Why is capacity important?
Although ship orders and construction activity are useful to get the insiders’ perspective, analysts 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 day-to-day operations 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—or vice versa.
Annual capacity growth remains in downtrend
From August 16 to 23, year-over-year growth in 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, rose for Panamax and Supramax vessels: from 10.19% to 10.23% and 9.62% to 9.68%, respectively. Capesize vessels, on the other hand, fell from 5.30% to 5.25%.
Driven by large placements of new ship orders, shipping capacity had ballooned over the past two years, as companies expected global trade growth to continue at a record. The recent decline in year-over-year capacity growth shows development. With construction levels falling, it’s just a matter of time until capacity growth falls even further.
Weekly growth has yet fallen
Last year, several dry bulk shipping companies had pushed back deliveries—Capesize vessels in particular—as China’s economic growth fell and rates fell to a record low. This year, delays may not be that significant, as rates have risen above the lows. Currently, the eight-week moving average weekly growth rate remains above 0.10% for all three classes of vessels. From August 16 to 22, Capesize ships grew by 0.15%, Panamax by 0.15%, and Supramax by 0.12%.
Since the start of this year, Capesize vessel capacity grew 4.52%, Panamax by 7.28%, and Supramax by 5.75%. If an average of 0.15% weekly growth holds throughout the end of the year, we can expect an additional capacity of ~2.43%. There’s much debate over whether capacity will grow faster than demand this year. It’s difficult to say, since it depends on a variety of fluctuating factors—like number of ships scrapped, demand of ships, and order cancelations.
Near-term capacity growth not so worrisome
Last year, dry bulk trade grew 7%. It’s more likely than not that demand will just meet or exceed supply this year, given the increase in iron ore capacity in Australia and Brazil, which is expected to add 10% in iron ore trade and benefit Capesize vessels. August’s rate increase (August is historically a weak month) is a sign to be optimistic. Plus, higher grain shipments from a record crop production in the United States this year and poor harvests in China will likely support Panamax vessel demand later this year.
There’s also a wide consensus that shipping rates will recover in 2014. So while investors fudge over whether it’s this year or next year that fundamentals will improve, the market could continue to support share prices of companies like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Navios Maritime Holdings Inc. (NM), and Safe Bulkers Inc. (SB) with little downside in the near term.
Disclosure: I own shares in Diana Shipping Inc.
- Part 1 - Ship orders fell, but still positive trend for dry bulk shippers
- Part 2 - Falling ship construction activity points to lower supply ahead
- Part 3 - Should you worry about near-term dry bulk shipping capacity growth?
- Part 4 - Why shipping rates for Capesize vessels continue to outperform
© 2013 Market Realist, Inc.