Dry bulk shipping isn't exactly the most exciting industry sector to research. Even among sea-borne freight, oil-tanker companies overshadow dry bulk shipping companies. (The price of oil will do that.) But the dry bulkers — who carry cargo like iron ore, coal and grain — have much to speak for them, including low valuations, high-dividend yields and some potential for outright capital gains. And for those who love emerging-growth stories, dry bulk shipping companies are a play on Chinese economic growth expectations.
Indeed, dry bulk shipping represents a beguiling convergence of value and growth. Simply put, bulk freighters don't get the respect they deserve (for value investors, this is good). Investors tend to think about oil tankers, but dry bulkers haul about the same tonnage. In 2004, notes shipbroker and industry researcher Drewry Shipping Consultants, dry bulkers handled 38 percent of sea-borne trade, and tankers handled 40 percent. Stock valuations tell a different story. Natasha Boyden, equity analyst at Cantor Fitzgerald, points out that dry bulks trade around four times EBITDA, lower than the six-to-seven times tankers receive. Says Boyden, “It's not oil, and oil is the industry de jour. You'd think bulkers would trade at an industry multiple. After all, India and China are not going anywhere.”
The Macro Story
During the 1980s and 1990s, dry bulk was a sleepy trade, growing slightly — by just 2 percent annually. China changed all that. Recent surges in demand for cargo space on dry bulkers surged. In 2004, says Drewry, the annual growth in tonnage virtually doubled, largely on Chinese demand. Rates for global dry charters surged: The Baltic Dry Index, an index issued daily by the London-based Baltic Exchange, doubled in autumn to begin 2004 at over 4,000, then dropped again this spring, before recovering to a level over 3,000.
“Last year,” says Susan Oatway, Drewry senior analyst, “rates went through the roof. Since then rates have come off a bit, though they are still at levels that, prior to 2004, would be considered a high market.” Explains Oatway, “We saw massive demand for iron ore and coal, and freight rates hit unprecedented levels.”
There has been much hype over China's economic growth, but the hype may be true. The International Iron and Steel Institute forecasts 10 percent steel demand growth this year, and 7 percent to 10 percent more growth in 2006. Claims Oatway, “China is pumping out steel like there's no tomorrow.” Adds John Kearsey, research head at London shipbroker SSY, “This year, China's imports of iron ore come to about 270 million dead-weight tons, compared to 70 in 2000 and 134 million dead-weight tons taken by No. 2 importer, Japan. China's increase in bulk trade for 2005 is close to 100 million dead-weight tons, of which iron ore accounts for 60 million dead-weight tons. That increase was more than anybody predicted.”
Of course, the China trade did not go unnoticed among shipping financiers — or Wall Street for that matter, which trotted out 11 shipping IPOs and secondary offerings over the last year. Confidence about China's economic might and relatively easy financing terms led ship owners to order a record $51 billion of tankers and bulkers from shipyards last year, according to Clarkson Asia. For 2005, the global dry bulk carrier orderbook amounts to 20.7 percent of the existing fleet, with most vessels on the orderbook scheduled for delivery within 36 months. Though this flurry of new boats increases the likelihood of a glut in shipping capacity, Oatway claims, “That oversupply argument can be overdone. New orders have started to calm down a bit because there is no scrapping happening at all.” But that may soon change, says Tim Huxley of Clarkson Asia, who notes that ships only get scrapped when they don't make money. Right now, there is “a very large block” of ships, built in the 1980s that is approaching retirement age, Huxley says.
So far, the supply ramp is being absorbed, more or less, by strong demand. As Huxley notes, “If the supply story is worrisome, the demand story remains robust.” Adds SSY's Kearsey, “If demand performs in-line with the expectations of the world's mining companies, you are not likely to have protracted periods of weakness of the kind we saw in the 1990s or the 1980s, where the market stayed down for years.” One other caution: To be sure, betting on dry bulk is a bet on China. (Without China, would dry bulk trade fall apart? Without hesitation, Kearsey answers, “Yes.”)
Two Good Ways to Play
Of the recent IPOs, two standouts include dry bulk specialists DryShips, which did an offering in February, and Eagle Bulk Shipping, in June. Both issues appear reasonably cheap.
Eagle Bulk is the largest U.S.-based owner of “Handymaxes,” with 11-7 of its 11 ships are the slightly larger Supramaxes, versatile vessels that can navigate smaller harbors in India and Japan. Its fleet composition provides Eagle flexibility since, as Kearsey notes, the Handy's versatility makes it the ship most resistant to downturns. Eagle's ships average six years in age, as compared to 15, the industry average. Another healthy sign: Eagle has chartered 100 percent of its 2005 available days, and 74 percent for 2006. That means that three-quarters of its boats are already booked for next year.
Veteran contrarian money manager Seth Glickenhaus (who, at 91, claims “to be approaching middle age”) holds a sizeable position in Eagle, having bought shares both on the initial offer and recent secondary. Notes Glickenhaus, who runs $1 billion or more for Glickenhaus & Co.: “Eagle has all their ships out on charters and is not vulnerable to spot. I like that, because it's not too long, but long enough to give you visibility for a year or two. And that $2.24 dividend is, if anything, on the low side. You're going to get a bitch of a high yield, about 15 percent at least for a year and a quarter. Do I need to say anything more?”
DryShips owns 21 Panamax (or midsized) ships, the world's second-largest fleet, along with two smaller ships and four Capesizes, the big boats. In contrast with Eagle, Dry is chartered 65 percent at the spot rate. That would appear to be sound strategy given that spot rates are tilting higher. If the art of chartering lies in controlling spot-rate volatility, Eagle and DryShips present contrasting approaches, with Eagle more cautious, and DryShips more aggressive about future charter rates.
On the analyst consensus, DryShips shares trade at a forward price-to-earnings ratio of four times while yielding 5 percent. According to renowned value investor Scott Black, an investor in DryShips, “China is booming, so DryShips still has a good business. You've got a company selling at $15 a share, with $13 in book and $3 in earning power; I mean, that's enough to resurrect Benjamin Graham from the grave.”
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