5.1 Dry bulk rates bottomed in 2Q/3Q 2013
Dry bulk rates staged a major recovery in 2H13, with capesize rates recovering sharply in 3Q and 4Q13, while panamax, supramax and handysize rates recovering convincingly from 4Q13.
The capesize rate recovery was caused by the substantial destocking of iron ore in China across 2012 and 1Q13, and with steel demand and production growing very well, restocking activity drove up exports from Australia and Brazil to China from 2Q13 onwards. This ultimately spilled over to the panamax sector, as capesize rates became too expensive. Nevertheless, capesize rates fell sharply in January 2014, as iron ore stocks in China have been largely replenished.
Supramax and handysize rates recovered only from 4Q13, partly because of the rush by Chinese importers to bring in cargoes of iron ore, nickel ore, bauxite, and other commodities from Indonesia prior to the export ban taking effect in January 2014. However, now that stocks in China of these commodities are plentiful, and with the export ban on nickel ore and bauxite from Indonesia finally in effect, rates for these smaller vessel sizes have corrected.
At the present rates, all vessel classes are earning more than their cash operating costs, which must be particularly encouraging for capesize owners because spot rates were below cash operating costs for most of 2012 and 1H13.
Iron ore demand likely to be strong, benefitting capesize and panamax ships. Demand for capesize ships look likely to be very strong in 2014, apart from a possible weak 1Q14, as the Chinese steel production is still powering ahead, and this will feed into demand for iron ore. We are forecasting a very healthy 7.1% yoy increase in seaborne iron ore imports in 2014, approximately the same as the 6.9% growth seen in 2013.
Chinese steel production likely grew 9.1% yoy in 2013, and even more aggressive apparent steel consumption growth of some 11.5% yoy, causing steel inventories to decline. Finished steel inventory days fell from 32.5 days in 2012 to 28.7 days in 2013.
This strong growth in steel production and demand also stimulated 8% yoy increase in domestic Chinese iron ore production, and kept iron ore import prices at very healthy levels of between US$120-140/tonne cfr.
We think that Chinese iron ore imports could weaken in 1Q14, as iron ore inventories at Chinese ports have risen to 88m tonnes as at 17 January 2014, up 27% against January 2013, and up from an average of around 70m tonnes during 1H13. Previously, iron ore inventories peaked at 98m tonnes in early 2012. Capesize rates have already crashed 70% to around US$12,000/day currently, from a peak of US$39,000/day last Christmas Eve, suggesting that Chinese iron ore importers have cut back on purchases. Another factor is the generally wet weather in both Brazil and Western Australia, which caused force majeure to be declared on some Brazilian shipments.
Moving beyond the 1Q14, we think that iron ore shipments will resume with a gusto and drive capesize demand. Higher demand for capesize ships will also drive demand for panamax ships, as typical capesize cargoes will be split into two or more panamax cargoes if capesize rates become too high. Panamax demand this year will also benefit from the expected 4.5% rise in seaborne coal shipments, and 3.8% rise in grain cargoes.
Indonesian coal exports unlikely to be affected by Chinese regulations. In 2013, the market saw the emergence of China‟s proposal to impose an import tariff or a ban on the import of “low-quality” thermal coal. Low-quality coal was first defined as thermal coal with a calorific value below 4,500kcal/kg, which was later revised to 3,900kcal/kg. Our Indonesian mining analyst, Erindra Krisnawan, wrote that the news caught the Indonesian producers by surprise since Indonesia‟s low-CV coal accounted for more than 90% of China‟s imports for the segment.
However, our Australian mining sector head Warren Edney, noted recently that “faced with opposition from the major power generators, China‟s government eventually abandoned the initial plan. But the proposal re-emerged by the end of 2013, this time with the “low-quality” term revised to only thermal coal with high levels of sulphur and ash. The latest proposal should affect Indonesian producers the least given that most of Indonesia‟s exports (particularly low-CV products) are low in ash and sulphur.
“We do not anticipate a dramatic decline in overall thermal coal imports in 2014, even if the NDRC is successful in altering regulations, as power generators cannot readily increase the quality of the coal which is burnt in their boilers. Our estimate is that the import tonnage loss for 2014 may be as low as 10m tonnes”.
As a result of the foregoing analysis, we do not expect any major change in 2014 of the nature of the thermal coal trade, of which Indonesian exports account for 45% of the total seaborne trade.
Nickel ore and bauxite trade expected to fall dramatically, hurting supramax and handysize demand. Demand for the smaller sizes – handymax/supramax ships and handysize ships – could be affected by the Indonesian ban on exports of nickel and bauxite ore, effective 14 January 2014. We are forecasting a 21% decline in the volume of seaborne bauxite cargoes, and a 46% fall in nickel ore cargoes, this year.
As a result, the total minor bulks trade inclusive of bauxite, is expected to see a net 1% decline in seaborne volumes in 2014, against a very healthy 6% growth seen in 2013.
The Indonesian ban generally prohibits the export of unprocessed ore in order to encourage miners to build refineries and increase the value added of its mineral exports. Coal was not included into the export ban. However, the government consented to exempting the exports of copper, manganese, lead, zinc and iron ore until 2017. Nevertheless, the exemption was not extended to Indonesia‟s exports of nickel ore and bauxite, and as a result, we should see large declines in exported volumes this year.
Indonesia‟s exports of nickel ore to China is about 60% of the global seaborne trade in nickel ore, while its exports of bauxite to China is 35% of the global trade in that commodity. Our mining analyst, Erindra Krisnawan wrote in a recent report that Indonesia accounts for around 60% of total Chinese nickel ore imports and is essentially the sole provider of the high-grade ore on which its nickel pig iron producers rely. For bauxite, China imports around 70% of its entire bauxite requirements from Indonesia.
According to a Tradewinds article, this trade to China relies primarily on supramax/handymax bulkers, and also panamax ships. Fitch Ratings estimates that Chinese refiners are holding up to a year in bauxite stocks, while consultancy Asian Metal estimates that nickel ore stocks at Chinese ports can last about four months, as a result of stocking activity in advance of the anticipated export ban. This means that Chinese importers do not need to rush out immediately to find alternative sources of nickel ore or bauxite, and seaborne volumes of these commodities will probably be weak for 1H14.
In the long-term, Chinese importers can buy nickel ore from the Philippines, although its quality of nickel ore is lower, but will have to turn to Australia for alternative supplies of bauxite, which will increase the tonne miles of the bauxite trade. However, the near-term impact of the Indonesian export ban is to curtail demand for the supramax ships serving the Indonesia to China trade, which will then also impact the handysize sector rates.
The bulk orderbook currently stands at 20% of the outstanding fleet, which is low by historical standards. The supramax sector has outstanding orders for 24% of its total fleet, while the handysize sector has 18%. These two sectors are closely linked, because these ships tends to have gears onboard for the loading or offloading of cargoes, and tend to compete in the smaller ports. As such, the supramax fleet development is also of concern to handysize owners.
Newbuilding activity picked up considerably in 2013, amounting to almost 80m dwt of new orders, from less than half that level in each of 2011 and 2012. Most of these orders were concentrated in the capesize and supramax segments, as owners positioned for an expected dry bulk freight rate rebound and in view of the still-low newbuilding prices.
Still, newbuilding deliveries peaked in 2011 and 2012, declined considerably in 2013, and will continue that decline from 2014 onwards. As a result, newbuilding deliveries net of forecasted scrapping should also continue its downward march. If demand for seaborne commodities hold up in the years ahead, which we presently expect, then dry bulk freight rates will continue to rise in the years ahead.
5.4 Demand-supply balance and rate forecasts
Reflecting our above analysis, we are expecting average capesize rates in 2014 to rise further from average 2013 levels, because seaborne iron ore demand growth of 7.1% is expected to be higher than forecast average capesize fleet growth of 4.4%.
Higher capesize rates should spill over into the panamax sector, which will also be supported by continued growth in coal and grain seaborne volumes.
On the other hand, we are expecting only modest improvement in supramax and handysize rates in 2014. because of nickel ore and bauxite volumes will be negatively affected by the Indonesian export ban. The impact of the ban is made worse because of the ample stocks of both commodities currently being held in China, as a result of the frontloading of those imports in 2013. While those two commodities accounted for only 5% of the global seaborne dry bulk trade in 2013, it accounted for 13% of the trade of the commodities that are typically carried by supramax and handysize ships, i.e. what is typically called “minor bulk”. Average freight rates for the supramax and handysize categories should improve much more in 2015, as the impact of the Chinese inventories wear off and as the Chinese source from alternative suppliers in the Philippines (nickel ore) and Australia (bauxite). The latter can actually increase tonne miles in the bauxite trade.
5.5 Valuation and recommendation
We maintain Overweight on the dry bulk sector, given the positive outlook for rates from 2014 onwards. Rates bottomed in 2013, and we have likely seen the worst of the dry bulk downturn. Our stock selection criteria are as follows:
• Stock prices must be below SOP valuations, which are calculated using the prevailing secondhand market value of ships, adding cash, deducting debt, and adding/deducting other net assets/liabilities.
• The companies must remain profitable, or at worst, endure only small losses. This is because the dry-bulk cycle will only recover gradually, and companies that are suffering large losses (e.g. STX Pan Ocean) may see their balance sheets eventually destroyed before the cycle turns.
At the moment, Pacific Basin and Maybulk both pass the two tests above, and we have Add calls on both.
Conversely, we have Reduce calls on STX Pan Ocean and Precious Shipping. STX Pan Ocean is technically insolvent after years of losses. Precious Shipping is also reeling from losses, though that does not imperil the company. That said, PSL‟s share price is significantly above its SOP. All our target prices are based on individual stocks‟ SOP.
Publish date: 24/01/14