Global shipping stocks have been among the worst-performing industrial equity group since 2008. They were first hit by a trade-slowdown caused by the global economic crisis and then the crash in commodity prices in 2014 due primarily to energy production increase in the U.S. and then the U.S.-China trade war in 2018.
Take a look below at how crude oil and shipping stocks in the ETF Invesco Shipping ETF (NYSEARCA:SEA-OLD) are inextricably linked:
I also included AMLP, which is an energy transportation MLP fund, to highlight how the fates of global shipping companies and domestic energy transportation companies are nearly the same.
As with MLPs, most of the shipping stocks in SEA focus on energy transportation. They gain from shortages for energy commodities and typically pay high dividend yields (ideally only when they have the available cash flow). After years of a large energy glut fueled by massive production growth in the U.S., most of these companies have been losing money and many are on the brink of bankruptcy or have recently undergone bankruptcy.
As recently detailed in "AMLP: Investor Capitulation Signals A Potential Bottom For MLPs," U.S. supply growth fundamentals appear to be slowing. Not to say we will return to a global energy shortage soon, but that it may come sooner than expected and investors may gain from looking for value opportunities in the sector.
While mid-stream MLPs generally pay higher dividends today, shipping stocks may have the best value opportunity and are already seeing positive catalysts. Importantly, the creation of new energy pipelines has remained high while the production of new shipping vessels has remained relatively low over recent years. In fact, new sweeping environmental regulations are forcing many tanker owners to scrap and will most likely increase new tanker production times.
These forces have caused a significant rise to the Baltic Dry Index which measures global shipping rates:
Since long-term profits for shipping companies and the baltic-dry index are directly linked, the rising index has boosted profits for many shipping companies and has helped build a potential bottom in SEA this year.
With the index rising, it is likely that the economic fundamentals for shipping stocks are turning around. Demand for shipping is rising faster than supply and slowing energy production growth indicates that demand has much higher to go, even if a global recession strikes.
Shipping stocks have actually not been highly correlated this year. Companies with higher balance sheet health and those operating in areas of higher demand have seen incredible performance this year, with many rising 50-150% (and are still cheap). However, many with a poor balance sheet and particularly those in the liquefied natural gas space like Golar (GLNG) and GasLog (GLOG) have fallen by 50%.
My base-case for 2020 is that correlations rise among shipping stocks and all will rise together, though perhaps not as much as the top shippers rose this year. This means that the Invesco Shipping ETF will likely be a strong contender.
The fund has been around since 2010 and has struggled to see strong inflows due to the industry's poor performance. It currently has an AUM of $47M, making it liquid enough for most investors. It has a fair expense ratio of 66 bps and pays 2.86% dividend yield (after expenses) which is likely to rise with improved tanker profitability.
The typical company does not currently have a high income as the ETF has a weighted average P/E of 46X, but it is still cheap on an asset-perspective considering it also has a weighted average PB of merely 0.84X.
Let's dig deeper into those fundamentals with our select fundamentals table of the stocks in the fund (ranked by earnings yield):
(Data Source - Unclestock.com)
As you can see, there is a strong relationship between negative earnings and high debt ratios which is a sign that many of these companies are struggling to make interest payments, but would otherwise have strong cash-flows.
Importantly, price-to-book ratios are very low for many of these companies with the median firm trading 13% below its book value. Of course, book value is difficult to judge for this industry since tankers suffer from heavy real depreciation and likely have tankers struggling to keep up with rising environmental standards (and thus could be worth less than they're marked at).
On a positive note, gross profit and revenue growth are generally strong for most companies (though with a large range). This demonstrates that the underlying fundamentals for these firms are improving. If they could only improve their highly-leveraged balance sheets and credit ratings, they'd likely be worth much more.
It seems clear that continued improvement in economic fundamentals will be the much-needed saving grace for many of those companies and could deliver extremely high turnaround returns.
While I do not believe that global geopolitical trade tensions will disappear anytime soon, the data indicate that shipping companies could be a strong buy at current prices. Individual companies that are closely tied to U.S.-China tensions like China's COSCO may not get to ride the bullish wave, but the U.S.-China trade only makes up a limited portion of global trade.
Overall, I see SEA as the simplest, lowest-risk investment into the industry, though returns could likely be higher by picking individual companies. Of those in the ETF, Seaspan (SSW) looks like the best based on its strong growth and high cash-flow yield while Euronav (EURN) appears to be the worst due to its very low pre-interest yield.
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This article was written by
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SSW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.