top stocks in the tanker industry and compared them with top stocks in the dry bulk industry. DSX and GNK were my dry bulkers (I didn't include DRYS here because drilling rigs compose roughly half their income and nearly all of their investment). OSG, TK and FRO were my tankers. It quickly became apparent to me that the tanker industry and the stocks that compose it are significantly weaker than dry bulk. I see this weakness first in the financials of those three tanker companies as well as in the underlying supply and demand dynamics for the tanker industry vs. that of the drybulk industry.


Of the aforementioned group of stocks, I believe that the dry bulkers have better quality assets: DSX had profit margins of 50% in '09, GNK 40%, OSG 6%, TK 9%, FRO 5% with equity growth for DSX of 20%, GNK 40%, OSG 8%, TK 6%, FRO 8%. They have stronger balance sheets with debt/cashflow of 1.8, 5.8, 8.4, 8.7, 15.4 respectively. Finally, they have more attractive valuations. Price to book comes out roughly a wash with 1.25, .8, .72, 3.83, .82 but on P/E dry bulkers are the clear winner: DSX 9.4, GNK 4.9, OSG 19.2, TK 27.7, FRO 16.1.


Now, this wouldn't mean too much in the long run if the market for tankers were set to be significantly stronger than the market for dry bulkers. However, the best projections I've been able to put together actually give a slight edge to the dry bulkers.


For the tanker market:


Projections in the latest World Oil Outlook from OPEC have world oil demand increasing by ~1.5% a year for the next 5 years. This is mirrored by the projections from the EIA. The IEA has a slightly higher 2% increase. Of course, what we're ultimately concerned with is tonne-mile growth. OSG, in a March presentation, predicts tonne-mile growth of 6% in '10 and ~4.5% for the next 3 years. According to market information in the Frontline q4 report (which they sourced from Fearnleys and their own in house research), supply of VLCCs is expected to grow 2% net (because of single hull scrapping) in '10 and then jump 12% in 2011, followed by 3% in '12 (which isn't to say more growth won't occur in '12 and beyond; most orders are made less than 3 years out). It's worse for Suezmaxes, with net growth of 10%, 12%, and 4% respectively. This growth rate of supply roughly matches demand growth for VLCCs and exceeds it for Suezmaxes, putting downward pressure on prices.


For the Dry Bulk market:


The supply side for dry bulkers looks grimmer than the supply picture for tankers. Based on the 2009 Review of Maritime Trade from the UNCTAD, dry bulk tonnage grew by 7% in 2009 and there's an orderbook of roughly 70% of current dwt. However, the demand picture that I've been able to put together is much stronger. Everyone has heard the anecdotal evidence of China and its insatiable demand for metals and coal. The hard numbers I've been able to find fit this picture well: according to the presentation Eagle Bulk Shippers gave at a J.P. Morgan conference in March, demand for iron ore is expected to grow 11% in 2010. In 2009, during the height of the recession, China increased YoY iron ore consumption by 38% (in case you think that they're just one case, China made up 67% of world iron ore consumption in '09). Demand for coal is expected to grow 37% by 2014 (8% CAGR). Minor bulks are expected to grow 7.8% in 2010. I don't know how this will translate into tonne-miles demanded, but given that there was a multiplier of base demand to tonne-miles demanded for tankers, I would imagine the same will hold for dry bulk (especially since most of the demand growth is coming from China, which will be importing nearly all of it's marginal demand). Thus the demand side looks significantly better while the supply side looks significantly worse for the dry bulk market. I'll make a very imprecise projection of which industry will come out ahead: given that supply growth of dry bulk ships is roughly 2.5x that for tankers (orderbook/dwt for dry bulk of 70%, 30% for tankers, not including scrapping or cancellations) while underlying demand growth for dry bulk is roughly 4x that for tankers (~8% vs. ~2%), I'm going to propose that prices for dry bulk will rise by more than prices for tankers over the next three years.


However, recalling the financials of the major dry bulkers and tankers I looked at, the dry bulkers don't actually need the market to improve in order to be great buys whereas tankers do. GNK has all-in costs per ship of ~18k per day (10.5k in cash costs) while the spot rate is ~35k/day for Capesizes and ~30k for Panamaxes and Supramaxes. GNK and DSX have been signing one and two year charters for their Panamaxes for ~25k and ~39k for their Capesizes. Thus, the situation for dry bulkers would have to get markedly worse--their average daily revenues would have to drop by ~33% from their ~30k levels in 2009--for them to stop being profitable. On the other hand, given their high debts, tankers seem to be right on the edge and need a recovery in their market to survive. According to their q4 presentation, Frontline's break even costs for a VLCC/day are 30.5k and 24k for Suezmax. Meanwhile charter rates in q4 were 33.2k for VLCCs and 21.3k for Suezmax. When the long term charters they signed in earlier years at higher rates expire, Frontline, and likely the rest of the shippers, are going to need higher spot rates or they'll be in serious trouble.



I'm posting this in hopes of receiving constructive criticism and feedback so that I can sharpen my analysis, make better investment decisions, and make more money. So please let me know what you think.







Disclosure: Long GNK and DSX