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 continues to fall 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 18, growth fell to just 2.20%—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 adjust 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.
Excess supply may persist
While supply growth is aggressively coming down fast, it remains questionable whether supply will outpace demand this year. Last year, crude oil export rose 1.4% on an annual basis. According to RS Platou, oil shipments fell by 2.2% during the first seven months of the year because of weak US and Chinese imports. Rates could fall a bit more or remain depressed in the short term.
Lower supply is long-term positive
But further reduction in capacity would have a long-term positive impact on supply, shipping rates, and crude tanker business for stocks like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), DryShips Inc. (DRYS), and Teekay Tankers Ltd. (TNK)—especially when supply growth is sitting at historically low levels. Bankruptcy is still a possibility, though, so beware. This is also positive for the Guggenheim Shipping ETF (SEA).
© 2013 Market Realist, Inc.