Macro Macchiato: Trust Me, I'm an Analyst
The Six Million Dollar Man...and then Some....
In Autumn 2018 I gave a presentation to an audience of financiers and investors in New York entitled “The Best Value Ship to Buy Today?” I considered historical variations in earnings and values, including their spread and limits. I looked at recent and forecast changes to trade patterns and vessel flexibility for different cargoes. I took into account changes to ship design and engine efficiency, plus suitability for burning low-sulphur fuels from 1st Jan 2020. And I considered ship owner appetite for newbuildings and the potential size of the second hand market. After all, I would want to profit from asset play with this investment. My analysis came up with one winner: a five to seven year old eco-design deep-well pump type Medium Range Products Tanker.
There was lots of upside potential and little downside left at that point in the cycle. At the time, ship brokers were assessing the price of a five year old MR tanker at around USD 17-18 million, some 50 per cent what they had been as recently as 2015. Let’s say your ship broker got you an acceptable ship for an acceptable USD 17.5 million.. According to the markets data page on the Capital Link website at the time of writing, a five year old MR is now worth USD 26 million. If you had found a good example two years ago and wanted to cash out today, take off 10 per cent from the five-year old price for two years’ depreciation and you have an estimated market price of USD 23.4 million. A gross capital gain of around six million dollars or 33 per cent for a two-year investment.
Meanwhile, basis Baltic Exchange data, if you started operating your acquisition in January 2019, to date you would have earned a daily average of around USD 18,500 operating the ship on the trans-Atlantic products market. On a ship with Opex of maybe USD 7,000 a day if you lavished care and attention on it, that’s a margin of USD 11,500 a day for 638 days (01 Jan 2019 to 30 Sep 2020), making a tasty USD 11.8 million. In total, you would have doubled your money in two years.
So if anyone was listening that Fall afternoon in Midtown and got an MR or two, I will let you buy me lunch next time I am in town. I don’t drink anymore (saving for my daughter’s college fees instead) so I’m a cheap date.
So That Was Then, What About Now?
I have been doing a similar exercise this year, in March and again now. This time there were no physical presentations to be made in New York, so I published the reports on my website, from where you can download them for about the price of a good lunch for two.
Using the same kind of criteria, plus considering the likely outlook in the context of the coronavirus pandemic, I am firmly of the opinion that it’s time to exit tankers and get into bulk carriers. I like those which can rely on China for a base load of demand, but which aren’t entirely reliant on China, like the Capesizes are, because they are very vulnerable to policy changes such as the coal import quotas and caps that were introduced this year.
I do like the look of Handysize bulkers. To be honest, I always have. You don’t hit paydirt on the scale of Capesizes in spiky markets, but you can make steady returns and still have the potential to double your money with well-timed purchases.
At this point in the cycle the fundamentals look pretty good to me. Here’s why:
Limited Supply Growth
The ~81 Mn Dwt Handysize bulk carrier fleet continues to grow as new designs are delivered from shipyards in China and Japan, who now build over 90% of all units of this type. The Baltic Exchange’s switch to a standard Imabari 38 design reflects this, though the great majority of extant tonnage is in the 25-34 k Dwt range. Contracting has been low in 2020 at only 15 vessels, which suggests some latent demand is being suppressed by Coronavirus. Demolitions have been taking place at an average of 30 years, which we adopt for modelling fleet growth, though this makes little real difference as not much tonnage built in the early 1990s remains afloat. I expect very mild net fleet growth in the coming five years to average only 1.62 Mn Dwt a year compared to an average of 2.67 Mn Dwt a year for the five years to 2020. That equates to average annual fleet growth for 2021-25 of 1.4%.
Strong Demand Growth for Next Two Years
Regular readers will be aware that the bulk carrier market has shrugged off the worst effects of Covid-19 disruption to trade. Analysis of trade patterns suggest that the Handysize market structure is stable, with most growth in the forest products trades in the Pacific. China’s infrastructure-based response to Coronavirus disruption is driving change in metals and coal, while US trade disputes with China, Canada and other partners have rippled through trade patterns. Overall, demand in 2020 is expected to be unchanged from 2019, a significant increase from my previous (March 2020) estimate of a 3% fall in demand this year. Growth next year could top 5.0% and could match that in 2020 if the global public health crisis is under control by then, which I assume it will be. Demand growth over the coming five years is forecast to average 3.0%.
A Note on Forecasting Methodology: Caution Urged
Comparing these forecasts for supply and demand with history suggests that Handysize bulker earnings (in line with larger ship sizes) should rise in the next two to three years. I’ve been working on my forecasting model since I was a data analyst for a credit research outfit back in the mid-1990s. I’ve used it on projects for miners, trading houses, ship owners, banks, insurers, ports operators, and investors. It uses historical estimates of supply and demand to create a Capacity Utilisation figure which is then compared with historical earnings (in this case the BHSI 6TC). A simple linear model can then be used to estimate future earnings based on the changes to Capacity Utilisation I think will occur due to my forecasts of supply and demand change. Now, this forecast – like all forecasts – is made at one point in time with and built into it is an assumption that the future context of the forecast will not change. We call it ceteris paribus – all other things being equal. Of course, in the real world, shipping markets are dynamic. Importantly, they react to expectations about themselves. If optimism spreads in the market, then rising sentiment leads to more newbuilding orders, less demolition, and a downturn in the freight market cycle. Equally, if pessimism is the prevailing sentiment, then scrapping will rise, newbuilding contracts will fall and supply will slowly come back into balance with demand, at which point falling freight rates will bottom out.
A Positive Outlook for Next Two to Three Years
Nonetheless, the data suggest to me that the Handysize dry bulk market cycle reset in the first half of 2020 and that we should enjoy two – possibly three – years in which demand growth outstrips supply growth. Historically, that situation leads to rapidly rising freight rates. Our model accordingly outputs a scenario which Handysize bulker earnings peak in 2023 at over USD 20,000 a day, a level last seen in 2010. If markets rise this fast, ship owners will respond. Supramaxes will compete for larger cargo stems. Shipowners will react with further orders as they always have and new deliveries will temper this peak. But there are grounds for optimism for at this point in the cycle. And you can get a modern Japanese 36 to 38 thousand deadweight Handysize bulker for a bit over USD 15 million at the moment (Supreme Star, 36,800 Dwt, built Japan 2016, sold recently for USD 16.0 million).
To me, this opportunity looks a bit like the MR tankers did two years ago.