The rate at which companies retire ships often reveals whether the dry bulk shipping is facing excess capacity or not. Overly optimistic behavior among firms before 2008 created huge backlogs of ship orders. Excess capacity has plagued the industry since then as as new ships were delivered. High scrappage rate points to ongoing excess capacity is negative for the shipping industry.
Scrapping rates do not seem to be slowing down
According to the data provided by IHS Global Limited, a global intelligence research company, 35 dry bulk ships were broken up from February 1st to 22nd of 2013. Illustrated by the slope of the graph above, companies have been aggressively scrapping ships since 2009, as new deliveries ate into day rates, revenues, margins and earnings. Recent data suggests the rate is not slowing down.
Negative in the short term
Companies often resort to scrapping last because the realizable value tends to be low. If vessels can be used to generate profits, it is preferable to keep them. Once the scrapping decision is made, the process is irreversible and new orders can take roughly two years to build. Until companies start to see preferable demand growth over supply growth, managers will continue to retire as many ships as they can, starting with the old ones. This is negative in the short to medium term because companies will incur restructuring costs on their income statements, lowering earnings.
Aggressive scrapping reducing capacity growth, opportunities ahead
Whilst new deliveries continue to pressure the industry, aggressive scrapping may be driving significant reductions in capacity growth, illustrated by a flatter slope over the past few months. As companies incur restructuring costs, day rates and industry utilization should improve.1
In the medium to long run, companies will have lower values for assets and stockholder’s equity on their balance sheets, which will boost returns on equity and assets when rental rates and earnings recover (on the condition that they have not gone bankrupt). Examples of dry bulk companies include DryShips, Inc. (DRYS), Diana Shipping, Inc. (DSX), Eagle Bulk Shipping, Inc. (EGLE) and Ship Finance International, Ltd. (SFL). The Guggenheim Shipping ETF (SEA), an ETF that invests in global shipping companies, will also benefit.
- Day rates are the average daily prices of shipping goods ↩
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