Why May industrial profits support dry bulk imports, positive for shipping

China Industrial Profit Growth (YTD)  2013-07-09Enlarge GraphIndustrial profit and economic growth

Growth in industrial profit often reflects economic growth. When economic activity rises, so does demand for industrial goods. Higher demand leads to more business, which in turn leads to higher earnings and free cash flows. To support higher demand, firms will purchase more raw materials, which tends to increase imports. Because China accounts for the bulk of global trade volume, rising industrial profit is often positive for the dry bulk shipping industry.1

Industrial profits growth cools from first two months

The latest data from the National Bureau of Statistics of China shows that industrial profits during the first five months of the year grew by 12.3% compared to the same period in 2012. This growth is higher than the data reported for the first four months, which grew at a rate of 11.4% year-over-year. Industrial profits have grown at a higher rate since mid 2012, as China injected fiscal stimulus in order to energize the economy. It’s positive to see that industrial profits in China continue to grow at a solid pace, despite the drop in iShares FTSE/Xinhua China 25 Index ETF (FXI) and the Chinese market since the government tightened the property market to cool down prices in February.China Industrial Profits Year-Over-Year Growth Jan and May 2013-07-09Enlarge Graph

However, a deeper dive into the components points to a diverging outlook. While private enterprises continue to enjoy high growth, state industrial enterprises (which comprise major steel manufacturers, construction companies, ship builders, and telecommunication companies) lag. Growth for state industrial enterprises stood at just 4.6% for revenue and 2.2% in profits recently, which means margins are compressed.

Industrial ProfitEnlarge Graph

Usually these compressed margins are negative, but further details on the profitability of the industry group reveal that mining companies are dragging down aggregate profitability. The mining and washing of coal, for example, saw a decline of 3.3% in revenue, while profitability collapsed by 42% year-over-year between January and May. Although this decline may lure manufacturers in China away from imports, the odds are that Chinese producers are struggling to compete against cheaper coal imports. More and more Chinese coal miners are suggesting the government impose taxes on imports to ease their negative impacts, but given the government’s stance on shutting down mines that are inefficient and allowing the market to weed them out, an import tax is unlikely. On a positive note, this will benefit steel manufacturers, who use coking coal to make steel.

Summary

As industrial profit hasn’t shown a sign of collapse overall, demand for further imports of key raw materials such as iron ore and coal is unlikely to collapse. This data supports dry bulk shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Naviios Maritime Partners LP (NMM), Safe Bulkers Inc. (SB), and Knightsbridge Tankers Ltd. (VLCCF).

To learn more about how China is affecting global shipping, see our Macro Trends page.

  1. The dry bulk shipping industry transports dry bulk raw materials, such as iron ore, coal, and grain.