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 experience sharp fall
On August 9, the number of dry bulk ships on order as a percentage of the existing number of ships fell sharply from 10.24% a week ago to 10.03%. The dry bulk orderbook as a percentage of existing capacity (measured in deadweight tonnage, DWT—the weight ships can safely carry on the water—and also including the ships under construction) fell to 17.43% from 17.64% a week ago.
This may look negative, because it means managers placed fewer new orders compared to the amount of ships entering construction or supply. On the one hand, a sharp decline in ship orders could mean managers were expecting or are expecting shipping rates to recover in the future and that we’re getting closer to those dates. On the other hand, if managers are wrong, it could mean larger supply growth over demand growth, which will hurt shipping rates.
Long-term trend and implication
Nonetheless, the rebound we’ve seen in new orders since the beginning of the year is still a positive sign that managers see much of the large backlog has cleared, the worst is over, and the supply-to-demand balance will normalize. This will translate into higher margins, earnings, and share prices 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).
Short- to medium-term fundamentals may still differ for each company. This is because dry bulk vessels can take up to two years to construct and firms such as Safe Bulkers Inc. (SB) and Navios Maritime Partners LP (NMM) are subject to lower revenue when some of their valuable contracts mature. But the pace 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. If shares do fall, they’ll likely find bidders.
Learn more about the key performance indicators of the dry bulk shipping industry
© 2013 Market Realist, Inc.