Market Playground

by Dennis “Cos” Costa

With all of the concern in the U.S. by investors, economists, and the financial media about a possible double dip recession, and with the markets down for the month of August, is there an opportunity presented to get into the badly beaten down dry bulk shipping companies? With weak numbers coming from U.S. government reporting bureaus, such as the Bureau Of Economic Analysis (BEA) reporting personal income and outlays, and the joint release of information from the U.S. Census Bureau and Department of Housing and Urban Development (HUD) on new and existing home sales last week, the dry bulk shipping market’s leading index, the Baltic Dry Index (BDIY: IND), has shown an increase of almost 45% for the month of August 2010.

The actual low point for the last six month period occurred on July 15th when the BDI was at 1700. The recent recovery  for this two month period was 67% higher, when on August 23rd 2010 the BDI was at 2841. The chart below shows the BDI activity for the last six months, in which the high for the period coincided with the general equity market recovery and reached 4187 on May 25th 2010.

The Baltic Dry Index is a number compiled daily by the Baltic Exchange, which is located in London, that assesses the price of moving major raw materials by sea along 26 world wide shipping routes on a time charter and per voyage basis. The BDI covers varying size ships from the smaller Handysize and Supramax carriers, to the larger Panamax and Capesize capacities for dry bulk commodities, including coal, grain, and iron ore. Some observers looking for early signs of regional and global economic activity, monitor the pricing in this index along with volume in dead weight tons (DWT) to catch a glimpse of trends in pricing and demand for these goods.

The theory behind this activity being an early economic indicator is that dry bulk materials primarily consist of raw components combined with or used directly in the production of intermediate or finished goods. Increases in demand for these raw materials usually represent increased activity with the destination nation’s economy, and puts pressure on the pricing for shipping for this in-demand cargo.

Some have argued that over the last several years the BDI is no longer as relevant a leading economic indicator, because the inventory of ships is high, resulting in excess capacity of shippers competing for cargo shipping contracts. This condition was exacerbated by the financial crisis, which had a dramatic effect on the flow of all commodities, and in turn shipping contract pricing from this lack of demand.

In addition, some of the largest of these dry bulk ships entered the worldwide fleet as oil tanker conversions to dry bulk carriers, with companies taking advantage of pricing efficiencies to fill the need for large dry bulk carriers. Some observers have interpreted the relatively low to flat pricing during this slow economic demand period for these raw materials to the inventory of ships available, and believe that this will continue — even as the worldwide economy begins to recover.

As was experienced when the financial crisis started, the high level of inventory of readily available dry bulk haulers, combined with a decrease in demand for these raw materials, did cause the BDI to plummet to the low 700 level in just six months from its record high of over 11,700 in mid 2008.

The shipping industry’s inventory of dry bulk carriers is viewed as inelastic, with new ships taking nearly 2 years to build and existing ships costing companies money to maintain while awaiting shipping contracts in port. An inelastic condition for an industry works both ways, making it important to keep in mind that when demand for commodities is high, regardless of commodity pricing, the price for shipping cargo goes higher with this increase in commodity demand.

Another factor affecting the index is that it is valued in U.S. Dollars and subject to the value of the dollar on the currency exchange markets, adding to volatility of the BDI to some degree. With the U.S. dollar recently trading at its lowest levels in 15 years against the Japanese Yen, this is a valid consideration in placing fair value on the index.  It should not be interpreted by this discussion that available shipping inventory and exchange rates are the only variables that effect the cost associated with the shipping charter pricing. During stagnant economic periods, shipping hardware inventories and foreign exchange rates have a more significant influence on the index than in times of greater demand for the goods being transported.

Another variable affecting shipping pricing are “seasonal pressures” which affect travel routes and the demand for raw materials required to generate energy to provide heating or cooling. These seasonal pressures are dependent on changes in weather and need to be considered carefully. Fuel prices, known as “bunker fuel” for the shipping industry, will also affect the cost component of shipping prices, giving affect up or down depending on these bunker fuel rates.

During high demand periods, “choke-points” in the shipping routes need to be considered and have a major impact on the prices reflected in the BDI. The shipping industry transports goods through a fairly narrow and finite number of shipping lanes and passageways. Areas like the straits of Hormuz, Bosporus, and Malacca, combined with the heavily traveled Panama and Suez canals, are commonly known choke-points, naturally capping passage by limiting the amount of ships that can pass through them each day.

Port congestion also plays a role in the costs associated and prices reflected in the BDI’s daily pricing composite. High demand for commodities, container goods, and oil and liquid natural gas create time delays adding dramatically to the availability of ships for transport in all categories.

When looking at the BDI it is important to understand that it represents a composite of not just the 26 world wide shipping routes on a daily basis, but also on the sub-indexes for the shipping industry broken down based on ship size (dead weight tons) as touched on earlier. The balance reached by the index is a representation of the demand for shipping capacity at any given time, against the supply of available dry bulk carriers for transport along the routes and ports required. Generally the more stable pricing exists in the smaller dead weight carriers, as represented by the daily Handysize Index (BHSI) and the Supramax Index (BSI). The more volatile indexes are that of the larger size dead weight carriers, represented by the largest carrier type Capesize Index (BCI) and the next largest, the Panamax Index (BPI). The chart below is a representation of this pricing volatility by capacity of ship being priced.

When looking at the dry bulk companies, some of the more prominent names to research and follow by market capitalization are companies like Star Bulk Carriers Corp. (NASDAQ: SBLK), Dianna Shipping (NYSE: DSX), DryShips, Inc. (NASDAQ: DRYS), and Navios Maritime Holdings Inc. (NYSE: NM). Some of the smallest dry bulk carriers are FreeSeas Inc. (NASDAQ: FREE), OceanFreight Inc. (NASDAQ: OCNF), and Seanergy Maritime Holdings Corp. (NASDAQ: SHIP). These three companies have market caps of less than $50M.

There are many who feel that the inventory issues, and protracted slowdown in the worldwide demand for raw goods, may bring with it consolidation within the Dry Bulk industry. Looking for companies who are struggling at this time, but with attractive assets, may be a place to begin to look for speculative investment.

It may be time for investors to keep an eye on the news for the demand of these commodities, the countries and companies that are in need of them, the companies and countries with the supply, and the dry bulk companies moving these goods to where the demand is. Watching  the daily Baltic Dry Index might be just what an investor needs to do when looking for gaining a leg up in determining a point of entry into some of these companies.

Position: Long NM, DSX. None in any other company discussed.

Contact the Author: denniscosta@marketplayground.com