Executive Summary
The shipping industry has gone through a typical boom-bust-cylce over the past 10 years and the year 2016 can be seen as the low point.
Since then operational profitability of shipping companies has improved significantly and the industry is facing a structural shift given the effects of IMO 2020.
Moreover, the vessel orderbook of most shipping segments looks benign compared to previous periods. Therefore, freight rates in 2020 are expected to show strength.
Market fundamentals are sound and at present the equity market segment is priced attractively by historical standards based on P/NAV and other metrics.
On the other hand, the global economy is facing headwinds. In recent weeks, a further escalation of the trade war between the US and China has led to macroeconomic uncertainty in an already low growth environment.
A recent sell-off in most cyclical equity market segments can be seen as largely a reflection of the uncertain outcome of further US-China trade negotiations in the months to come and the potential spill – over to overall global economic growth.
1. Supply and Demand in Shipping Market
Marine transportation plays an essential role in international trade and in the world’s economy as over 90% of the world’s trade is carried out by sea. The seaborne trade has grown at around 3.9% p.a. in the last decade and is expected to grow at 3.8% p.a. in next 5 years as projected by UNCTAD (United Nations Conference on Trade and Development). Growing demand for goods and raw materials and more consolidation within the shipping industry are expected to improve business operations for shipowners.
The table below shows the commodity demand for the period of 2010-18 and expectations for the current year and 2020. In 2019, uncertainty regarding trade tensions between China and the U.S. had negative implications on the world economy. This has led to decelerated demand for dry bulk and tankers with China being a key importer for these commodities. However, crude and refined product demand have remained strong. Expected demand growth for 2019 is 0.9% and 2.6% respectively according to Clarksons (July 2019). In 2020, demand for all dry bulk and tankers is estimated to increase at higher rates, especially oil demand is expected to grow at an average rate of 3.5%.
IMO 2020 coming into effect on 1st Jan 2020 will particularly stimulate demand for crude oil and distillate. Refiners will need to run an addional 2.2 mn barrels per day of crude through distillation in order to meet the increasing demand for compliant fuels.
Source: Clarksons, July 2019
Analysing the supply side over last 20 years it can be noticed that the shipping industry has gone through a typical “boom-bust-cycle”. The emerging market boom period has led to a peak in the order book in the years 2008-2012.
As the average duration to build a new vessel takes one to two years, depending on the type of ship, the negative effects of high order volumes have been realized in the last couple of years.
In 2016 the industry has reached a low point with industry-wide losses and depressed asset values.
Source: Clarksons
As a result of this, lenders have been more cautious and the orderbook has been significantly lower in the subsequent years from 2017 until to date.
Since the peak in 2014, the overall trend of ship financing has been declining both in terms of volumes and numbers of transactions. The global outstanding marine loan volume in last three years has been significantly below the average of the last 15-years.
Source: Dealogic, Marine Money
Moreover, IMO 2020 leads to additional costs on behalf of shipowning companies. Vessels have to be either retrofitted with scrubbers before 1st of January 2020 or as an alternative the more expensive VLSFO (Very Low Sulphur Oil) has to be used. The uncertainty effect of IMO 2020 is another reason why the orderbook has been more benign in recent years.
In July 2019, only 5% of tankers and 3% of bulk carriers were scrubber-fitted. 11% of tankers and 8% of bulk carriers were retrofit pending. By the end of 2019, only 14% of tankers and 10% of bulk carriers are expected to be scrubber fitted. At the end of next year 20% of tankers and 14% of bulk carriers are expected to be scrubber-fitted thereby creating significant off-hire retrofit periods (on average 4-6 weeks) which will further reduce available vessel supply in the market.
The supply demand balance for the year 2020 looks attractive based on a forecast from Clarksons.The below graph shows the estimates for the tanker segment.
Source: Bloomberg, Clarksons
Freight rates could go up by 35% for dirty tankers, 25% for clean tankers and 23% for gas carriers in 2020 according to a recent Bloomberg analyst survey.
Upbeat market expectations are already reflected in the freight forward market. Since the beginning of this year, 1-yr time charter freight rates are showing an upward trend for both the dry – bulk and crude oil segment.
Source: Clarksons
2. Valuation of the shipping equity market
Shipping companies are currently valued at discount to their net asset value. As reported by Clarksons Platou in June 2019, crude and product tankers’ price-to-NAV were at 0.8x and 0.85x, respectively. Both figures were lower than the 10-year average of their respective segment.
Source: Bloomberg, Clarksons Platou
Moreover, vessels asset prices are trading at a discount compared to their 10-year average
Source: Clarksons
As opposed to the broad market segment such as the S&P 500 Index, shipping equities (Proxy: Russell 2000 Shipping Index) are still trading at a discount to their 10-year average based on the EV / EBITDA ratio.
Source: Bloomberg
3. Macroeconomics Uncertainty and trade war effects
Seen in isolation, the trade war impact on the US and China is potentially large. But in aggregate the bilateral US-China trade with a share of 3.7% of global trade is still relatively small..
Total tariffed trade is only limited to 1.7% of global seaborne trade, based on a recently issued research report by Clarksons.
Moreover, Clarkson Platou estimates the impact of trade war on container trade to be -0.4% in tonne – miles demand for 2019. As compared to an estimated overall tonne-mile growth of 2.3% in 2019 and 4.1% in 2020, the actual impact of the recently issued tariffs may actually be more limited than initially feared.
Cyclical equity segments such as the shipping industry have been particularly hurt during the market turmoil in August when a tit-for-tat trade war escalation has set in between the US and China.
This type of market reaction is largely a reflection of the uncertain outcome of further US-China trade negotiations in the months to come and the potential spill – over to overall global economic growth.
Issued by:
Thang Do, MSc
Portfolio Manager
Seahawk Investments GmbH
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