Shipping - Surf On The Rates Momentum
We are NEUTRAL on shipping. The rate upswing across all segments in 2013 presents trading opportunities. The dry bulk sector’s valuation has somewhat priced in optimism of a recovery while we see tankers eventually catching up, although caution is advocated due to the weaker macro prospects. We prefer MISC for its diversified exposure.
Baltic Dry Index perks up. In December, the Baltic Dry Index (BDI) rose to its highest level in 27 months on the back of higher imports of iron ore in November (+18% y-o-y) and coal from China. This rising demand also boosted iron ore and coal prices. Dry freight rates in the spot market have climbed 40-70% in the past 30 days, with Handymax and Supramax seeing strong demand. The spike in rates for the smallersized vessels will benefit Maybulk (MBC MK, NEUTRAL, FV: MYR1.75) given its 55% exposure in these vessels by deadweight tonnage (DWT). The 6% growth in supply of total tonnage of dry bulk vessels in 2013 is expected to marginally exceed the 5% growth in tonnage demand. Thus, 2014 is poised to be a better year for overall freight rates as demand and supply will be more balanced. Clarksons Research expects both demand and supply to grow by 5% in 2014, while we expect overall rates to improve by about 35%/25% for FY14/15 respectively.
Crude tanker rates to remain volatile. Crude tanker rates remain volatile, with no clear indications of recovering in the near term as overall demand for oil continues to remain weak amid an oversupply of crude tankers. Meanwhile, chemical tankers in Europe are still hit by a surplus of tonnage despite some activities on the Transatlantic Westbound route. Wood Mackenzie expects China’s oil imports to surpass that of the US in 2017, and be the key driver of a recovery in tanker rates by 2015 given that the longer distance from the Atlantic to China will absorb the excess capacity due to higher vessel utilization. Meanwhile, tanker rates are expected to remain volatile in 2014 but we see average rates inching up by 15% in 2014 and 25% in 2015 as the stronger demand eases the over-supply.
More caution on LNG shipping. The shale gas boom in the US has not only dimmed the outlook for crude tankers but also that for LNG shipping. We have seen LNG buyers show hesitation in signing longterm contracts out of fears that LNG prices and shipping costs will get cheaper in the future. Moreover, the slew of new LNG vessels coming into the market next year will exacerbate the situation and inevitably result in a glut.
Maintain NEUTRAL on Shipping. In our view, investors can trade on this sector on any rates upswing across shipping segments, but keep a close eye on the rates and stock prices. That said, rates would need to be stronger vs our assumptions to warrant any upgrades to our fair value estimates. MISC is our only BUY in this sector given its diversified exposure as its non-shipping segment will mitigate the concerns arising from the LNG segment when the upcoming short-term vessel contracts expire
Baltic Dry Index: The best sector to be in now; but has valuation reflected optimism?
The Baltic Dry Index inches higher. The BDI has reached its highest level in 27 months on the back of higher imports of iron ore and coal from China. This was also reflected in iron ore and coal prices. Dry freight rates in the spot market have risen by 40-70% from the first week of November up to the present, with Handymax and Supramax vessels drawing strong demand. The strong rally in the smaller-sized vessel segment will benefit Maybulk (MBC) given its 55% exposure to these vessels by DWT.
Defying the typical year-end slump. Of late, smaller-sized vessels saw a stronger year-end jump in freight rates on expectations that the Chinese economy is on track for a solid recovery. Average fixture rates for 1Q2014 point to a weighted average freight rate of USD12,211/day, which is higher than the average USD8,968 that Maybulk will likely achieve this year. While rates are expected to remain volatile, signs are pointing to a rising trend. Our current
assumptions for Maybulk include a 35%/25% improvement in overall rates for FY14/15 respectively.
Rate outlook for 2014. The 6% growth in total capacity tonnage of dry bulk vessels this year is expected to marginally exceed the 5% growth in tonnage demand. 2014 is poised to be a better year for overall freight rates as demand and supply will be more balanced. Clarksons Research expects both demand and supply to grow 5% in 2014.
Asset prices on an uptrend, but could be cause for concern. Dry bulkers have been optimistic this year given the strength of orders, as vessel prices (for both newbuilds and second hand vessels) have been on an uptrend since bottoming early this year, rising in tandem with the a growing orderbook to total fleet size ratio (measured by DWT). Prices of Capesize vessels have surged at the strongest pace – at 16-30% - over the past three months. In the longer term, however, this may revive worries of an oversupply as we anticipate more deliveries from 2015 onwards, which could cap the increase in rates as the utilisation rate remains lower than anticipated. Nevertheless, while orders are on the rise, we note that the percentage of slippage to total DWT ordered in 2013 –at 36% - is the highest since 2010, which helps ease concerns of an oversupply in the shipping sector. This also means that only 64% of the projected vessel orders were delivered this year. The high slippage is due to a tighter financing environment whereby shipyards are already in dire need for working capital.
MAYBULK not a BUY yet. Maintain NEUTRAL. We think the market has already priced in the uptrend in rates, judging from the 32% YTD surge in Maybulk’s share price in spite of continued losses in its core shipping business, even at current freight rates. Moreover, if we value associate POSH at a 25% premium to its purchase cost – which will imply a 13x FY14 P/E for its offshore division - this would value Maybulk’s shipping operations at a steep FY15 P/E of 28x vs the sector’s FY14 average of 22.5. As such, we maintain our NEUTRAL rating on Maybulk, with an unchanged FV of MYR1.75, premised on a valuation target of 1x FY14 P/BV that is in line with the peer average.
Tanker Shipping (crude and LNG): Volatility to persist
Volatility to reign in crude tanker rates. Crude tanker rates remain volatile, with no clear indications of recovering in the near term as overall demand for oil continues to remain weak amid an oversupply of crude tankers. The daily earnings of very large crude carriers (VLCCs) showed a very strong seasonal rebound at the start of September due to improved demand emanating from activities in the Far East, as long haul voyages to some extent mitigated the tonnage oversupply. Aframax tankers, in which MISC (MISC MK, BUY, FV: MYR6.09) has significant exposure, continue to face an oversupply as demand for these ships in the Gulf of Mexico remains weak, no thanks to the discovery of the cheaper shale gas that has made the US less dependent on oil imports.
Meanwhile, chemical tankers in Europe are still hit by a surplus of tonnage despite some activities on the Transatlantic Westbound route. Wood Mackenzie expects China’s oil imports to surpass the US’ in 2017, and be the key driver of a recovery in tanker shipping rates by 2015 given that the longer distance from the Atlantic to China will absorb the excess capacity. Meanwhile, volatility in tanker shipping rates is expected to persist in 2014, but we expect average rates to jump 15% in 2014 and 25% by 2015 as the supply situation eases owing to stronger demand. With the worst being over for petroleum tanker shipping, a recovery in the segment’s earnings for MISC next year is on track.
Iran’s potential end to embargo could pose downside risk. A potential downside risk to crude tanker rates is the lifting of sanctions on Iran as this could potentially result in the conversion of the country’s floating storage tankers and as a result, exacerbate the oversupply situation. In a bear case scenario, the conversion of these vessels could potentially add 6% more capacity to the current VLCC fleet. However, as these floating vessels will be brought out of near lay-up conditions, we believe time and cost considerations may reduce the likelihood of Iran’s floating storage vessels entering the market all at once.
A more cautious tone on LNG shipping. The shale gas boom in the US has not only dimmed the outlook for the crude tanker space but also that of LNG shipping. We have seen some hesitation on the part of LNG buyers to sign longterm contracts for fear that LNG prices and shipping costs will be cheaper in the future.
This is in contrast to the strong optimism seen after the Japan earthquake, which drove up trade demand for LNG cargoes and vessel orders. The hesitation of LNG buyers and their inability to secure long-term contracts have been the cause for delays in completion of mega LNG projects , which are in turn also experiencing cost overruns and technical challenges. Exacerbating the situation further is the slew of LNG vessels coming into the market in 2014, resulting in a potential glut. This does not bode well for MISC as five of its vessels are on short-term contracts that will expire on gradually over the next few years. MISC stated that one liquefied natural gas (LNG) vessel charter is expected to expire in June 2014, but talks are already ongoing with Petronas, which is keen on chartering the vessel.
MISC remains a BUY. Nevertheless, MISC remains our Top Pick in the Malaysian shipping space despite the increasingly challenging landscape for tankers. Our FV is unchanged at MYR6.09, premised on SOP (please see table overleaf for the valuation details). Our investment thesis for MISC is centered on its diversified businesses, which are still reporting earnings growth (except for the heavy engineering division), that should cushion the losses suffered by its petroleum and chemical shipping business. We anticipate a recovery in earnings (at least at the EBIT level) this year. Furthermore, we hold the view that there is still value in its liquefied natural gas (LNG) segment even though its parent company, Petronas, has said that it will be acquiring its own LNG fleet. In our opinion, such a move signals the possibility of a second attempt by the national oil company to take its 63%-owned subsidiary private.
Maintain NEUTRAL on Shipping. We maintain NEUTRAL on the shipping sector. In our view, this is a trading sector play on rates upswing across all shipping segments, but investors should closely monitor rates and stock prices. Any selldown in the share prices of shipping stocks opens up a trading opportunity. However, rates would need to be stronger than our assumptions to warrant for any further upgrades in fair value.
Publish date: 31/12/13