Why you should ignore dry bulk shipping capacity growth
Why is capacity important?
Analysts evaluate capacity growth to see whether it will exceed demand growth, instead of solely relying on indicators such as ship orders and ship prices that reflect managers’ perspective of future supply and demand dynamics. 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. On the other hand, when capacity increases can’t meet demand growth, shipping rates will rise, which bodes positively for dry bulk companies’ top line revenue, bottom-line earnings, free cash flows, and share prices.
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Capacity growth rises, but it’s not so important at the moment
On October 18, the year-over-year growth in Capesize vessel capacity, measured in DWT (deadweight tonnage, the weight a ship can safely carry across the ocean), jumped to 6.18% from 5.84%. Growth also picked up for Panamax, rising from 10.14% to 10.51% over the same period, while Supramax saw a bit of decline from 8.67% to 8.65%. Analysts use year-over-year growth to adjust for seasonality and to make comparisons on a more long-term trend rather than a short-to-medium-term perspective.
An increase in year-over-year capacity growth could be negative, because it negatively affects year-over-year shipping rates. Conversely, lower capacity growth would be positive for year-over-year changes in capacity growth (explained in shipping rates). However, I wouldn’t read too much into the recent increase to get a long-term picture of the dry bulk shipping industry.
Why? Because the recent increase in year-over-year capacity growth has been driven by the start of lower supply growth around this time of the year in 2012. Excluding Supramax vessels, Capesize and Panamax weekly supply growth fell significantly from the start of October to November. While Capesize capacity grew on average above 0.1% a week, it fell to close to zero. Capacity growth fell to zero as rates dropped to a record low, prompting shipping companies to scrap vessels or delay and cancel new ship deliveries.
Outlook on fleet utilization
Investors probably shouldn’t read too much into the latest data, plus maybe for the next few weeks. After all, industry experts expect 3.5% annual growth for 2014 and 2015, while the dry bulk trade has historically grown at ~5.5% over the past few years, unadjusted for high or low economic growth.
This means fleet utilization (the supply-to-demand balance) and shipping rates should rise even if economic growth isn’t in the higher end. This case would be positive for dry bulk shippers like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Holdings Inc. (NM), Safe Bulkers Inc. (SB), and the Navios Maritime Partners LP (NMM).