Why ship orders affect dry bulk shipping companies’ share prices

Market Realist

Why you shouldn't be afraid of dry bulk shipping industry pullback (Part 4 of 6)

(Continued from Part 3)

The importance of ship orders

The number of ships on order reflects managers’ expectations of future supply and demand differences. When they expect future supply to increase more than demand, managers will refrain from purchasing new ships. However, when they expect demand to outpace supply growth, companies return to the shipyard to place new orders, on the condition that they expect to generate profits with the new vessels. So rising or high levels of ship orders often indicate that shipping rates will rise. Since dry bulk ships usually take one to two years to construct, the indicator is often more relevant to long-term investment horizons.

Managers are optimistic

Last week, we saw a broad increase in ship orders. The number of Capesize ships on order as a share of existing vessels rose 2.58%, from 10.07% to 10.33%. Panamax ships also rose, albeit to a lesser extent, from 15.27% to 15.40%, marking an increase of almost 1.0%. Supramax saw the largest increase of 5.14%, from 4.36% to 4.58%. The broad increase in ship orders last week follows a significant increase in Capesize rates, which now stands above 2012′s highs.

Backlogs of new ship constructions have been turning around since the start of the year, with Capesize vessels showing the most stabilization. While it looked like Supramax orders would start turning around at the start of 2013, the indicator continued to slump since April. This is a possible negative if the decline wasn’t due to increased construction activity—highlighting the need to look at several indicators to get a picture of what’s happening in the industry.

Managers are likely reluctant to significantly add new orders to Panamax vessels, as current orders remain elevated. But the increase we’ve seen since May (along with orders in Capesize vessels) is quite positive. Higher shipments of iron ore from Australia and Brazil are currently driving rates higher, which is likely to carry through towards winter—typically a strong season for Capesize vessels, as iron ore shipments from the southern half of the Earth rise and Chinese mines close. We could also see some upside for Panamax vessels due to lower supply growth and higher grain shipments later this year, as the USDA currently projects a record output of crop.

Implication for shipping companies

There’s much debate over whether demand will outpace supply growth this year, with analysts and CEOs throwing out numbers all over the place. But the turnaround in orders, or the steadier decline in orders, points towards lower supply growth ahead and suggests that industry profitability should normalize over the next few months and years. This is long-term positive for dry bulk shippers like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Navios Maritime Holdings Inc. (NM), and Safe Bulkers Inc. (SB).

Continue to Part 5

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