Elevated 7% capacity growth negatively affects shipping firms short-term

Capacity is an important factor that directly impacts companies’ top line (revenue) in a highly commoditized industry, like shipping. When capacity grows faster than what is demanded, competition will rise among individual shipping firms as they try to utilize idle ships and cover fixed costs. This will lower day rates, which will negatively affect bottom line earnings, free cash flows and share prices for companies, such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM) and Safe Bulkers Inc. (SB).

Elevated 7% capacity growth negatively affects shipping firms short-term

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Capacity flirts with 7.0% growth

Dry bulk capacity, measured in DWT, grew 7.09% year-over-year in May, according to the latest data available from IHS Global Limited.1 Year-over-year capacity growth has hovered around 7.0% lately, after falling from near 10.0% at the start of the year. This points to a slightly negative short-term outlook as new builds continue to be delivered, depressing shipping rates, earnings and free cash flows for dry bulk shipping firms.

During the last week of May, capacity grew by 0.19% week-over-week. As it is necessary for average weekly capacity growth to stay below 0.11% for capacity to grow less than 6.0% (Jefferies’s minimum expected dry bulk demand growth for 2013), last week’s data was negative. Although capacity growth has yet to fall further, the dry bulk industry has shown substantial progress since the beginning of 2011 when capacity was growing at 16% year-over-year, primarily driven by over purchases of new ship builds as managers became too optimistic with future trade growth before the financial crisis.

Short to long-term views

Shipping companies, such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB) and Navios Maritime Partners LP (NMM), will likely stay depressed in the short-term as global trade grows less than capacity and valuable contracts mature. During the first quarter of 2013, capacity grew by just 4.5%, according to RS Platou — an international ship and off-shore investment bank.

However, economic growth is expected to be stronger during the later half of 2013, and while HSBC’s May manufacturing PMI data for China, the largest importer of dry bulk material, was negative, the country’s real estate sector appears resilient with several leading indicators pointing to a sustained recovery (see our macro driver section for more info). For investors looking to diversify investments across several companies, they can look towards the Guggenheim Shipping ETF (SEA), which invests in the largest shipping companies worldwide.

  1. DWT: a weight measurement that indicates the amount a ship can safely carry and transport across oceans.

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