The Baltic Dry Index (BDI), which tracks worldwide international shipping prices of various cargoes like iron-ore, coal and grain, currently sits at its 2009 peak and just recorded its largest weekly gain of the year. A newbie investor keen on the shipping sector may well be inclined to pick the cheapest stock based on p/e ratio or one trading closest to its 52 week low. After all, there is no brand value to be had in this industry. A venerable shipping firm with a centuries old history can expect no more for use of its ships than the going rate set by the BDI – the same for an upstart with little or no experience in the business.
How do you spot premium value in a commodity business?
Kevin Sterling, Transport Analyst with Winston-Salem based BB&T (NYSE:BBT) notes that when it comes to spotting winners for the long haul (sorry, couldn’t help myself) the balance sheet is king. Low debt and a healthy cash stash will catch his eye, but he also looks for management that has been through multiples cycles of the shipping industry (which typically last 5-7 years), the type and duration of contracts, the quality of shipper’s clients, and the age of its fleet.
“For as long as the shipping industry has been around, there have been new companies that race to enter the business as they see rates going higher,” noted Sterling. “This leads to over capacity and a bottoming out of the cycle. They’ve never learned. The Companies with debt so high they can barely afford to cover their interest notes represent this cycle’s next targets for companies that have mastered the cycle.”
Today the BDI hovers at a relatively historical norm of 4,111. The last two years saw the index reach peaks well above 11,000. Sort of like that 4 bedroom colonial whose value doubled in 3 years, these prices were not sustainable. Banks may be forced to take ownership of the ships from shippers underwater on their loans, and they will not hesitate to sell, even at a loss.
Sterling says experienced management teams are likely to lever up in down markets and raise equity in good markets. Most lever up at the top of the market, and bankers make it easy to do. When the inevitable down market hits, the cycle masters will be positioned to buy on the cheap from their distressed peers.
Wall Street currently rewards shippers that provide good earnings visibility. This means that analysts value stable contracts locked in for 3-5 years over the potential upside that could come with leasing on the spot market. Risk management may not be sexy, but neither is bankruptcy. The Street has loved and will again love the hare, but the tortoise has the momentum. Shipping analysts are now more attentive to the balance sheets of a shipper’s clients - 5 year leases with companies that are bleeding cash will not impress. Sterling notes that Athens-based Diana Shipping (NYSE:DSX) goes the extra mile to add visibility. Diana discloses the credit facilities and balance sheet condition of every one of its customers.
Though experienced management is considered an asset, an experienced fleet is not. Even if global trade returns to normalcy, a glut of previously ordered ships due in the coming years is expected to limit the extent of a meaningful price recovery. Sterling says that companies with the youngest fleets will have first access to the best routes. “Given a choice between leasing a new ship or an old one, it’s a no brainer. Clients usually pay the fuel costs and the newer ships will be more fuel efficient. That decision goes directly to the bottom line.”
As for using the BDI as a tool in his analysis, Sterling believes the correlation was more relevant a few years ago. The index does not tell you much about individual ship capacity and is likely a better measure for the commodities market. Besides, the BDI measures spot pricing and most shippers have left the spot market upside for the consistency, often as the insistence of their lenders.
But he does appreciate how far the term Baltic Dry Index has come in terms of popular nomenclature. “A few years ago no one outside of the shipping industry would ever use the term. Now because some view it as a barometer for global economic activity and because CNBC profiles it every day, it’s gotten to the point where you expect to overhear people at cocktail parties reference the BDI.”
Asked what other metrics he pays more attention to and the answer goes to where one might expect. China. He watches China’s manufacturing activity and order flow.
So on a scale of 1 to 10, how much emphasis does a dry bulk analyst put on Chinese economic data? After all, it’s a big world out there and the BDI measures 40 different trade routes across the globe.
“I’d say a 9 or 10. Make that 10. You can not underestimate the importance of China.”
There is a dry bulk stock to fit just about any investor style. Diana is considered the poster child of consevrative management and is lauded by Motley Fool Matthew Barker as a company Darwin would love for its adaptability. Barker writes that Diana intends to parlay its pristine balance sheet into opportunistic growth by acquiring vessels “in a gradual and disciplined manner” at favorable prices. http://www.fool.com/investing/general/2009/11/12/how-do-shippers-look-now.aspx?source=itxsitmot0000001
Greece-based Paragon Shipping (Nasdaq:PRGN), a smaller firm founded in 2006, is quickly developing a reputation for prudent management. Its debt level is manageable enough that management just voted a 5 cent quarterly dividend (4% annual yield). As for visibility, assuming all options are exercised, Paragon has secured contracts for 100%, 90% and 45% of its fleet capacity in the remainder of 2010, in 2011 and in 2012, respectively. Paragon CEO Michael Bodouroglou said in the last quarterly release that ”Our chartering strategy provides us with substantial visibility into both our revenue and cash flow going forward. This gives us the confidence to strategically invest in the growth of our business as the right opportunities present themselves.” Sounds very Diana-esque.
Fellow Greek firm Navios Maritime (NYSE:NM) is not taking a wait and see approach. It seems to be zoning in on the new fleet strategy and just announced a $400 M financing to continue growth plans that call for delivery of 21 new deliveries before 2013. The firm has taken steps to manage the downside risks by locking in 100% term charter coverage through 2010 and buying insurance against contract defaults.
Whether or not you invest in this sector, rest assured that one size does not fit all when it comes to dry bulk stock selection.