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Weekly dry bulk digest: Fundamentals show bullish light (Part 4)

Continued from Part 3

Why is capacity important?

Although ship orders and construction activity are useful to get the insiders’ perspective, investors must also look at capacity growth to see whether it meets demand so that they don’t rely totally on managers, who can get caught up in the day-to-day operation without seeing the bigger picture. When capacity grows faster than demand, competition rises among individual shipping firms as they try to use idle ships and cover fixed costs. This lowers day rates, which negatively affects bottom line earnings, free cash flows, and share prices for companies. But when demand grows at a faster rate, it’s positive for dry bulk shippers.

Dry Bulk Capacity 2013-07-30Enlarge GraphCapacity growth breaks below 6.0%

Dry bulk capacity, measured in deadweight tonnage (DWT, the weight a ship can safely carry across the ocean) and published weekly by IHS Global Limited, broke below year-over-year growth of 6.0% last week, at 5.84%. Year-over-year growth using the last four weeks of data, which smooths out short-term noise, fell from 6.28% during the prior week to 6.08% this week. Driven by large placements of new ship orders, shipping capacity had a huge run over the past two years, as companies expected global trade growth to continue at a record, fueled by China’s massive investment-led economic growth. The recent decline in year-over-year capacity growth to just ~6.0% is a positive development because total dry bulk demand grew by just 4.5% during the first quarter of 2013, as reported by RS-Platou, an international ship and offshore investment bank.

Dry Bulk Capacity Growth 2013-07-30Enlarge Graph

But the real test will come during the second half of this year. While we may see another record year of iron ore exports coming out of Brazil and Australia, with large mining companies pushing ahead with their capacity expansion plans, several dry bulk shipping companies have pushed back deliveries during the second half of 2012 as China’s economic growth fell and shipping rates fell to a record. The eight-week average weekly growth rate, shown in the chart above, fell to an average of 0.075%. Since the start of this year, capacity has grown ~3.7%. Unless we see the average weekly growth rate come down below 10%, capacity will likely grow by 7% this year, which will limit the further upsides for dry bulk stocks towards the end of the year.

Implication of lower capacity growth

Current excess capacity growth is still a negative, because it will continue to pressure shipping rates, which negatively affects revenues and earnings, and could harm medium-term share prices—especially if several maturing contracts were drafted out above current market rates. If investors (the market) start to focus more on short-term fundamentals and become more risk-averse, share prices of stocks such as Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Knightsbridge Tankers Ltd. (VLCCF), Navios Maritime Partners LP (NMM), and DryShips Inc. (DRYS) will probably fall. Nonetheless, the current trend is positive for the industry’s long-term outlook. If investors stay focused on the favorable long-term prospects, dry bulk shipping companies will find support.

Learn more about the key performance indicators of the dry bulk shipping industry

Continue to Part 5: Shipping rates to see how shipping rates are doing, or go back to Part 1 to see the list of key shipping indicators.