Shipping industry recovery is real, but timing remains uncertain

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Nov. 20 2020, Updated 11:13 a.m. ET

Ship orders reflect managers’ assessments of the industry’s future demand and supply balance. Dry bulk shipping companies will often place new orders when future demand is expected to increase more than supply, on the condition that they expect to generate profits with new vessels.[1. Dry bulk shipping companies engage in the transportation of dry raw materials, such as iron ore, coal and grain across water.] Since dry bulk ships usually take one to two years to construct, ship orders are most applicable to long-term investment horizons.

Vessel order update for May 31st

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For the week ending May 31st, the number of dry bulk ships on order as a percentage of existing number of ships rose from 9.09% the prior week to 9.26% this week, driven primarily by additional placement of new ships purchases. As it is the largest percentage increase in a month, this suggests managers are becoming more optimistic about the long-term prospects of the industry, and supports the view that the industry is in the process of turning around.

Dry bulk orderbook as a percentage of existing capacity measured in deadweight, which includes ships under construction, also rose during the same period, rising from 16.69% to 16.78%.[2. DWT is a measurement of how much a ship  can safely carry on water.] Last week’s figure points to a positive development in the industry’s recovery, because a rising orderbook, although negative in the short-term, suggests managers were more bullish and had placed more new orders of ships than the ones delivered.

Maintained cautious outlook

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Although it is encouraging to see that ship orders are returning to normality, investors still want to be cautious. Year-over-year capacity growth remained above 7.0% last week, which has a negative impact on companies revenues, earnings and free cash flows (see Elevated 7% capacity growth negatively affects shipping firms short-term). Such companies include DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Eagle Bulk Shipping Inc. (EGLE) and Safe Bulkers Inc. (SB).

Diana is best positioned to take advantage of an industry recovery because most of its near-term maturing contracts are settled at current market rates. If shipping rates rise, Diana will be able to capitalize on higher contract rates. If shipping rates fall or stay constant, it has less to lose compared to other firms with more valuable contracts, which provides a favorable asymmetric return to risk opportunity (see Why Diana will outperform Safe Bulker and Navios Maritime for details). Investors can alternatively invest in the dry bulk shipping industry through the Guggenheim Shipping ETF (SEA). The ETF performs similar to the Dow Jones Global Shipping Index by investing in large shipping companies worldwide.

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