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The importance of capacity
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.
Capacity growth remains in downtrend
On September 27, year-over-year capacity growth for crude tankers stood at 3.10%, measured in deadweight tonnage. The latest data shows that year-over-year capacity growth has remained in a downtrend, falling from 3.20% on September 20 and 3.55% on September 13. Like the orderbook indicator, year-over-year growth has remained in a downtrend overall.
Why use year-over-year growth?
Analysts look at year-over-year growth because it adjusts for possible seasonality and short-term noise. Demand figures are often quoted on a year-over-year basis for the same reason, which also makes it easier to compare supply and demand. If supply growth outpaces demand growth, shipping rates won’t rise. This can negatively impact shares.
Capacity growth: Coincident and lagging indicator
As an indicator itself, capacity growth is often considered a lagging or coincident indicator. This is because there’s usually a lag between when managers see increased demand growth, placing new orders, and when they get the delivery of vessels. 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 generally considered negative for shipping companies. However, if capacity growth does fall below demand growth, you can expect shipping rates to rise.
Effect on crude tanker stocks
Unless shipping rates are rising, you should interpret falling supply growth as a negative for the earnings of tanker stocks such as Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), and Ship Finance International Ltd. (SFL)—at least in the short term. To a lesser extent, this will negatively impact the Guggenheim Shipping ETF (SEA) as well. Navios Maritime Acquisition Corp. (NNA) could also be negatively affected if industry fundamentals don’t return by 2017 and beyond.
© 2013 Market Realist, Inc.