Shipping recovery on the horizon

"There are indications that market sentiment is starting to improve," admits Johnny Plumbe, executive chairman at shipbroker ACM Shipping (ACMG). "The worst is over." Mark Williams, research director at Braemar Seascope, agrees. "Nobody is feeling irrational exuberance," he says, "but there are grounds for some cautious optimism for 2014." And Clarkson's (CKN) top number cruncher Jeff Woyda told us recently there was "light at the end of the tunnel."

But, as Mr Williams says, none are getting carried away. Several themes at play since the credit crunch are still washing through the system. Huge numbers of ships ordered during the boom years were still being built and hitting the seven seas as the west began navigating a series of damaging recessions. Freight rates and ship values plummeted, credit dried-up and high profile bankruptcies followed.

Calling the turn is also made more difficult by the sheer complexity of the shipping industry, with myriad variables such as vessel size, age, range, cargo and sea route that affect freight rates. "You can’t put everything in the same box," warns Mr Plumbe. That said, the market for refined product tankers shipping gasoline and diesel has improved and the outlook for Very Large Gas Carriers is "relatively positive." Rates for huge Capesize bulk carriers have firmed, too.

Rates on rising tide

London-based shipbrokers like Clarkson, Braemar Shipping (BMS) and ACM generate lots of cash, but freight rates determine how much money they make. Arranging a charter typically earns them 1.25 per cent commission, so when rates rise, commission and profits do, too. All three companies have kept growing broking volumes, but low rates have hit both the top and bottom line.

Of course, there are worries that the US Federal Reserve will soon begin withdrawing its economic stimulus. Less dynamic growth in China and the threat of a credit crunch there are concerns as well. Moreover, shipping capacity is still outstripping demand. But a quick glance at the Baltic Dry Index (BDI), a tracker of freight rates for vessels carrying dry bulk like iron ore, coal, grain and cement, offers some encouragement.

The index is up about 60 per cent this year at an 18-month high, driven in part by restocking of iron ore and coal by China. Yes, there have been false dawns since the index's six-month plunge from near 12,000 to below 700 in 2008. But the positives are slowly stacking up. Australia, for one, predicts iron ore exports will jump by 14 per cent over the next 12 months. Both thermal and coking coal should rise, too.

Engine room of growth

That's hardly surprising. China has held off buying iron ore and coal from the Aussies, knowing that prices will fall further when the Fed turns off the taps. So there’s latent demand and there will be further restocking by Beijing, probably from the end of the third quarter, reckons Mr Williams. What's more, a strong dollar, to which the Chinese renminbi is still effectively pegged, makes their imports "doubly cheaper" and could "turbo-charge" demand.

A booming shale gas industry has also had a big impact. The abundance of cheap gas in the US means less coal is being burnt there which, instead, is being shipped to Europe where expensive oil is keeping the price of natural gas high - a kind of "hydrocarbons arbitrage." High oil prices will only fuel this trend, and there’s no incentive for Europeans to stop burning coal either since its carbon emissions trading scheme collapsed. That bodes well for rates and the BDI given the transatlantic route makes up about a quarter of the index.

This year’s peak shipping seasons are generating further optimism, too. We’re hearing prospects for the grain season for dry bulk in both the northern and southern hemispheres look good right now. While, for container ships - which depend on the health of the western consumer - freight rates have held-up well, so new big ships are being brought in. High demand ahead of the winter fuel-burning months always causes a fourth quarter peak in oil transport, and cold winters are always good for business.

Balancing act

There’s also more evidence that the global fleet is beginning to rebalance. Less tonnage is being delivered and more ships are being scrapped earlier than historic norms. "It’s already hard to trade 15-year-old ships," says Mr Plumbe. Estimates already point to dry bulk fleet growth slowing to low single digits in 2014 - a decade low - while tanker fleet growth is now at its lowest since the early noughties.

Yet ship orders have risen, mostly for tankers carrying refined products. That's driven largely by a shift in the global refining market from Europe and east coast of America to the Middle East and Asia where facilities are built for export. Clearly, owners think there’ll be more demand for shipping when these new ships come on stream from late 2014.

A second-hand vessel will cost you a little more as well. Ships over 15-years old are just scrap value plus whatever cash flow it can generate in the last years of its life. But prices have risen over the past few months or so, says Mr Williams. "That’s possibly an indication that buyers anticipate the freight market will rise, too, and that ships will throw off more cash flow in future."

But having fallen so far, ships are still as cheap as they've been since the mid-1980s and both ship owners and investors wanting to play the asset cycle are licking their lips. Traditional European shipping banks may be out of the game, but the Greek families aren't and they generally get it right. Having sold out at the top of the cycle they have begun buying back in. A stronger US currency, which inflates valuations for dollar-denominated assets, adds to the attraction.  

IC VIEW:

There's a growing sense that the shipping cycle is reaching a turning point and, when it does, the sector will flourish. That, however, is unlikely to happen for at least another year. Until then, there's little the ship owners can do. But brokers can make a difference by growing volumes to compensate for historically low rates. They can also develop other parts of the business that are less dependent on the ebb and flow of volatile freight rates. Braemar and ACM generate lots of cash, too, which underpins healthy dividend yields of about 6 per cent for the patient investor.