Continued from Part 1
The importance of ship orders
One measure that reflects managers’ expectation of future supply and demand differences is the number of ships on order. When managers expect future supply to increase more than demand, they refrain from purchasing new ships. However, when they expect demand to outpace supply growth, companies return to the shipyard to place new orders, on the condition that they expect to generate profits with the new vessels. So, rising ship orders often indicate that shipping rates will rise. Since dry bulk ships usually take one to two years to construct, the indicator is often more relevant to long-term investment horizons.
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Ships on order rise to record in 2013
For the week ending July 19, the number of dry bulk ships on order as a percentage of the existing number of ships fell from last week’s record of high of 10.27% in 2013, to 10.16%. The dry bulk orderbook as a percentage of existing capacity (measured in deadweight tonnage, DWT—the weight ships can safely carry on the water) rose, however, adding 17 basis points (0.17%) to last week’s 17.61%, which results in 17.78%. The divergence between the two indicators points to the possibility of a pick-up in construction activity. (We’ll explore whether this inference is accurate or not in Part 3: Ship construction).
Until early this year, new orders have remained depressed due to a record backlog of new ship deliveries. As supply was growing faster than demand, managers refrained from placing new ship orders. The rebound we’ve seen in new orders is a sign that managers see that much of the large backlog has cleared and that they expect demand to outpace supply growth. Diana Shipping Inc. (DSX), for example, has been purchasing several ships in the secondary market in anticipation of higher shipping rates.
Implication for dry bulk shipping outlook
A higher expected growth rate in demand relative to supply is positive for shipping rates, and it would translate into higher margins and earnings for dry bulk shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Knightsbridge Tankers Ltd. (VLCCF), Safe Bulkers Inc. (SB), and Navios Maritime Partners LP (NMM).
While short- to medium-term fundamentals may still differ because dry bulk vessels can take up to two years to construct, the brisk rate at which managers have been placing new orders (unlike tankers) suggests companies are rather optimistic regarding the dry bulk shipping industry’s outlook—likely due to large supply and demand growth differences in the near future. Moreover, since the value of a company is based on future expected earnings potential, the market has started to price in the favorable long-term outlook.
Learn more about the key performance indicators of the dry bulk shipping industry
© 2013 Market Realist, Inc.