Dry-Bulk Shipping Demand Dries Up

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Saturday, 22 November 2008

The end of the commodities bull market has certainly left its fair share of victims in its wake. Shares of basic materials, energy, fertilizer, metals and mining stocks have all been slammed as commodity prices have come crashing back to earth. Dry bulk shipping stocks may have shed the most blood as they are dependent on global demand for coal, iron ore, oil and other commodities to make profit and as demand has dwindled, so has investor appetite for shipping stocks. One Index Paints a Thousand Words
Investors need look no further than the Baltic Dry Index to measure the share price erosion in shipping stocks. The Index is a daily average of the cost to ship various raw materials around the globe. Essentially, it measures the cost paid by the receivers to have their goods shipped to them. The Index has fallen nearly 92% from a record high of 11,793 on May 20 to around 859 on Thursday, Nov. 20.
Wilting Demand, Growing Dividends
As demand from emerging market economies, such as China and India, has wilted for commodities ranging from copper to coal to iron ore to zinc, shares in the world's top dry bulk shippers have followed suit. Unfortunately, recent demand trends show a pervasively downward trend and when the trend dissipates, is anyone's guess.
Despite the fall in share prices, shipping stocks may be offering investors some value here, especially when considering their almost freakishly high dividend yields.
Are Dividend Cuts Next?
The problem with fat dividends and their accompanying lofty yields in times of financial strain is that they represent an easy avenue for companies to save cash by cuts or elimination of the dividend. Look no further than Diana Shipping. The company recently announced plans to suspend its dividend. To ease the blow, the company did initiate a $100 million share buyback plan.
On the other hand, Excel Maritime recently announced solid third-quarter results and bolstered its quarterly dividend to 40 cents a share, so it appears the cut may be exclusive to Diana or that the company is just being prudent at the current time.
Small Cap Transformation
Due to the deterioration in their share prices, DryShips, Eagle, Excel and Genco all currently sport market values of less than $500 million, falling within the definition of "small cap". Diana is the "giant" of the group with a market cap of almost $800 million. It would appear that these shippers have sailed into unchartered territory given their formerly beloved status just six months ago.
The global credit crisis has proved an extreme source of peril for firms such as DryShips and Eagle as front-end buyers cannot get the credit they need to buy commodities. Combine that with a weaker Chinese economy which equates to lower steel demand, and DryShips, Eagle and their rivals are not building larger fleets and are, instead, letting many of their ships sit empty at docks around the world. Genco is in the same situation as the company announced earlier this month it had scuttled plans to expand its fleet by six ships. On top of that, JPMorgan downgraded Eagle Bulk Shipping to 'underweight' from 'neutral' on Nov. 20, citing a potential breach of debt covenants if the value of assets have fallen too low.
Anything But Smooth Sailing
Expectations called for a slowdown in the group in 2009 or 2010, but the credit crisis hastened the group's downturn. On a fundamental basis, the stocks may appear cheap as all sport a P/E ratio below 3, which was partially due to declines on Thursday. The value in these stocks comes from their dividends, and if more follow Diana by cutting or suspending dividends, investors should sail straight out of the dry bulk shipping sector.
As adapted from Investopia