From Recession to Recovery: Forecasting the Future
Speech by Clay Maitland at the Capital Link Greek Shipping Forum
“The sea gets sick, but it never dies.”-Greek saying
“Shipowners are optimists by nature and training.” -Antony Chandris
Since ancient times, the business of shipping has been risky and unpredictable. Often subject to political and social change, its financial fortunes have often been affected by external developments. Wars, the weather and, in modern times, depression and recession have added to the usual uncertainties faced by the shipowner. Some transactions, involving the buying and selling of corporations, often involve loading debt onto the operational parts of the business. This can lead to cheese-paring, cutting of costs and services and the sale of assets to pay managers and investors, in order to meet debt payments. Therefore, the economic prognosis is important, for numerous reasons.
In doing this, and because shipping is part of larger global trade forces, it is important to identify economic trends, and to distinguish between symptoms or consequences and the conditions that cause them.
Although we are said to be seeing distressed conditions in shipping markets, and predictions have been made that we have, or perhaps have not, “reached bottom,” Some shipowners are buying new or recently built dry bulk vessels. Most observers now believe that China’s and India’s demand for iron ore and coal, over the next two years, will increase. China’s iron ore stocks, for example, have stood at 67 million tons for the past four months; this does not do much for China’s long-term needs, which, it is felt, are bound to increase.
I would suggest that, in forecasting the demand for dry bulkers and tankers, one must look at long-term needs, and trends, and not at snapshots of the Baltic Dry Index.
Investors who have been responsible for the growth in shipping over the past ten years have their own somewhat questionable investment philosophy: whatever the Baltic Dry Index has done between yesterday and today will guide us on what will happen over the foreseeable future. This seems to have been the philosophy of some financers, prior to November of 2008, regardless of whether what you were buying was salvage tugs or VLCCs. There are more analytical approaches, however. First, you have to know how to make sense of the market indicators, one of which is the BDI. The BDI is calculated in London, by the Baltic Exchange, which determines from shipbrokers what the shipping rates are for three categories of dry cargo ships along 26 routes around the world. As such, it is an approximate indicator for transportation of commodities such as iron ore, coal and grain, along those routes, together with the approximate supply of ships to carry them.
In the period directly before the collapse of Lehman Brothers, it started to decline from a peak of just about 11,700, dropping almost vertically by 94% between May and December of 2008. It then rose again, until August of 2009, when it dropped from 4,290 to just under 2,400.
At the same time, during 2009, newbuilding orders, January to December, also dropped abruptly.
With the global economic crisis resulting in a diminished requirement for new tonnage, the number of vessels ordered fell by 87%, to 412 ships of all types from the 2008 total of 3,113. This was a drop of 93% from the record high of 2007 - - 5,935 ships.
How do we foretell the future? The ancient Athenians sought to interpret future events by examining the heavens. The Romans on the other hand, placed more faith in the flight of birds and the entrails of poultry and other domestic animals. Today, some of us turn to the BDI.
But is this any more rational than the methods of olden times? There are strong indications that shipping markets, except for container fleets, are in the early stages of a slow but steady recovery.
If we look at component indices, it becomes clear that in 2010, more than half the outstanding dry cargo orderbook will be cancelled.
Moreover, demand has held up. Steel prices are recovering and stabilising.
In the oil sector, it is a different story: not so much expansion, as diversification. Although demand is not expected to grow in 2010, the oil majors are going about a major diversification effort, particularly designed to exploit reserves in very deep waters. This means that more semi-submersible oil rigs are being built, and that they will be a bigger commitment to the offshore supply and storage sector. An important factor in forecasting the future is predicting the value of ships. This comes as close to necromancy and primitive superstition as it is possible for us to get in our business.
Stated as a mathematical process, which it is not, it is possible theoretically to determine the actual price of ships on the secondary market; adjust that value for inflation and depreciation, and compare it with the price of the same ship as a newbuilding.
This assumes of course that you can establish what the newbuilding price of your target vessel actually is.
It also assumes that the market in second-hand ship prices, or newbuildings, has found a bottom. I am one of those who believes that, at least in the dry and liquid bulk sectors, it more or less has.
Predicting the pace of what undoubtedly will be a slow recovery for all sectors - - dry and liquid bulk and container - - means that we must make better decisions than we did two and a half years ago. We must also ask whether ships of a particular type or category are priced below their actual value, relative to the market price average at the present time.
There are certain clues as to how to predict trends for the balance of 2010 and into 2011. The first thing that we should take note of, in my opinion, is that while dry bulk trade declined by about 10% during the third quarter of 2008, it increased in the third quarter of 2009.
On a year-to-year basis, comparing the fourth quarter of 2008 with the fourth quarter of 2009, Chinese imports, of iron ore and coal, the basic essentials of steel production, grew by 50%. There was, indeed, massive growth of steel consumption by China in 2009. Now however, it is likely that that will slow down, even in a robust economy.
It is predictable that in 2010 and 2011, growth in the dry bulk sector will be powered by Asian economies outside of and beyond China.
If you are planning to buy ships, do bulkers look like a good deal? Some shipowners clearly believe so: Navios snapped up a number of “capes” in the last quarter of 2009; Eagle Bulk seems to feel that dry bulk is a “shining market,” with significant cash-flow potential. The period of acute trauma, brought about after the collapse of Lehman Brothers, now appears to be behind us, even though aftershocks in the Eurozone, and possibly in the United States, arising from sovereign debt fragility, are decidedly not things of the past. Major dry bulk operators consider that we have entered the era of cash-flow purchase transactions, not to mention newbuildings. Despite greatly diminished asset values, the year 1929 actually resulted in an increase in the overall volume of sale and purchase transactions, compared to 2008. Moreover, December’s figures for benchmark newbuilding prices indicate a degree of stabilization in many of the key sectors.
In the face of these hopeful “green shoots” of recovery, the tight or nonexistent bank lending picture is undoubtedly a cause for concern. Private equity transactions, as pointed out above, imply taking on a pool of debt; they do, however, also provide pools of capital. Public offerings use stock as a currency for growth. The great question is: when are the banks going to start lending again?
One prominent executive Angeliki Frangou of Navios, commented at the recent New York shipping conference of the Hellenic and Norwegian-American Chambers of Commerce: “You can definitely say that you are seeing a bottom, when you see foreclosures.” These have been mercifully rare, and it may be that a considerable number of nonperforming loans are what is holding up a restoration of normal conditions in shipping credit markets. That said, there are obvious special opportunities available, be they with shipyards, banks or private equity. Shipowners, particularly in the extended Greek diaspora, are making strategic plans.
Will there be debt financing available for shipping? Where will it come from? One of the biggest problems in securing finance is the value of the asset - - the ship itself. As Hamish Norton of Jefferies and Co. remarked at the conference “You can’t finance something that costs more than it’s worth.” Banks are reluctant to lend where debt appears to be significantly higher than the value of the asset or assets. Factors include the belief among bankers (and that I share), that real losses in the shipping industry will emerge over the coming year, and will therefore be seen to have increased. As a famous central banker once said, “It’s when the tide goes out that you can see who isn’t wearing a bathing suit.” The base rate may still be relatively low, but the cost of funds to the banks will go up; lending as a ratio of funds will probably be limited to 10 or 11%. One banker recently expressed reluctance to lend outside his bank’s “home jurisdiction.”
These are discouraging words, indeed. As Hamish Norton quipped: “Look, when we are young, we may believe in the tooth fairy; but does anyone here expect us to believe in the money fairy?”
What about bonds? It must be remembered that the nonamortizing nature or a bond and the fact that it is unsecured, means that it can provide the ability, for the shipowner, to accumulate growth capital much more so than equity financing. It has the characteristics of being insecure in nature, at least in the underlying asset - - the ship.
Attention has also been focussed in this unique and difficult market on initial public offerings (IPOs), particularly in a market where shipping companies are actually trading - - depending of course on whether the share price will be attractive. If an owner has equity in a valuable ship, banks and public bond markets may have money available; the critical problem is for those borrowers who do not have an ongoing relationship with their prospective lender or lenders, or a solid reputation in the business. It is here that banks will, to an increasing degree, examine the quality and operational reputation of a shipping company.
If it is decided to float an IPO, it is generally considered that a high dividend level is an obstacle. But, once an IPO is successfully launched, an established company that has maintained a reasonable dividend for its shareholders will of course have an advantage in the market.
While activity and interest are starting to pick up, global seaborne container trade for the year 2009 is now estimated to have shrunk by 9.1%, standing at 1,198 million tons, the first year on record in which it declined in two subsequent years. Container traffic on the principal routes from Asia westbound to Europe, and eastbound to North America, was down overall by about 15% for the calendar year 2009.
Faced with problem loans, must a bank foreclose at all? Foreclosure raises certain problems; deferral presents others. For a bank, it is much better to work with a customer, computing - - in other words predicting - - long-run cash-flow. Otherwise, the lender may end up as a shipowner. For most banks, the maximum length of a deferral is 12 months. What happens if a ship is sold, subject to deferrals?
Shipping and freight credit markets have been damaged by the global financial crisis. While time charter rates have generally been volatile, this has been a part of the pricing environment since 2003. What is new is the curtailment of hedging mechanisms such as the freight futures (FFA) market. The return of greater stability in the futures and hedging markets is essential to an increase in traffic flows and fleet growth. Most seers predict an overall fleet growth of 8 to 9% for 2010, for bulkers and tankers. From Chinese and Korean yards, only 29% of the bulkers and tankers on order were delivered in 2009; it is clear from this that the orderbook is not only subject to change, but no doubt was overstated in the first place!
As our faithful guru, Martin Stopford of Clarkson’s has observed in World Fleet Monitor, which I highly recommend as a source of data and comfort: “All that is needed to solve the industry’s problems is to scrap everything over 20 years old. But getting owners to part with old ships is rarely easy, and such a result would require a nuclear winter in the shipping industry, which nobody really wants. So, for now, the focus is on dealing with the orderbook problem.”
The bottom line is that although China is clearly cooling down its economy - - or attempting to do so - - we are at least approaching a recovery stage in all sectors except boxships. They, too, will recover, because the Greeks have always been right: the sea will never die.
China will stand by its shipyards, and other elements in its growing maritime sector. Exports from and imports to the BRIC countries (excepting Russia) will also continue to grow, although at rates that may vary over the next 10 months.
After that - - you decide.