The importance of ship orders
The number of ships on order reflects managers’ expectations of future supply and demand differences. When they expect future supply to increase more than demand, managers will 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 or high levels of ships 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.
Capesize and Panamax classes are the most optimistic
On August 16, the number of dry bulk ships on order as a share of existing ships fell slightly for Capesize vessels, from 10.14% to 10.13%. Panamax and Supramax class vessels, on the other hand, showed improvements, rising from 15.91% to 16.15% and 4.76% to 4.87%, respectively.
The overall backlog of new ship constructions has begun to turn around since the beginning of the year, with Capesize vessels showing the most stabilization. While it looked like Supramax orders would start turning around at the start of 2013, the indicator continued to slump since April. Orders for Panamax vessels remain higher than other ship classes, but they’ve also risen since the end of May with Capesize vessels.
The weak orders in Supramax vessels possibly reflect managers’ expectations of limited tightening of excess supply ahead. Yet it could also be an opportunity if demand picks up, since supply won’t grow as much. While Panamax vessels continue to hold the number-one lead in orders—which could lead to more than necessary supply growth—the increase we’ve seen since May (along with orders in Capesize vessels) is quite positive. The demand is likely fueled by expectations of higher iron ore and grain shipments.
Implication for shipping companies
There’s much debate over whether demand will outpace supply growth this year. But the turnaround in orders, or the steadier decline in orders, points towards lower supply growth ahead, and suggests that the industry return should normalize over the next few months and years. This is long-term positive for dry bulk shippers like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Navios Maritime Holdings Inc. (NM), and Safe Bulkers Inc. (SB).
Note that short- to medium-term fundamentals may still differ for each company, because dry bulk vessels can take up to two years to construct and firms such as SB and NMM are subject to lower revenues when their valuable contracts mature. Still, the value of a company is based on future expected earnings potential, and the market has started to price in the favorable long-term outlook. If shares do fall, they’ll likely find bidders.
© 2013 Market Realist, Inc.