Deep-value investors should take note of what’s happening in the global shipping industry. The outlook for shippers is so bad right now, you could call it “shippergeddon.” Conditions are full-on catastrophic, due to a triple-whammy of negative impacts.
It isn’t time to act, but it’s time to keep an eye out. A horrible outlook for shippers now could produce significant opportunity later, when shipping stocks rise again, like Lazarus from the dead.
Some of the biggest investment gains come from industries that have gone through a near-death experience, with crushed valuations leading to a tripling or quadrupling of share prices just to get back to “normal” conditions.
You know conditions are bad when a bellwether index hits all-time lows. But how about when an index goes negative for the first time in history — and then goes even more negative as an encore?
That’s what just happened to the Baltic Capesize Index (BCI), an important component of the Baltic Dry Index. Last week, the BCI went negative (below zero) for the first time ever. This week it plunged further into negative territory.
Capesize vessels are the world’s largest dry cargo ships, transporting raw materials like grains and iron ore. “Capesize” refers to the fact that such ships are too big to fit through the Suez Canal or Panama Canal — hence they have to sail around Cape Horn instead to travel between the Atlantic and Pacific oceans.
The BCI plunged because shipping rates have plummeted across the board. Capesize China-bound iron ore and coal ships, for example, are reportedly booking less than $2,600 a day — an incredible 93% drop from their peak rates in 2019. Supertankers, which can transport 2 million barrels of oil at a time, have seen jaw-dropping rate declines of 95% from the 2019 highs.
“Shippergeddon” is a result of three factors hitting at once:
- The coronavirus outbreak is shutting down global trade
- Fuel prices have skyrocketed due to new pollution rules
- Chinese shipyards are backed up or shut down completely
The first problem is global trade screeching to a halt.
In addition to reduced economic activity, stepped-up quarantine measures are making it harder to ship anything. At the same time, heavy-handed China coronavirus quarantines have turned ports into ghost towns. Even if the ports remain open, there is a shortage of trucks and trains to move cargo in and out.
The second problem is skyrocketing fuel costs. As of Jan. 1, 2020, harsh new rules kicked in requiring ships to reduce sulfur emissions by more than 80%. There are only two ways to meet that goal: Shipping companies can pay more for low-sulfur fuel, which is wildly expensive, or they can retrofit their ships with “scrubbers” to keep burning the older, cheaper stuff.
For shippers, fuel costs can represent half the operating budget. That makes “scrubber” installations a good deal: Though a retrofit scrubber installation costs a few million dollars per vessel, it can mean multi-million-dollar fuel cost savings for a number of years, via continued ability to burn the dirty stuff.
But the high demand for scrubber installations runs into the third issue: China’s shipyards, where most of the scrubber installations take place, are either completely shut down or backlogged severely because of the coronavirus outbreak.
Put it all together and you’ve got the worst of all worlds for shippers right now. Cargo rates have fallen through the floor due to coronavirus impacts on global trade. Fuel costs have shot through the roof due to strict new emission requirements as of Jan. 1. And scrubber installations — a relatively low-cost way to save on fuel — have been taken off the table due to China’s shipyards going dark.
In terms of shipping stocks, nobody should try to catch a falling knife. For shippers, nobody knows how much worse it will get, and the bottom could still be a way off.
But we do know that, at some point, commodity prices will rebound, fuel costs will fall, and scrubber installations will be accessible again as shipyards bounce back. When the market starts to anticipate that triple reversal of fortune, beaten-down shipping stocks could double or triple in price.
TradeSmith Research Team