Why is capacity important?
In a commoditized industry, supply is an important metric that directly impacts companies’ top line or revenue performance. When excess supply is building up (higher supply compared to demand growth), competition among shipping firms will increase, as firms will try to use idle ships and shipping rates will fall. This will negatively affect companies’ revenues, which also affects earnings, free cash flows, and share prices.
Supply growth falls sharply!
Year-over-year growth has been falling rapidly lately. In mid-2013, it was at 4.0%. On October 4, it was at 2.68%. Last week, October 11, it dropped to 2.26%—a level that hasn’t been seen in years. These supply growth measures use deadweight tonnage rather than the number of ships.
Year-over-year growth is often used to adjusts for possible seasonality and short-term noise. As figures for demand are often quoted on a year-over-year basis for the same reason, it makes it easier to compare supply and demand.
A coincident or lagging metric
Analysts often consider capacity growth a lagging or coincident indicator. This is because there’s usually a lag between the times managers see increased demand growth, place new orders, and get the vessel delivery.
Conversely, when demand growth is falling, shipping firms can’t simply cancel orders from shipyards. So supply growth could remain elevated and impact shipping rates negatively. Falling capacity growth is negative for shipping companies—unless supply growth does fall below demand growth and rates rise.
Will it be enough?
While supply growth is aggressively coming down, it remains questionable whether it will be come in less than demand. Last year, crude oil export rose 1.4% on an annual basis. According RS Platou, oil shipments fell by 2.2% during the first seven months of the year.
Rates could fall a bit more, but the worst is likely over for crude tanker companies like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), and Ship Finance International Ltd. (SFL) in terms of rates. Bankruptcy is still a possibility, so beware.
© 2013 Market Realist, Inc.