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Is it Time to Buy Ships? And Where Are We in the Cycle?
By Charles de Trenck, Transport Trackers
Over recent years, I’ve been trying to understand the pattern of corrections in ship prices (setting aside supply-demand and construction costs for a minute). To better understand the correction, I’ve taken to trying to strip out the noise coming from dollar volatility. The problem, as I see it, is too many of us have been trapped by looking at performance within a tautology of prices going up in dollar terms because the dollar was going down.
If we use gold as a yardstick rather than the dollar to answer the question of whether to buy ships now, the conclusion long term is generally more positive based on past trends. But the story told is also quite different.
If we use DXY (dollar strength against non-dollar basket) then the answer is more mixed, if we are in a dollar upward revaluation period. The trap is that if the dollar rebounds too much, we may be in for an extended slow down which will hurt companies which bought over-priced ships (ie, which were more defensive when the dollar was declining, as they were part hedge against that dollar decline…). The Euro’s problems in relation to the Greek debt crisis add another layer, which shifts the relationship of dollar-Euro-gold, of course.
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Betting on Tankers
Last week it was dry bulk. This week, all the fuss seems to be revolving around the tanker market. A Wall Street Journal “Money & Investing” section cover story on the popularity of shorting tanker stocks drew some attention. As did a bearish report from R.S. Platou, a much-talked-about, products-focused IPO from Aries Maritime, positive reports form Jefferies and Banc of America and tanker stock coverage initiations from First Albany. So what, exactly, are the arguments going around, and of what should tanker market players and their financiers be aware? It’s still impossible to predict the future, but we can tell you what some of the competing arguments are.
R.S. Platou analyst Erik Andersen drew a lot of attention with his bearish report on shipping, particularly tankers. According to Mr. Andersen, the seasonality justification for low spot rates – which brokers say have dropped into the upper teens for VLCCs on some routes – is badly overblown. He notes that from 1997-2004, the average second quarter rate was about 37.5% lower than the average fourth quarter rate, completely out of order with the drop in rates from $147,000 in the fourth quarter of 2004 to $41,000 so far in the second quarter of 2005. However, this is still above the 8-year average second quarter rate of $35,000 – albeit with higher bunker prices – suggesting that perhaps the $147,000 was more of an anomaly than the $41,000 is a sign of a crash. Still, tanker fleet annualized growth figures of 6-7% compared to a comparable rate of 1% annually over the decade from 1993-2003 are somewhat ominous. Citigroup Smith Barney analyst Charles de Trenck noted how the current weak rates are making the tanker market the first among the shipping sectors to experience the pricing pressures derived from growing capacity. But on the bright side, Mr. Andersen did write that he does not believe tanker markets will weaken so much as to create a weak year for owners.
Analysts Magnus Fyhr and Douglas Mavrinac at Jefferies & Company have a much different take on the current market situation. They said in a report issued to reiterate their buy rating on Ship Finance International that they expect tanker demand to be firm on increasing OPEC production. Importantly, the analysts believe that incremental fleet growth of 21 MMdwt scheduled through the end of the year is likely to be absorbed by increased tanker demand.
Evincing similarly positive sentiments, analysts Daniel Barcelo, Philippe Lanier and Pierre Sargeant of Banc of America Securities issued a report on oil tankers optimistically titled “Hold On for the Summer Heat.” They note that a 5% tanker stock pullback over the past two weeks has been related more to Arabian Gulf VLCC market conditions than to the tanker industry as a whole, much of which has remained fairly strong. Additionally, they point out that the 450 vessel global VLCC fleet has grown by only two vessels so far in 2005, implying that softened rates could not be explained by supply buildup, but rather are a product of a reduction in Arabian Gulf export volume and a temporary buildup of available tonnage in the gulf. Analyst Craig Irwin of First Albany appears to agree, having this week initiated coverage on General Maritime, OMI and Arlington Tankers with a Buy rating. And a group of Asian investors that market sources say recently put their money into a very expensive $140 million VLCC newbuilding have put their money where their mouth is when it comes to predicting a strong VLCC market for years to come.
Much of Wall Street, however, seems to have sided with R.S. Platou on the more bearish side of the debate, as a widely disseminated article titled “Shorts Expect Tankers to Take On More Water” strongly suggests. Teekay, OMI, Knightsbridge and General Maritime are all being subjected to this phenomenon, with Frontline leading the pack. Investors are brazenly betting that tanker stocks will keep falling. Whether or not this will happen is hard to tell, though the practice certainly is not encouraging for those hoping to see their tanker investments appreciate.
Charles de Trenck’s 7 Reasons to Short Shipping Stocks
1. There is a negative correlation between the dollar and the BDI of -0.37 since 1986.
2. The dollar to U.S. Rev/TEU correlation is -0.7 since 1987.
3. Freight is a commodity and commodities fall in dollar rebounds.
4. Since Breton Woods collapsed there have probably been three major periods of massive dollar declines; looks like we just had the third.
5. Wal Mart tells us consumers could very well be about to be maxed-out from the cumulative effect of buying binges in the 1990s.
6. Wal Mart accounts for 25+% of China outbound container shipping volumes Wages in China for Wal Mart low-end goods are rising faster than any potential RMB revaluation.
7. Ship capacity on order — almost any type of ship you care to choose; tankers, bulkers, containers — is currently equal to about seven years of normalized demand.
Since Mr. de Trenck’s advice was issued, transport stocks have been getting shorted in Hong Kong all week, and three of the top five are shipping names.
“COSCO Pacific and China Merchants have taken a reasonable licking, in line with traditional volatility. We still think COSCO Pacific is over-priced (our official long-term view on valuation), but would expect a rebound or a breather in correction,” said Charles. He simply doesn’t care for currently listed companies nor Coscon’s upcoming IPO. “Pricing and IPO of parent’s container shipping arm at top of cycle remains an issue which will contribute added volatility to sector.
Charles also pointed out that Taiwan shipping was in a distressed state on 16 May, with reports that rates from Taiwan to the U.S. fell 12%. “For now, we maintain our view of a low-end of 3-5% revenue/TEU growth in 2005E against a market view that was as high as 7%,” he said. Also news such as the more than 7% per TEU cost hike cited by NOL mean that costs are outracing the weaker revenue gains.
A.P. Moller Bids for P&O Nedlloyd
In early 2004, it became clear to us that 2005 would be the most active year of consolidation among shipping companies in history. Our belief was underpinned by the fact that shipping companies were generating loads of cash from both operations and the capital markets, the fundamentals for the shipping industry looked set to remain strong and shipyards were operating at or near full capacity. So, armed with loads of cash and good prospects, it is natural to expect that companies would look to reap operational and financial synergies and leverage through growth, and that that growth would come in the form of corporate deals rather than single vessel purchases. And that is exactly what has happened in virtually every sector of the international shipping industry.
The Biggest Gets Bigger
In the latest and most dramatic example of this phenomenon, A.P. Moller-Maersk launched a takeover bid this week for 100% of the shares in Royal P&O Nedlloyd in the largest container shipping M&A deal ever. The takeover bid values P&O at Euro 57 per share, which represents a 41% premium to the then-current price and a 45% premium to the price over the last six months. The bid is also a whopping 130% over the rights issue price on the deal that received Marine Money’s Deal of the Year Award this year and values the company at 1.6x FY05E. Although we expect Royal P&O Nedlloyd shareholders and P&O shareholders, who own 25% of Royal P&O Nedlloyd, to vote in favor the deal, the European Commission may require Maersk to sell off certain routes in order to consummate the deal legally, which could in turn spark a series of smaller M&A deals.
Randy Sesson at Goldman Sachs is representing A.P. Moller on the transaction, JP Morgan is representing Royal P&O Nedlloyd and Citigroup is representing P&O.
Valuation Metrics – AP Moller Set to Get P&O for Free
The transaction is an important one for both AP Moller and the container market in general. As you can see from the graph on the first page, the deal solidifies AP Moller’s position as the world’s largest carrier by taking out the number 3 player and propelling itself to a size that is set to be more than double that of its next largest competitor. On the industry level, the good news is that it shows APM’s bullishness about the outlook for the market, even despite the enormous post-panamax containership order book and some gloomy forecasts by analysts. The loss of P&O from the Grand Alliance will have a negative impact on fellow members NYK, OOCL and Hapag-Lloyd, as Grand Alliance has historically been an effective competitor to Maersk although we can hope that the rationalization of tonnage might ultimately help lessen the blows of looming overcapacity. In a research note, Citigroup container shipping analyst Charles de Trenck said he thinks the deal might raise the ante for other container lines, perhaps suprring NOL to acquire Wan Hai Lines, which has loads of ships on order. De Trenck also surmises that Evergreen could potentially be hurt, so we would expect this transaction to cause a spate of mergers and acquisitions.
Like any truly good M&A deal, this one is beneficial to everyone involved. Shareholders in Royal P&O Nedlloyd get a great valuation for their shares at a time when many think the market might start to weaken. If they want to remain exposed to the industry, they can use their tender proceeds to buy shares in AP Moller. And for AP Moller, the deal is fantastic. With synergies of around $350 million and AP Moller’s P/E valuation of 10x, the company’s share price should increase by the entire purchase price of the new company. Adding in the $400 million of earnings that Royal P&O Nedlloyd is expected to generate in 2005 will bring the number to $4 billion. Put another way, one could make the argument that AP Moller is getting Royal P&O Nedlloyd company for free!
Written by: carisk | Categories: Freshly Minted, Mergers & Acquisitions | May 12th, 2005 | Add a Comment
Charles de Trenck Expects Costs, Capacity to Wipe Out Container Rate Gains
Citigroup Smith Barney analyst Charles de Trenck, referred to by some as ringleader of the container bears, has unleashed another attempt to burst what he calls “a perfect bubble.” This time he keeps up the frontal assault on capacity increases, and in the latest Container Trades report, he is attacking on the cost flank. In addition, he insists that good economic indications from the U.S. economy are not bright enough to fend off the storm clouds of a capacity overhang. The dollar is simply too weak.
Mr. de Trenck believes the real question now is the structure and level of the imminent decline, which “will end in tears, but the decline could be slow in the absence of demand slowdown catalysts,” particularly if the U.S. economy remains stable.
While there has been some downward guidance recently from major containers lines, Mr. de Trenck suggests that port congestion won’t help the lines as much as the container execs say it will. He also suggests that the 2005 rate moves will be influenced by whether the U.S. dollar is able to stage a mild recovery or not.
For dry (and container) rates there were periods (such as internet boom years) where both rates and dollar moved up together. But taking weekly moves over the entire April 1986 to February 2005 period, the analyst found a mildly negative correlation of –0.37.
There is rising rhetoric from the lines in advance of May contract season in Transpacific. There is indeed a potential average hike of US$75/FEU, with some hikes around US$150/FEU, against US$285 proposed. Great news but nearly every investor Mr. de Trenck met on a recent roadshow agreed that capacity on order is a key concern. The major surprise for them was that US$ costs/TEU are likely to rise more than US$ rev/TEU. Whatever rates are doing right know, however, Mr. de Trenck believes the increases will be wiped out by costs, then the industry will be pummeled by the capacity tidal wave.
Written by: carisk | Categories: Freshly Minted, Market Commentary | April 28th, 2005 | Add a Comment
Box Market Heading for Bruising, Say Citigroup Analysts
Box Market Heading for Bruising, Say Citigroup Analysts
UK-based Citigroup Smith Barney analysts Simon Smith and Roger Elliott issued a bearish beginning of the year report on container shipping titled simply and ominously: “Hangover Starting.” The metaphor seems to be particularly apt and widely used in shipping these days, where even as they revel in phenomenal profits, everybody is aware that at some point the party is going to end and they are going to have to deal with Sunday morning…and worse yet, Monday. Smith and Elliott see that morning coming, and coming soon. In particular, they cite unfavorable early 2005 rate negotiations, no break from WTO-enforced removal of textile quotas, rising cost pressures and an increasingly unfavorable supply demand balance.
Asia-Europe trade lane agreements, traditionally a good indicator of the year’s price environment, yielded flat rates this year which, while not terrible in themselves, will not do much to help shippers faced with rising costs. Unit costs are expected to grow by 3-4%, partially due to a weak dollar but also attributable to a loss of positive carry which, according Citigroup Smith Barney analyst Charles de Trenck, is a natural occurrence when topline drivers, i.e. negotiated rates, slow but momentum on higher costs, i.e. past negotiated contracts for equipment, boxes, etc., continues. This is where the “hangover” can be directly traced back to the “party.”
Not only this, but if the Asia-Europe trade lane agreements yielded flat rates in the current environment, the future for container shippers grows increasingly bleak as supply looks set to outstrip demand by progressively larger amounts over the next two years, with capacity growth estimated by Citigroup Smith Barney at 12.4% and 15.4% for 2005 and 2006 respectively, while demand growth is forecast at 8% and 9% for the same years. These demand growth numbers are not feeble, but they are also not strong enough to stop the gap from growing, though the picture could be somewhat altered if differences between predicted and actual scrapping and utilization materialized.
Tariffs & Tidal Waves
An anticipated boost in demand when WTO members agreed to lift all quotas on textiles and apparel on December 31, 2004, however, has so far turned out to be what Smith and Elliott disparagingly call a “damp squib.” They attribute this to actions by authorities designed to mitigate the effects of the quota removal while complying with it in word. And as for the tsunami, it seems to have had a blessedly small impact on the industry as a whole, as minor damage sustained in some places is more or less balanced out by higher volume, which is expected to not yield particularly higher profits as many shippers will be contributing their much-needed services charitably.
High Risk: AP Moller and P&O
In the same report, Smith and Elliott categorized both P&O Nedlloyd and AP Moller as High Risk, rating PONL a reasonably optimistic HOLD with a target price of 39 euros and AP Moller a less positive SELL with a target price of DKr40,000. In the case of P&O Nedlloyd, the analysts believe that the group’s exceedingly low price to book and EV/EBITDA multiples give the group potential to close the gap with itself and the majority of the sector, thus keeping the stock price at least level even if the container sector as a whole were to fall to a lower center. On the contrary, they sees more downside risk for AP Moller, citing in particular “poor disclosure to public shareholders, which we believe puts them at a disadvantage.”
China: A Light in the Tunnel
In another Citigroup Smith Barney Report, analysts Yiping Huang and Lan Xue auspiciously predict that the long-awaited “landing” in China will be “soft.” They forecast that the government will move from administrative to monetary tightening, allowing interest rates to rise gradually and the exchange rate to become more flexible. And while they do expect the investment slowdown to have negative consequences for commodities markets, they look for more level growth in consumption. So whether or not there are bad times ahead for the container market, highly China-dependent markets and sectors such as dry bulk may have better things coming. And maybe even the participants in the container party will wake up to a soothing brunch with which to nurse their hangovers so that they can speedily recover.
UK-based Citigroup Smith Barney analysts Simon Smith and Roger Elliott issued a bearish beginning of the year report on container shipping titled simply and ominously: “Hangover Starting.” The metaphor seems to be particularly apt and widely used in shipping these days, where even as they revel in phenomenal profits, everybody is aware that at some point the party is going to end and they are going to have to deal with Sunday morning…and worse yet, Monday. Smith and Elliott see that morning coming, and coming soon. In particular, they cite unfavorable early 2005 rate negotiations, no break from WTO-enforced removal of textile quotas, rising cost pressures and an increasingly unfavorable supply demand balance.
Asia-Europe trade lane agreements, traditionally a good indicator of the year’s price environment, yielded flat rates this year which, while not terrible in themselves, will not do much to help shippers faced with rising costs. Unit costs are expected to grow by 3-4%, partially due to a weak dollar but also attributable to a loss of positive carry which, according Citigroup Smith Barney analyst Charles de Trenck, is a natural occurrence when topline drivers, i.e. negotiated rates, slow but momentum on higher costs, i.e. past negotiated contracts for equipment, boxes, etc., continues. This is where the “hangover” can be directly traced back to the “party.”
Not only this, but if the Asia-Europe trade lane agreements yielded flat rates in the current environment, the future for container shippers grows increasingly bleak as supply looks set to outstrip demand by progressively larger amounts over the next two years, with capacity growth estimated by Citigroup Smith Barney at 12.4% and 15.4% for 2005 and 2006 respectively, while demand growth is forecast at 8% and 9% for the same years. These demand growth numbers are not feeble, but they are also not strong enough to stop the gap from growing, though the picture could be somewhat altered if differences between predicted and actual scrapping and utilization materialized.
Tariffs & Tidal Waves
An anticipated boost in demand when WTO members agreed to lift all quotas on textiles and apparel on December 31, 2004, however, has so far turned out to be what Smith and Elliott disparagingly call a “damp squib.” They attribute this to actions by authorities designed to mitigate the effects of the quota removal while complying with it in word. And as for the tsunami, it seems to have had a blessedly small impact on the industry as a whole, as minor damage sustained in some places is more or less balanced out by higher volume, which is expected to not yield particularly higher profits as many shippers will be contributing their much-needed services charitably.
High Risk: AP Moller and P&O
In the same report, Smith and Elliott categorized both P&O Nedlloyd and AP Moller as High Risk, rating PONL a reasonably optimistic HOLD with a target price of 39 euros and AP Moller a less positive SELL with a target price of DKr40,000. In the case of P&O Nedlloyd, the analysts believe that the group’s exceedingly low price to book and EV/EBITDA multiples give the group potential to close the gap with itself and the majority of the sector, thus keeping the stock price at least level even if the container sector as a whole were to fall to a lower center. On the contrary, they sees more downside risk for AP Moller, citing in particular “poor disclosure to public shareholders, which we believe puts them at a disadvantage.”
China: A Light in the Tunnel
In another Citigroup Smith Barney report, analysts Yiping Huang and Lan Xue auspiciously predict that the long-awaited “landing” in China will be “soft.” They forecast that the government will move from administrative to monetary tightening, allowing interest rates to rise gradually and the exchange rate to become more flexible. And while they do expect the investment slowdown to have negative consequences for commodities markets, they look for more level growth in consumption. So whether or not there are bad times ahead for the container market, highly China-dependent markets and sectors such as dry bulk may have better things coming. And maybe even the participants in the container party will wake up to a soothing brunch with which to nurse their hangovers so that they can speedily recover.
EQUITIES Analyst of 2002
Since this time last year – when news of the Enron collapse was still fresh as was the image of the collapse of the Twin towers – the WorldCom debacle, Mr. Grubman and Citibank, Martha Stewart, Global Crossing and the Sarbanes-Oxley legislation have all passed-through against the backdrop of lowering interest rates and a skittish group of world stock markets creating a very thin margin of error for equity and debt analysts alike. There are calls in the US for analysis to be completely separated from the banking sector and, in the midst of this, many investment banks have tried to clarify their ratings systems by stopping altogether publishing target prices and limiting the meaning of their ratings.
This may or may not be a good development for investors. But for shipping equities which are illiquid for the most part – excluding the cruise sector which we largely consider leisure/hospitality stocks – in a cyclical industry it could reduce coverage. One small change in the environment for most any of these shares and there is a drastic swing in value. An even greater dearth of coverage could make this condition worse.
CRITEREA Because of this backdrop noted above, it is really difficult to empirically declare one shipping analyst better than another. It becomes a subjective enterprise in many ways. In fact its most important to note that few, if any, of the analysts cover the same group of shipping equities, so comparing one analyst to another in an empirical manner is basically not feasible. Therefore we will be giving out two awards to shipping equities analysts this year: The Marine Money Shipping Equities Analyst of 2002, which will be judged on empirical and subjective data compiled by Marine Money and the Marine Money Reader’s Choice Shipping Equities Analyst of 2002, which is chosen by the popular vote of a select polled group. No one analyst can win both.
Written by: carisk | Categories: Deal Of The Year Awards, Marine Money | January 1st, 2003 | Add a Comment
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