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Further increase in capacity presents a risk to dry bulk firms

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Further increase in capacity presents a risk to dry bulk firms PART 1 OF 1

Further increase in capacity presents a risk to dry bulk firms

Further increase in capacity presents a risk to dry bulk firms

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When an industry is plagued with overcapacity, managers must find ways to remedy the problem. One of the ways this is done in the dry bulk shipping industry is retiring old ships that are less efficient. This helps reduce supply and increase prices for shipping dry bulk materials, such as iron ore, coal and grain, which will lead to higher revenues, fleet utilization and earnings.

About 6% of existing capacity has passed depreciable life

According to Pareto Securities (an independent full service investment bank focused on sectors, such as oil, exploration and production, and shipping), about 40.2 million dwt (deadweight tonnes) of existing supply is more than 25 years old. For ships more than 20 years old the number almost doubles to 73.7 million dwt. Dry bulk ships are often depreciated over a period of 25 years from the commencement of service, as mentioned in several companies’ annual reports. However, due to industry overcapacity, managers may be incentivized to further reduce capacity by selling assets that are over 20 years old instead of just above 25.

Further increase in capacity presents a risk to dry bulk firms

 

Retirement will not cover new capacity additions in 2013

Nonetheless, the retirement of ships more than 20 years old will not be enough to cover an estimated amount of 100 million dwt coming online in 2013. Assuming that every ship over the age of 25 will be broken apart and no new deliveries will be canceled or delayed, a base case of net 60 million dwt (or an increase of ~9.0%) will be added to current supply. However, investors should use this data in conjunction with demand growth. If demand grows faster than supply, shipping rates should rise along with industry’s capacity utilization, which will improve the industry’s fundamentals.

Some dry bulk firms that will be negatively affected

This is negative for dry bulk firms, such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE) and Safe Bulkers Inc. (SB). As the Guggenheim Shipping ETF (SEA) invests in large global shipping companies, and about 42% of the shipping industry engages in transportation of dry bulk, the ETF could be negatively affected if demand does not grow faster than supply.

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