Dry Bulk Shipping Report 2015-16

Some commentators believe that

current market conditions suggest that

the cycle is now in such a position, with

newbuild prices having continually

fallen and Deutsche Bank predicting in

their September 2015 Industry Update

on Dry Bulk shipping, that 2016 will be

a transition year characterized by slow

and steady improvement, giving way

to a sharper recovery in 2017. In fact,

some owners, such as Seanergy, which

acquired seven vessels from Restis

Group at $183 million in September

2015, are already taking advantage of

low asset prices to expand their fleet,

gain market share and replace their old

tonnage.

GROWTH POTENTIAL

Although there are many old shipping

companies that rely on the potential

of the industry as a long-term income

generator, for smaller investors this

is largely a speculative investment

focusing on capital appreciation in the

shorter term, with the aim of avoiding

the volatility of multiple market cycles.

It is therefore not surprising that a

number of private equity products are

focusing on the sector, looking to buy

assets cheaply and to take advantage of

markets and management to increase

their value in a short period. This is

currently very much aided by the

presence of undervalued companies as

well as distressed assets. Wilbur Ross,

a well-known private equity investor,

pointed out in 2013 that “shipping is

large, is experiencing long-term growth

and will recover within private equity’s

three to five-year investment horizon”.

MARKET FRAGMENTATION

The growth potential is also assisted

by the fragmentation of the market,

making entry for new or smaller

owners possible as they do not face

massive, consolidated competition with

the ability to control pricing to their

advantage. However, this lack of control

of pricing also explains some of the

volatility in the market, with charterers

wielding significant power in depressing

pricing when so many smaller entities

exist and are keen for business during

difficult periods. That said, some owner/

operators have attempted to mitigate

this by pooling their vessels to give them

better negotiating power in certain

charter agreements, with the earnings

shared on agreed terms between those

vessels.

In times of lesser supply of vessels,

pricing power switches firmly back to

the owners and their prices are then

only restricted by what the market will

pay. Such pricing issues would suggest

the potential for difficulties whilst over-

supply and negative macroeconomic

factors play out, as is currently the case,

but asset appreciation when supply

shrinks and improved macroeconomics

come into play, as is widely predicted in

the next several years.

At such times, the demand for second

hand vessels is strong. Ship values

generally follow earnings trends so that,

where charter rates have increased,

second hand values have shown a

corresponding increase, and vice versa.

TANGIBLE ASSET

The investment sector benefits

from being a tangible asset, where

investments are generally based

on the value of ships, meaning that,

unlike a money market instrument,

there is usually no risk of complete

devaluation overnight. Having said

that, like the majority of real assets,

particularly those which work to earn

their keep, the advent of newer models

and the traditional financial markets/

economic conditions do affect the

value of Dry Bulk ships, although the

rate of devaluation will depend on the

original asset, with Japanese and Korean

vessels currently attracting a premium

versus Chinese built vessels because of

superior quality, value and longevity.

It can be viewed as a relatively liquid

asset, with a number of global Sale &

Purchase shipbrokers (such as Clarkson

Platou plc, Braemar ACM Shipping

and North South Maritime) providing

agency services for ship owners looking

to expand or reduce their fleet, but an

added benefit of ships is that they have

a scrap value which can be accessed

as an exit safety net, meaning that it

is very unlikely for there to be total

loss of investment. Scrap prices are

determined by steel prices and vary

with supply and demand and between

the nations which undertake this work;

they include Bangladesh, India, China,

Pakistan and Turkey

. The price is

calculated per ldt (lightweight dead

tonne) and according to figures from

September 2015, the average value of

a Handymax bulker was $3.07 million,

at $330/ldt

. The proportion of the

original vessel purchase price offset

obviously depends on the purchase

price, but the October 2015 pricing for

a ten year old second hand Handymax

was around $10 million whereas a

fifteen year old Handymax was around

$6 million

. Such a vessel would have

five to ten years working life left and,

depending on movements in scrap

value, up to 50% of its asset value

guaranteed by the scrapping option.

Bear in mind also the room for the

value of such a ship to rise with market

improvements, as the price of a fifteen-

year-old Handymax was at $13.5 million

as recently as February 2014, $22.5

million in June 2010 and $50.5 million

in the heady times of April 2008. The

attraction of buying an asset at $10

million which could bring in income to at

least pay its costs and potentially more,

whilst its value potentially increases by

a third, or doubles, or more, thanks to a

rising market, is clear.

INVESTMENT HORIZON

For individual investors, given the

nature of this market and the risks of

volatility, the most sensible investment

horizon would certainly be a short-

term one mirroring the typical private

equity or Enterprise Investment Scheme

exit at three to five years. There is

a concentration risk involved with

investing in one specialised sector like

this, so it would perhaps not really be

suitable as a first foray into investments

and is probably better as an addition to

an existing portfolio.

The investment case suggests a modest

allocation as a short-term commitment,

within a balanced portfolio, is justifiable

“There is little if any dispute about the fact that shipping is the most carbon-efficient mode of

transportation ... international maritime shipping accounts for just 2.7% of annual global

greenhouse gas emissions”

World Shipping Council