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Why is capacity important?
Capacity is an important factor that directly impacts companies’ top line (revenue) in a highly commoditized industry, like shipping. When capacity grows faster than demand, competition rises among individual shipping firms, as they try to use idle ships and cover fixed costs. This lowers day rates, which negatively affects 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), Eagle Bulk Shipping Inc. (EGLE), and Safe Bulkers Inc. (SB).
Driving farther away from 7.0% growth
Dry bulk capacity, measured in deadweight tonnage (DWT, the weight a ship can safely carry across the ocean) and published weekly by IHS Global Limited, grew 6.39% year-over-year for the week ending July 5, while year-over-year growth using the last four weeks of data stood at 6.72%. This is the lowest increase the dry bulk shipping industry has experienced since the end of 2009. Shipping capacity had a huge run over the past two years, driven by large placements of new ship orders, as companies expected global trade growth to continue at a record, driven by China’s massive investment-led economic growth. The fact that capacity growth fell below 7.0% is a relief to the dry bulk shipping industry, because growth has flirted around 7.0% for a while, which is higher than China’s dry bulk demand growth of 4.5% reported during the first quarter of 2013 by RS-Platou, an international ship and offshore investment bank.
What the fall means
Lower capacity growth may excite some investors and bid up the stock prices of dry bulk companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), Eagle Bulk Shipping Inc. (EGLE), and Navios Maritime Partners LP (NMM). This development, in addition to higher ship orders, has supported these companies during the first half of this year. But current excess capacity growth is still a negative for dry bulk shipping companies’ revenues, because it will continue to pressure shipping rates (see our Shipping Indexes Page for articles on current rates), which negatively affects earnings and medium-term share prices—especially if several maturing contracts were drafted out above current market rates (see Maturing contracts present significant downside for certain shipping firms). If investors (the market) start to focus more on short-term fundamentals and become more risk-averse, share prices of dry bulk shipping companies will likely fall in the short term. Nonetheless, the current trend is positive for dry bulk shipping companies’ long-term outlook.
For further analysis on why risk remains in the short term, see Insurance cost for China’s default remains high, negative for dry bulk shipping.
© 2013 Market Realist, Inc.