It’s not often the shipping sector gets much attention from the British media, let alone from investment and personal finance outlets. Given that merchant shipping still facilitates 90 per cent of international trade, using approximately 102,000 commercial ships worldwide, that might seem surprising.
One reason for the lack of attention is the sector's diminutive size in the domestic economy. For investors, all that remains of Britain's rich maritime heritage is a couple of London shipbrokers. Another reason may be the volatile nature of the market, which makes it difficult to project the future conditions these companies will face.
When the shipping market boom of the 2000s came to a sudden end with the 2008 crash, vessel earnings plunged in a well-documented downturn. As western economies have slowly emerged from the recession, City analysts have long predicted a recovery for shipping. But investors have been long frustrated. For example, in 2010 DVB Bank – a specialist financier for the sector – said the outlook for 2012 appeared “considerably brighter”, with the imbalance between supply and demand due to shrink. In fact, according to Braemar Seascope data, the imbalance grew steadily up until 2013. Any gains in ship earnings accrued in the first recovery rush of 2009-2011 were consequently lost in 2012.
This boom-bust pattern has continued. Fast-forward to late 2013 and orders for new ships started to accelerate again, with the ClarkSea index of ship earnings - often referred to as the industry's heart-rate monitor - 9 per cent ahead of its historical average. But the second and (to date) third quarters of 2014 were tough again, and the index has now reverted to early 2009 levels.
The key problem in 2009-2012 was the over-supply caused by huge ship orders in the boom years. That's still a problem, causing volatility in freight rates, but it seems to be a diminishing one. Rising fuel costs have driven demand for more fuel-efficient tonnage. But the pace of deliveries has also slowed: shipping association BIMCO says it expects dry bulk fleets to grow by an average of 4.4 per cent this year. In the containership segment, fleets should grow by an average 5.7 per cent.
In any case, volatile rates are more of a problem for ship owners than brokers like Clarkson (CKN), which delivered a 46 per cent improvement in underlying profits in the first half. Finance director Jeff Woyda admits the down-cycle is making trading tricky, but attributes Clarkson’s strong performance to investment in the business, including new global offices and staff. Every business division at Clarkson is now in profit – even its finance division, which was forced to restructure in 2013. If there's a real recovery story to be found in the shipping sector, it may be Clarkson, which has substantially outperformed the Baltic Dry benchmark index of shipping rates since the financial crisis (see graph).
A company keen to follow Clarkson’s lead is Braemar Shipping Services (BMS), which merged with Aim-listed player ACM Shipping (ACMG) in May. ACM had long rebuffed potential bids, but finally agreed to the tie-up with Braemar. Braemar finance director Martin Beer says the enlarged company will be able to serve clients in a way “neither company was able to” previously. But Mr Beer doesn’t expect market conditions to be radically different in a year’s time. The industry "might be in slightly better shape,” he says, but warns that any improvement so far “hasn’t translated into better rates.”
One cause for optimism is the improving trend signalled by Danish shipping and oil conglomerate Maersk (DK:MAERSKB). It raised its full-year underlying profit outlook in August, and announced a share buyback of up to $1bn for the next 12 months. Admittedly, that's worth less than 2 per cent of the group's current market capitalisation. Yet Maersk hasn’t chosen buybacks as a means of managing excess capital before. The news went down well with the market, with the shares rising 5 per cent.
Dubai-based ports operator DP World (DPW) also seems to be thriving. First-half profits rose 26 per cent, which it said was the result of extra capacity and improving trends at its global terminals across the Asia Pacific and Indian subcontinent, Europe and the United Arab Emirates. It’s also investing heavily, pouring $350m of capital into the portfolio in the first half of 2014 alone.
Meanwhile, maritime services group Ocean Wilsons (OCN) had a tough second quarter, resulting in a 32 per cent drop in operating profit for the first half. The Brazilian maritime unit was the key problem, suffering from delivery delays and suspensions to future work. Shipyard revenue fell 23 per cent to $17m, pushing shipyard cash profits down 76 per cent to $1.7m.
IC View:
The over-capacity problems fuelled by the shipping industry's pre-recession spending binge are not over yet. But growth in capacity does seem to be petering out, suggesting potential for a medium-term recovery, particularly in freight rates. That could benefit both traditional shipbrokers and port services and maritime companies. But investors need to stock-pick carefully, looking for companies with strong cash reserves and flexible business models that can absorb the impact of an unpredicted downturn.
Favourites
Clarkson (CKN) is clearly a star performer, having tapped into the right markets at the right time. The shares do trade on a punchy 19 times forward earnings, but we think shareholders should pay for quality if they want to invest in such a volatile industry as shipping. The newly enlarged Braemar-ACM business also holds promise, going some way to consolidate a highly fragmented industry.
Outsiders
At the time of the interim results, we rated Ocean Wilsons (OCN) as a buy simply because the shares traded at a discount to larger peers in the sector. But questions remain over the resilience of the business model, particularly given the sector's dependence on wider macro-economic trends. If Brazil’s economy grows, Ocean Wilsons' current operational deficiencies should be temporary. If not, however, more contract delays and further suspension to planned work could be on the cards as demand drops off.
