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Industrial output remains weak, short-term negative for dry bulk shipping shares

China Industrial Output 2013-07-18Enlarge GraphSignificance of China’s industrial output

China’s industrial output—crude steel and electricity outputs, to be specific—are bellwethers of demand for raw material shipments. When industrial production rises quickly, so does demand for raw materials, such as iron ore and coal, which often accompanies higher domestic production and imports. Since dry bulk ships take one to two years to construct, supply is quite inelastic. So changes in imports have large impacts on shipping rates, and vice versa.

Industrial output slows

The year-over-year change in China’s industrial output fell to 8.9% in June from 9.2% in May. Industrial output has fallen from last year’s December high of above 10% growth, when the government clamped down on soaring housing prices and shifted its stance towards lower economic growth in return for a more sustainable growth rate.

China Crude Steel and Electricity Output 2013-07-18Enlarge GraphFor the same month, crude steel output growth fell to just 4.6%, much lower than May’s figure of 7.3%, while electricity output rose to 6.0% year-over-year growth, higher than May’s 4.1%. The data coming out of crude steel was negative, as it suggests manufacturers may be seeing weakening demand. However, the data was not all very bad. In China, most steel manufacturers are affiliated with the government. As such, they do have a responsibility to keep workers employed. Unless they’re losing significant money, companies have noted it’s often better to keep output constant rather than shut furnaces down only to restart them later. So, until we see a much lower growth rate for crude steel, investors may want to take a more optimistic view.

Bulls and bears

Investors have worried since a few months ago about whether the government’s move to cool the property market down would hurt industrial output. While the bulls will say industrial output continues to grow positively and hasn’t fallen off a cliff, the bears will point out that output growth isn’t as high as it was before. They’re both right. Compared to before the financial crisis, in 2010 to 2011, industrial output has consistently stayed above 10% for steel and electricity output. This time around, however, growth reports have been lower, as the government’s not so eager to energize the economy by pumping more stimulus into it like it did before, because China’s transitioning to a consumption- and private enterprise–led economy. Just like how a job switch can be time-consuming and take some ramp-up time, the switch will take a while.

Implication for shipping

Because share prices reflect the future outlook of a company’s earnings potential, lower output growth will negatively impact shipping rates, which could pressure share prices of shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Safe Bulkers Inc. (SB), and Navios Maritime Partners LP (NMM) in the short term. While China’s economic growth is unlikely to expand as fast as it once did, the market will eventually come to realize this change, knowing that the world isn’t going to collapse, which will be positive for long-term share price movements driven more by long-term fundamentals.

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