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Hop on board another China growth play
Strong demand from China is just one reason the outlook for shipping companies is sunny. Here's why shippers that carry iron ore, coal and grain may float your boat.
By Michael Brush
Quick: Whats the best investment play on the 2008 Beijing Olympics?- a. General Electric (GE, news, msgs), parent of Games broadcaster NBC.
- b. Sneaker maker Nike (NKE, news, msgs).
- c. Shipping companies.
It's not the sexy choice, certainly, but it's the so-called dry-bulk shippers, which schlep millions of tons of iron ore, coal and grain around the globe each year.
And the Olympic connection?
The Chinese government views the Olympics as a major debutante ball, a coming-out party, says Oak Associates economist Ed Yardeni. They are fully aware that reporters from around the world are going to be coming and looking all over the country. I think that is the major reason they will continue to prepare the entire country for that event.
The upshot: China will continue spending on massive infrastructure projects to build superhighways and bridges, and to expand the electricity grid and communications networks.
That's not to say the Olympics is the only demand driver. Strong foreign demand for Chinese-made goods keeps the country's economy growing at an astounding rate. This year, that rate will be about 9%, and next year, 9.2%, says Richard Herd of the Organization for Economic Co-operation and Development.
Filling football fields
China is going through a very metals-intensive phase of its industrial development, says Mark Lidiard, spokesman for BHP Billiton (BHP, news, msgs), a leading iron ore producer.
How intense?
China should import about 265 million tons of iron ore this year. China will use that iron ore to make about 345 tons of steel, or around 35% of the steel made in the world. China uses just about all the steel it makes.
Related news and commentary on MSN Money
Next year, says Lidiard, China should import about 305 million tons of iron ore, an impressive 33% higher than last year. Put in the form of a rectangle on a football field, that iron ore would reach 19 miles high, calculates John Jorgenson, a mineral commodity specialist with the U.S. Geological Survey.
To import all that ore, China will hire out a good portion of the 6,000 ships that carry dry bulk around the world each year. Indeed, Chinas demand will account for about 70% of the global sea-based traffic in iron ore next year. Most of the ore China imports will come from Australia, Brazil and India.
China has surprised most market participants in the last 24 months, and I think they will continue to surprise, says Christopher Georgakis, the chief executive of Excel Maritime Carriers (EXM, news, msgs), one of the half dozen or so publicly-traded dry-bulk shipping companies. Others include: Quintana Maritime (QMAR, news, msgs), a recent initial public offering where insiders have been big buyers, DryShips (DRYS, news, msgs), Eagle Bulk Shipping (EGLE, news, msgs) and Genco Shipping & Trading (GSTL, news, msgs).
Besides iron ore -- which accounts for about 25% of their business -- these shipping companies transport lots of coal. Coal makes up about 28% of their trade. Here, too, there are favorable trends. High oil and natural-gas prices drive up demand for coal. And higher coal prices mean shipping rates for coal go up. Australia and Indonesia are the worlds leading exporters of coal, shipping chiefly to Europe and Japan, the worlds leading importers.
Too many boats?
One big fear that keeps potential investors out of shipping stocks is that shipyards -- especially new ones expected to come online in China -- might produce too many vessels, pushing down shipping rates.
But unlike shippers transporting oil or liquid natural gas, dry-bulk shipping companies probably wont face a capacity glut anytime soon. Two reasons:
- Shipyard capacity in Korea and Japan, the two biggest shipbuilding countries, will remain tight for several years before China brings shipyards online. That is not going to happen overnight, says Quintana Maritime chief executive Stamatis Molaris. Shipbuilding capacity is very tight until the back end of 2008.
- Shipbuilders make better profit margins turning out vessels that transport oil, liquid natural gas and containers. So they allocate most of their capacity to these kinds of vessels rather than dry-bulk ships, says Sumit Mathai, a research analyst with Kayne Anderson Capital Advisors. Mathais firm holds most of the dry-bulk shipping companies in its Kayne Anderson Energy Total Return fund (KYE), a closed-end fund.
To be sure, several new dry-bulk ships will come on line next year, which could temporarily disrupt dry-bulk pricing. Thats one reason Magnus Fyhr, a maritime analyst with Jefferies & Co., thinks dry-bulk shipping rates could be a little soft next year. But once we get through 2006, I think 2007 and 2008 look attractive, given that you dont have many shipyard deliveries, says Fyhr.
Counting new ships and ships that will be scrapped, Fyhr predicts the global dry-bulk fleet will grow 6% in 2006, 5% in 2007 and 3% in 2008. But demand for those kinds of ships should grow at least as much, if not more, say industry insiders. We think demand will grow 4% to 5% a year, so we think there will be a shortage of ships at some point and freight rates will be going higher, says George Economou, chief executive of DryShips.
Bulk consolidation
All bets are off if the global economy weakens, cutting into demand for shipping. But these publicly traded dry-bulk shipping companies dont necessarily need healthy shipping rates alone to boost profits.
The industry is highly fragmented, with lots of small operators, says Mathai at Kayne Anderson. So the public dry-bulk shippers -- with access to the capital markets and stock to use in acquisitions -- can go on a buying spree, consolidating the industry and boosting profits by wringing out costs.
A good example is Excel, which went to the capital markets twice in the past year to raise cash -- to fund its plan to expand by purchasing vessels.
We went from five vessels to 18, and we reduced average fleet age from 25 years to 13 years, says Excel chief executive Georgakis. Typically, dry-bulk ships get scrapped after an average of 26 years of service.
Georgakis says his company now needs to digest the purchases, but it isnt finished with acquisitions. He doesnt expect the company will have to raise more money -- which often drives down a stock price -- to continue its acquisition campaign.
Heres a closer look at a few bulk shippers:
The spot-market players
Morgan Stanley analyst Mark MacLean expects a substantial recovery in dry-bulk freight rates this quarter because of seasonal trends in grain trade, strong demand for coal and firmer steel pricing.
If he is right, that would help Dryships and Excel Maritime Carriers, both of which have a lot of exposure to short-term movements in bulk shipping rates. Instead of letting vessels out in long-term contracts, they reserve a big part of their fleets for contracting on short notice, in the so-called spot market.
The dividend payers
Many of these dry-bulk shipping companies pay surprisingly high dividends. Eagle Bulk Shipping has a 14.2% dividend yield. Diana Shippings yield clocks in at 13.9%. Genco Shipping & Trading and Quintana Maritime, two recent IPOs, are slated to start paying sizeable dividends soon.
To support dividends, these companies typically turn to longer contracts for more reliable revenue streams. We want to have everything locked in for as long as possible to get predicable cash flow, says Quintana Maritimes Molaris.
They aren't risk-free dividend payers, however. A soft economy could hurt shipping rates, which would drive down the share prices of bulk shippers considerably. Plus, some dry bulk shippers, like Diana Shipping, pay out all their free cash flow in the form of a dividend. So at some point, they will either have to go to the capital markets or divert some cash flow to raise money to buy more ships.
Friends in the right places
Like many of the dry bulk shipping companies, Quintana plans to expand through acquisitions. But it also has a network of handy contacts.
Large shareholders and founding partners of Quintana include Corbin Robertson, Jr., who is chairman of Natural Resource Partners (NRP, news, msgs), the second largest owner of coal in the U.S. after the federal government. Also on the list are First Reserve Corporation, a private equity firm with large coal holdings, and American Metals & Coal International, a mining company. Together, these Quintana stakeholders control large amounts of coal and iron ore deposits in the U.S. and Australia.
Our company will be leveraging our sponsors broad relationships and access to these key commodity markets, says Molaris. It will be natural for us to serve the needs of our sponsors to carry coal and ore from here to there.
Stock pick
With this column, I'll add Quintana Maritime to my Expert Picks portfolio, and we'll see how it does from here.
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