Continued from Part 3
Why is capacity important?
Although ship orders and construction activity are useful to get the insiders’ perspective, investors must also look at capacity growth to see whether it meets demand so that they don’t rely totally on managers, who can get caught up in the day-to-day operation without seeing the bigger picture. When capacity grows faster than demand, competition rises among individual shipping firms as they try to use idle ships and cover fixed costs. This lowers day rates, which negatively affects bottom line earnings, free cash flows, and share prices for companies. But when demand grows at a faster rate, it’s positive for dry bulk shippers.
Annual capacity growth falls to a new low
On August 2, dry bulk capacity, measured in deadweight tonnage (DWT, the weight a ship can safely carry across the ocean) and published weekly by IHS Global Limited, rose to 607.64 million deadweight tonnage, while annual growth fell to a new low of 5.71%. Year-over-year growth using the last four weeks of data, which smooths out short-term noise, fell from 6.08% during the prior week to 5.91% this week.
Driven by large placements of new ship orders, shipping capacity had a huge run over the past two years, as companies expected global trade growth to continue at a record, fueled by China’s massive investment-led economic growth. The recent decline in year-over-year capacity growth is a positive development because total dry bulk demand grew by just 5.1% during the first five months of 2013, as reported by RS-Platou, an international ship and offshore investment bank. Further growth in iron ore shipments coming out of Brazil and Australia due to capacity expansions, as well as an expectation of a record grain output in the United States, should lift demand higher towards the end of the year.
But the real test will come during the second half of this year. Last year, several dry bulk shipping companies pushed back deliveries as China’s economic growth fell and shipping rates fell to a record low. The eight-week average weekly growth rate, shown in the chart above, fell to an average of 0.075%. Since the start of this year, capacity has grown ~3.7%. Unless we see the average weekly growth rate come down below 10%, capacity will likely grow by 7% this year, which could limit further upsides for dry bulk stocks until the end of this year.
Implication of lower capacity growth
Current capacity growth is still a negative, because it will continue to pressure shipping rates, company revenues, and earnings. This could harm medium-term share prices—especially if several maturing shipping contracts were drafted out above current market rates. If investors (the market) start to focus more on short-term fundamentals and become more risk-averse, share prices of stocks such as Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Knightsbridge Tankers Ltd. (VLCCF), Navios Maritime Partners LP (NMM), and DryShips Inc. (DRYS) will probably fall. Nonetheless, the current trend is positive for the industry’s long-term outlook. If investors stay focused on the favorable long-term prospects, dry bulk shipping companies will find support.
Learn more about the key performance indicators of the dry bulk shipping industry
More From Market Realist