Dry bulk equities – Beginning of a super cycle, or just an upswing?

Dry bulk stocks were the best performers (up 50.3% YTD) among the sectors we cover and are pricing in 1.34x times NAV on average. The time-charter rates too are at a multi-year high. All these developments have created a buzz and around a potential market ‘Super cycle’.

Arguments in favour of ‘super cycle’

1. The current rally

The mention of super cycle has increased consistently over the last fewS weeks, with the dry bulk shipping rates and stock prices providing evidence for the same. However, it is not just the spot rates and stocks, FFA traders have also reported extraordinary numbers.

In the second week of February, the derivative dry freight market recorded the best week of the 21st century with trading notional volume exceeding USD 1bn, since more than 75,000 contracts were traded (data from FIS) across Capesize, Panamax and Supramax segments. As commodity prices are surging, many players have been caught short in the rally, thereby pushing volumes up in the short squeeze. This has been the case especially for the Panamax spot market, which has been the highest gainer among all vessel classes on a YTD basis.

The current rally, which can be traced back to early December 2020, after a firm spot market in 3Q20, has defied the usual trend of seasonally weak first quarter. Larger vessels staged a comeback in 2020, which is now being supported in an equal vigour by the Panamaxes. For example, Diana Shipping (DSX), a mid to large vessel owner/operator under our coverage which fixes its vessels exclusively on long-term charter, has seen a spike in its fixtures. On 11 March 2021, DSX announced the time charter contract for its 2008-built Newcastlemax at USD 17,750pd (minus commissions) for 105 days, followed by USD 24,700pd (minus commissions) after 105 days at least until 15 January 2022. Compare that to a 6 March 2020 fixture, where Sideris GS, a 2006-built Capesize was fixed at least until 15 October 2020 at USD 12,700pd (minus commissions). A similar trend can be seen in Panamax fixtures. On 26 February 2021, DSX fixed a 2013-built Panamax at USD 16,500pd (minus commissions), much higher than its previous charter fixture at a gross rate of USD 10,800pd (minus commissions).

2. Vessel operators on a second-hand buying spree as orderbook touches historical lows

Other economic factors, ranging from the weakening US dollar to the expectation of accelerating GDP thanks to the increased tolerance for a higher inflation have played their parts in boosting the overall sentiment for the commodity markets as well. While the demand for commodities has been on the rise, the supply of dry bulk vessels has been diminishing over the last decade. Nevertheless, the current orderbook paints a rather rosy picture for the dry bulk operators.

While the orderbook is strained, major vessel operators under our coverage have been on a buying spree. An interesting observation about these second-hand transactions is that they are focused on mid-sized modern vessels, Ultramaxes and Kamsarmaxes to be more precise.

As mentioned earlier, we expect more such deals to go through in the coming months. COVID-19 left cash-stripped operators like Scorpio Bulkers (now Eneti Inc) grasping for straws, leading to a flurry of vessel sales. Combine that with cash rich and fundamentally strong operators like Star Bulk (SBLK) and Pacific Basin (2343:HK) wanting to expand their fleet and subsequently their market presence, and we end up with a lot of vessel transactions. Second-hand vessel acquisitions provide for prompt delivery (usually within three to six months) and attractive prices at the moment along with the bandwidth of availability of funds with large operators makes a good case for higher transactions. As we mentioned in our 2020 report on SBLK (Star Bulk – Fortune Favours The Bold), the acquisition strategy involves funding a sizeable portion through issuance of new shares. SBLK still has a free float of just under 100mn shares, with the authorisation to issue up to 300mn common shares. The current multi-year high stock price of USD 16.18 (as of 12 March 2021) can help mop up funds should SBLK decide to issue shares. Pacific Basin, another such example, which uses a mix of debt and cash to finance its acquisitions, has reduced its net debt through 2020 (USD 714mn at end FY20 as compared with USD 758mn at end FY19). This is in turn leading to a larger, stronger asset base, upward-revised NAVs and multi-year high stock prices.

3. China and Chinese policies working the market

The growth in charter rates has been led by various direct and indirect drivers, including global optimism after the success of various vaccines and an ultra-loose monetary policy in major economies. The various stimuli packages, especially from the Chinese government, focused primarily on infrastructure development which drove iron ore demand. This was further aided by the increasing soya imports. In the first two months of 2021, grain trade between the US and China surged to 28.0 million tonnes from 16.6 million tonnes in the same period of 2020, benefiting mid-sized vessel operators. For example, Pacific Basin (2343:HK), Hong-Kong based mid-sized vessel owner/ operator under our coverage, reported head-turning numbers in its latest annual report (FY20).

4. Political dispute between Australia and China

The political dispute between Australia and China is another factor that helped the tonne miles, but not so much the seafarers. As of end February 2021, with the relations between the two countries going from bad to worse, the number of vessels carrying Australian coal stranded at Chinese ports was still as high as 48 (11 Capesizes and 37 Panamaxes).

Shipping associations and unions have been urging governments to resolve the standoff at the Chinese coastline, where it is estimated that as many as 75 vessels were stranded at one time. While behind-the-scenes negotiations have seemingly led to the softening of the dispute and freeing up of some vessels, trade relations remain strained. This conflict however had a positive impact on the overall dry bulk shipping. While Australia is now exporting coal to India and Japan, which provide for a greater tonne-mile demand, China is also diversifying its coal import sources to farther off countries like South Africa, thereby increasing the tonne-mile demand.

Capesize is not the only vessel class to benefit from China-Australia tensions, as even Panamax vessels were in greater demand after China imposed a tariff of 80.5% on Australian barley in May 2020 and the former imported higher quantities of barley from Argentina and Ukraine. Australian barley exports to China fell from 3.9mn tonnes in 2018 to 1.2mn tonnes in 2020, compensated by the 257% YoY increase in Argentinian barley and 180% YoY increase in Ukrainian barley during the same year. This has helped the mid-sized segment as much as the coal ban helped the Capesize and Panamax segments.

Arguments against ‘super cycle’

1. Rising oil prices

The oil price has been rising recently to reach around USD 70 per barrel. The rise has been supported by production cuts by major oil producers and optimism about demand recovery in 2H21. However, the outlook for oil in the long run isn’t as rosy as it used to be, with many international agencies now believing that oil’s best days are behind it. However, in the short run, oil prices have a decent outlook amid the production cuts and political tensions.

Oil prices play an important role in dry bulk trade. First, higher oil price will decrease energy production, leading to higher extraction/mining cost for most commodities and thereby raising the raw material prices. When the cost of raw material such as coal, increases, its trade becomes expensive. Second, higher oil prices (bunker prices) result in more expensive long-haul shipments, a cost which operators try to pass on to the charterers.

In the current context, it may dampen import demand too, especially in the major dry bulk markets such as China and India given both the countries have the ability to draw down on inventories built up during the price war between China and the US as well as the spread of the pandemic in 2020.

2. Second wave of COVID – a major dampener for economic recovery

Despite the ongoing vaccination drives, many countries are experiencing the second wave of the virus with some countries imposing lockdowns while others contemplating possible restrictive measures. France closed its borders for all non-EU countries from 31 January 2021 even as parts of the country are under weekend lockdowns and other restrictions in addition to the national night curfew. With cases rising in Greece since January, which include Athens, saw new lockdown measures were put into place with the shutdown of non-essential services. Czech Republic is also imposing tighter lockdown restrictions. Additionally, the increasing number of cases in Italy, Spain, and Belgium could put the brakes on economic recovery, and consequently hurt trade and vessel operators in the process.

Conclusion

Despite increasing evidence of an upswing in dry bulk shipping, market players are divided on the duration of this upswing, and whether it can qualify as a super cycle. Some expect it to fizzle out in three-to-five months, with others expecting it to phase out in three-to-five quarters, while a percentage expects it to last for as long as until 2023. Everyone however holds consensus that it is a great time for dry bulk shipping and its equity shareholders.
Source: Drewry