The price of a ship depends on two factors: the amount of cash the ship can generate within its useful life and the cost of steel — the main material used in ship construction. Rising vessel price is often a positive indicator for dry bulk shipping firms, such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE) and Safe Bulkers Inc. (SB), because it allows them to secure cheaper debt (or more of it). Higher vessel price is also an indication of higher expected cash flows in the future and vice versa.
Steel price fell but Panamax price stayed constant in February
At the end of February 2013, prices for new builds, 5 years old and 15 years old Panamax ships (a class of ships that a majority of firms mentioned above operate) stood at $24.50 million, $18.50 million and $8.00 million. Although steel price in China cooled from $4,133 to $4,073 per metric tonne (mt), the three different ship prices stood unchanged from the prior month.
Because dry bulk vessels take up to two years to construct, prices for Panamax vessels are less volatile compared to steel. Unlike steel price, which is subject to short term fluctuations, construction companies take into consideration steel price over the next few months. Thus, vessel price tends to have a strong correlation to steel price with ~0.61 for Panamax vessels aged 15 and 5, neither very strong nor weak.
Correlation difference shows low demand for new purchases
Interestingly, new builds price has a lower correlation of 0.43. When steel price rose from January 2009 to January 2011 due to higher global economic activity, new builds stood flat, whereas the values for 15 and 5 years old ships rose. Likely causing the difference in correlation compared to vessels age 15 and 5 is the large amount of orders which managers placed pre-2008 (see “Orders for dry bulk ships have yet to rebound signaling continued uncertainty“). That has capped demand for new orders and restrained construction companies from passing higher steel prices to dry bulk shipping firms.
As long as the correlation between price for new builds and steel stays low, it is an indication of excess capacity within the dry bulk shipping industry for the medium to long term. Excess capacity is generally negative for dry bulk shipping firms, and for an ETF that invests in large shipping companies worldwide: Guggenheim Shipping ETF (SEA).
However, investors should be aware that even if managers continue to hold off on purchasing new ships, if fleet utilization increases due to higher demand growth relative to supply growth, dry bulk shipping stocks and the Guggenheim Shipping ETF will rise.
© 2013 Market Realist, Inc.