1. Egypt situation
We have all seen the pictures of demonstrations in Egypt and regime change in Tunisia. The question for investors now is the following:
- Will Egypt be the next domino, or will Mr. Mubarak somehow find a way to stay in power in the near-term?
- What will happen before we know what the end game will be?
- Will the Suez Canal be closed?
- Will the populations in Saudi Arabia, Libya, Iran, etc be inspired and follow suit?
- Is this driven by food inflation that hurts the general population of these countries?
- Strikes in oil loading ports in the rest of the Middle East?
- Will piracy spread from the Horn of Africa?
I can't claim to know the answer to this, but if we step back, then what do we know is:
- Situations like this are not settled quickly. They are not one week affairs. Even if he did step down immediately, then what government will be formed afterwards?
- Regime change or attempts to change regimes are messy affairs.
- It makes for very emotional pictures.
What can we expect of Mr. Mubarak:
He has been president since 1981 and is 82 years old. He obviously is not a popular person, but it is also equally obvious that he doesn't care and that he has (had) staying power.
I don't think we can expect him to change his way of thinking. Very few 82 year olds do this, so I expect him to resist an immediate regime change vigorously.
What can we expect of the demonstrators:
They have started out rather peacefully and I sincerely hope that will continue. However, it may not as frustrations may build. Let's imagine that in a week from now people are still demonstrating, but Mr. Mubarak has not stepped down. Having money equals power and if the demonstrators want to weaken his position then taking steps to close the Suez Canal will be an efficient step.
I really don't know how this will end, but I also think it is fair to say nobody does.
The shipping business is not a great one. It is very cyclical and capital intensive. It is characterized by low barriers of entry and fierce competition.
Demand is derived from changes in GDP times a multiplier, as global trade generally grows faster than global GDP.
Supply is driven by new orders of ships in good times, and few orders in bad times, and the demolitions of ships at the end of their economic life.
The current situation is one of over supply and order books that are too large. The issue is not with demand.
In my opinion, the only sensible way to invest in shipping companies is when things look negative, wait for global GDP growth to catch up with over supply and then get out.
Time charter rates for container ships are currently in the lower part of historical averages, tanker rates are low and dry rates very low. You can look up the charts on bloomberg.com here: contex, baltic dirty tanker index and baltic dry index as reference.
What would you do if you had the requirement to transport oil, gasoline, coal etc by sea?
I think you would be eager to secure additional tonnage in case you really had to take the long route around Africa. Ship owners, of course, know this too.
The combination of low T/C rates, low share prices on many ship owning companies, a quickly growing world economy and a vivid situation that could provide the spark to turn things around to me this makes for a compelling investment case for investing in ship owning companies.
Prices haven't moved much yet since the Egyptian story hit the wires, but this is because most people aren't fearful yet. This builds over time as people see and read more and more about it. This is what trends are made from - more and more people adopting the same beliefs.
Going long ship owning companies that benefit from this may also have positive portfolio properties, as it is reasonable to expect this to be negative for GDP growth and a so-called risk off event.
Look for companies that have short outstanding T/C agreements as they will benefit the most.
Another supporting argument is that T/C rates often bottom around the Chinese new year, which is now, so this may help too.
4. Investment implications
This should be USD positive as risk off events are normally USD supportive.
In the dry cargo space, I use a balance sheet valuation model to calculate the fair value. It is basically net liquid assets + value of long term time charters + market value of ships. As the different companies have different leverage levels, and thereby also risks, I focus on the implied under/overvaluation of the ships: BALT (Ships are +29% undervalued), EGLE (+14%), ESEA (+27%), FREE (+15%), GNK (ships are -10% overvalued), PRGN (fair value), SB (fair value), SHIP (+10%) and SBLK (fair value).
In the container ship space I use a discounted cash flow model. I have written extensively on these companies here on SA so have a look at the articles: SSW (price target of 24.25) and CMRE (price target of 24). GSL is overvalued in this space. Unlike dry and tanker, the T/C rates are actually going up for container ships. They are currently at their highest in years.
I expect the tanker space to benefit the most from this, followed by dry bulk and lastly, container ships.