Why rising scrappage is a short-term negative for dry bulk stocks

Market Realist

Federal shutdown and sentiment hit dry bulk stocks (Part 5 of 6)

(Continued from Part 4)

The significance of scrapping level and shipping rates

For a short-to-medium-term assessment of supply and demand dynamics (depending on how you slice and dice it), investors can look towards ship scrappage (retirement) activity. The rate at which companies scrap ships often reveals whether the dry bulk shipping industry is facing excess capacity. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on shipping rates and maintenance costs.

Scrapping activity rises, but remains in down-trend

On October 4, the total number of ships retired since IHS Global Limited began collecting the data in 2005 rose to 2,194 ships—an increase of seven vessels from last week. On an eight-week moving average basis, used to show a clearer trend, the number of vessel scrapped had increased to 7.5, from 7.13 vessels last week.

While last week’s data was negative, and could reflect some weakness in the dry bulk sector in the near term, scrapping activity has remained in a downtrend since June 2012—a medium-term positive. As long as rates continue to rise, we should see scrapping activity fall to levels seen during 2009 and 2010.

Falling scrappage is actually positive, not negative

Although companies often report the number of ships available to scrap as evidence of limited supply concerns, the reality is that several ships do celebrate birthdays beyond 25. Companies are also unlikely to scrap ships just because they’re old and will often try to hold on to old vessels as long as they can find customers to use them. So although the industry can scrap another 200 ships, investors should see falling scrappage as a positive sign that shipping rates are rising.

Current trend positive for dry bulk shipping companies

As long as scrappage activity continues to fall over the medium term, it’s a positive indication that fleet utilization (supply and demand dynamics) is tightening, and that shipping rates will rise in the future. Higher shipping rates will translate to higher earnings, cash flows, and share prices. The current trend is positive for dry bulk shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), Navios Maritime Partners LP (NMM), and Navios Maritime Holdings Inc. (NM).

Continue to Part 6

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