In the shipping industry, excess capacity has a significant impact on the price of transporting goods. When capacity grows more than demand, prices generally fall as shipping companies try to cover fixed expenses by attracting more demand, just like clothing retailers do during end of season clearances. Unfortunately, falling prices have resulted in much lower margins and negative free cash flows for companies in the industry, which has continued to worsen because of a weak global economy over the past five years.
On February 1, 2013, IHS GLobal Limited, a research intelligence company, reported a 4.4 billion increase in shipping capacity measured in deadweight tons (dwt) in January. Deadweight tons (dwt) is a measurement of the capacity that ships can carry across the industry. Although the 4.4 billion dwts only represents a 0.75% increase from December’s figure of 584.8 billion, it is a 9.0% increase year-over-year. The significant increase in capacity is driven mainly by a large backlog of ships that were ordered before the financial crisis, when shipping companies became too optimistic regarding Chinese growth expectations. As long as the backlog of new ships remains elevated, ship rental prices (called day rates) will remain pressured by further increases in capacity.
Additionally, capacity utilization (the number of ships or time unused) will remain low for the industry overall, which hurts companies’ margins. This is negative for the Guggenheim Shipping ETF (SEA), an ETF that generally provides returns similar to the Dow Jones Global Shipping Index. For individuals who already own or are considering investments in shipping companies, they should carefully monitor the margins of companies including Dry Ships, Inc. (DRYS), Diana Shipping, Inc. (DSX), and Eagle Bulk Shipping, Inc. (EGLE).