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.

Analysts at Morgan Stanley, which also is serving as joint bookrunning manager on the Quintana deal, Mark MacLean, Ole Slorer and Akshay Soni issued what is probably this week’s most comprehensive outlook on world shipping with their commodity shipping industry report. In this report, the analysts addressed with healthy confidence concerns that have been piqued this week about both the tanker and the dry bulk sectors. Even while recently the dry bulk market has taken a turn for the worse and such experts as John Kartsonas of Citigroup Smith Barney have advised against investing in tanker stocks, the Morgan Stanley reports explains smoothly that the “world has been gripped in a mild China panic over recent weeks.” It goes on to say that, “the dry bulk market is pointing to some minor weakness, albeit from very high levels, and appears to reflect a degree of seasonality.”

While they note that the “global economy appears fragile” and that capesize dry bulk rates in particular are showing notable weakness, they attribute the rate change more to seasonal factors and note that chartering rates and chemical shipping rates “have remained surprisingly firm.” The analysts expect that the global economy and the closely linked global shipping industry may be slowing down, but show no signs of collapse. While rating the entire shipping sector as “In Line” with other sectors, MacLean, Slorer and Soni do view the sector as “modestly undervalued, with near term fundamentals pointing to a classic seasonal upturn.” They believe that “strong global incremental oil demand of 4 mbpd over the next two years coupled with a tight refinery market supporting continued increases in cross trade should ensure a continued tight and volatile tanker market while the combination of port congestion and a continued strong Chinese economy should support the dry bulk market.”

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.

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.

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.

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.”

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.

Is the Sky Falling in on Tanker Equities?

Is the sky falling in on the tanker market? That seems to be the question of the day. There are certainly those who would assert that it is, or is about to, as rapidly falling tanker stock prices and even more rapidly falling charter rates remind many of the barren shipping landscape of the 80s and parts of the 90s. Then there are those who would disagree and have drawn a very different conclusion based on their view of tanker market fundamentals. We thought it might be useful to take a look at these views and the opinions behind them as investors and operators recover from an ungraceful destruction of the tanker equities.

The Beginning of the End…?

Citigroup Smith Barney analyst John Kartsonas reports that dayrates for all classes of vessels have fallen by an average of more than 60% while Jefferies analyst Ray Wu reports that VLCC spot rates have fallen around 80% over the past eight weeks. JP Morgan analysts note that tanker stocks themselves have correspondingly fallen by 20-35%. An extrapolation of current trends would of course predict future devastation of the tanker industry, but fortunately these trends appear to be more of a temporary correction than an indicator of future rate and stock price falls.

Momentum vs. Value

In the first place, importantly, this sort of gargantuan drop was almost universally anticipated. No one thought the unprecedented rates and stock prices seen in November were sustainable. The question, rather, was when, how far, and how hard they would fall. OSG CEO Morten Arntzen exhibited this philosophy in his explanation to Bloomberg: “I never told anyone that the rates would stand at $200,000 a day. But I enjoyed it.” Savvy investors must have been able to identify with this sentiment in late autumn. JP Morgan analysts Jon Chappell, Gregory Burns and Hassan Malik noted that their 2005 projections, pre-the recent fall, had “already factored in seasonal declines, the impact of an OPEC production cut, and the belief that the November rate levels were not at all sustainable.” The difference between them and the more bearish Citigroup Smith Barney reports appears to have been more along the lines of how to prepare for and del with the dropping tanker market situation than over whether it would occur. So who were the investors that have moved suddenly and in droves to substantially more cautious tanker market positions?

The Chappell-Burns-Malik report argues that the recent massive drop in the tanker stocks represents “the exodus of a vast number of momentum investors,” to which the analysts attribute the tanker stocks’ “meteoric” rise and subsequent fall. Now that the stocks have come back down to earth, the JP Morgan analysts expect a return of the value investors. Indeed, Hibernia, who downgraded Top Tankers to a HOLD just as the stock tumble began in early December, has just upgraded the company back to a BUY, indicating they expected something of the recent fall and seem comfortable that the worst is over.

Citigroup and JP Morgan on Supply & Demand

The supply demand balance, is, naturally, also extremely important in determining the prospects for the tanker market’s health in 2005. The JP Morgan report looks for fleet expansion of 19.2 mdwt, or 5.9% capacity growth, in the coming year while Citigroup reports demonstrate comfort with a slightly higher growth number of around 21.5 mdwt, a growth rate of close to 7%. As the orderbook is a known number, discrepancies revolve more around scrapping expectations, largely involving how tanker companies will deal with the new IMO regulations set to come into effect in April of this year. In the demand arena, Citigroup’s Kartsonas expects growth of around 2% as compared to 7% this past year, with OPEC’s one mbpd production cut to reduce tanker demand by as much as 7-8 mdwt with a shift to less long-haul and more short-haul tonnage. OMI’s Robert Bugbee told Tradewinds that he expects demand to be stronger than this, pointing out factors such as China’s intent to build a strategic petroleum reserve that could easily raise demand by one mbpd. Also on the upside, the JP Morgan analysts used IEA forecasts to estimate tanker demand growth of 13.5 mdwt. This discrepancy seems to be largely geographic with respect to oil supply.

Material Gains

Yet another dispute revolves around whether shipping stocks are cheaply or expensively priced. Kartsonas notes their expense relative to historical levels while the JPM analysts note their cheapness relative to many other industries. You can look for yourself at their P/NAV ratings in the “Fair Value” table. As usual, the truth probably lies somewhere in the middle. While the extraordinary spot rates witnessed in the past few months may have dissipated, current rates are still comfortably above breakeven levels, which are estimated in the low $30Ks for a typical being above mid-cycle and even comparable to annual highs in more typical years as shown in “Rate Comparison” chart. Not only that, but this past boom has seen shipping companies increase transparency, modernize their accounting practices and begin to access whole new pools of capital, all of which contribute to lowering their cost of capital and increasing the opportunities for financing available to owners and operators.

The tanker companies are now seeing that not all their new supporters will stick around when the fad passes, but they have undoubtedly succeeded in raising their profile and increasing the breadth of their long-term support base. Just as importantly, the companies are continuing to demonstrate strong performance, in a far more sustainable fashion than before, and, as the JP Morgan trio pointed out, they offer the potential for share buybacks, dividend increases and consolidation.

Is the sky falling in on the tanker market? That seems to be the question of the day. There are certainly those who would assert that it is, or is about to, as rapidly falling tanker stock prices and even more rapidly falling charter rates remind many of the barren shipping landscape of the 80s and parts of the 90s. Then there are those who would disagree and have drawn a very different conclusion based on their view of tanker market fundamentals. We thought it might be useful to take a look at these views and the opinions behind them as investors and operators recover from an ungraceful destruction of the tanker equities.

Citigroup Smith Barney analyst John Kartsonas reports that dayrates for all classes of vessels have fallen by an average of more than 60% while Jefferies analyst Ray Wu reports that VLCC spot rates have fallen around 80% over the past eight weeks. JP Morgan analysts note that tanker stocks themselves have correspondingly fallen by 20-35%. An extrapolation of current trends would of course predict future devastation of the tanker industry, but fortunately these trends appear to be more of a temporary correction than an indicator of future rate and stock price falls.

In the first place, importantly, this sort of gargantuan drop was almost universally anticipated. No one thought the unprecedented rates and stock prices seen in November were sustainable. The question, rather, was when, how far, and how hard they would fall. OSG CEO Morten Arntzen exhibited this philosophy in his explanation to Bloomberg: “I never told anyone that the rates would stand at $200,000 a day. But I enjoyed it.” Savvy investors must have been able to identify with this sentiment in late autumn. JP Morgan analysts Jon Chappell, Gregory Burns and Hassan Malik noted that their 2005 projections, pre-the recent fall, had “already factored in seasonal declines, the impact of an OPEC production cut, and the belief that the November rate levels were not at all sustainable.” The difference between them and the more bearish Citigroup Smith Barney reports appears to have been more along the lines of how to prepare for and del with the dropping tanker market situation than over whether it would occur. So who were the investors that have moved suddenly and in droves to substantially more cautious tanker market positions?

The Chappell-Burns-Malik report argues that the recent massive drop in the tanker stocks represents “the exodus of a vast number of momentum investors,” to which the analysts attribute the tanker stocks’ “meteoric” rise and subsequent fall. Now that the stocks have come back down to earth, the JP Morgan analysts expect a return of the value investors. Indeed, Hibernia, who downgraded Top Tankers to a HOLD just as the stock tumble began in early December, has just upgraded the company back to a BUY, indicating they expected something of the recent fall and seem comfortable that the worst is over.

The supply demand balance, is, naturally, also extremely important in determining the prospects for the tanker market’s health in 2005. The JP Morgan report looks for fleet expansion of 19.2 mdwt, or 5.9% capacity growth, in the coming year while Citigroup reports demonstrate comfort with a slightly higher growth number of around 21.5 mdwt, a growth rate of close to 7%. As the orderbook is a known number, discrepancies revolve more around scrapping expectations, largely involving how tanker companies will deal with the new IMO regulations set to come into effect in April of this year. In the demand arena, Citigroup’s Kartsonas expects growth of around 2% as compared to 7% this past year, with OPEC’s one mbpd production cut to reduce tanker demand by as much as 7-8 mdwt with a shift to less long-haul and more short-haul tonnage. OMI’s Robert Bugbee told Tradewinds that he expects demand to be stronger than this, pointing out factors such as China’s intent to build a strategic petroleum reserve that could easily raise demand by one mbpd. Also on the upside, the JP Morgan analysts used IEA forecasts to estimate tanker demand growth of 13.5 mdwt. This discrepancy seems to be largely geographic with respect to oil supply.

Yet another dispute revolves around whether shipping stocks are cheaply or expensively priced. Kartsonas notes their expense relative to historical levels while the JPM analysts note their cheapness relative to many other industries. You can look for yourself at their P/NAV ratings in the “Fair Value” table. As usual, the truth probably lies somewhere in the middle. While the extraordinary spot rates witnessed in the past few months may have dissipated, current rates are still comfortably above breakeven levels, which are estimated in the low $30Ks for a typical being above mid-cycle and even comparable to annual highs in more typical years as shown in “Rate Comparison” chart. Not only that, but this past boom has seen shipping companies increase transparency, modernize their accounting practices and begin to access whole new pools of capital, all of which contribute to lowering their cost of capital and increasing the opportunities for financing available to owners and operators.

The tanker companies are now seeing that not all their new supporters will stick around when the fad passes, but they have undoubtedly succeeded in raising their profile and increasing the breadth of their long-term support base. Just as importantly, the companies are continuing to demonstrate strong performance, in a far more sustainable fashion than before, and, as the JP Morgan trio pointed out, they offer the potential for share buybacks, dividend increases and consolidation.

The Beginning of the End…?

Citigroup Smith Barney analyst John Kartsonas reports that dayrates for all classes of vessels have fallen by an average of more than 60% while Jefferies analyst Ray Wu reports that VLCC spot rates have fallen around 80% over the past eight weeks. JP Morgan analysts note that tanker stocks themselves have correspondingly fallen by 20-35%. An extrapolation of current trends would of course predict future devastation of the tanker industry, but fortunately these trends appear to be more of a temporary correction than an indicator of future rate and stock price falls.