Analysis: breathing is harder for box lines as they climb higher debt mountains
I have been looking for signs that the container shipping industry is getting used to ...
This year could turn out to be the one when container shipping investors finally reap the rewards of their not inconsiderable patience, according to new analysis from Drewry Financial Research Services (DFRS).
Despite few signs that trade growth on the world’s major routes is likely to be anything other than sluggish, the company argues that if you look at the box shipping industry through the prism of its capital cycle, 2017 could be when investors in box shipping stocks see a reversal of their recent (mis)fortunes.
“Even as container shipping risks another year of high supply growth in 2017, the directional trend seems to suggest the worst of supply growth is behind us,” said DFRS.
“Drewry forecasts that global freight rates are set to increase by 12% in 2017, after four years of decline.
It added, in a research note: “The profit pool of the industry will be cornered by the sector leaders, in our view.”
The central idea behind capital cycles is explained in a recent book, edited by financial journalist Edward Chancellor, which features a series of essays written by fund managers at Marathon asset management.
They say that as capital flows into an industry, supply of that industry’s assets and production – in this case, container vessels and liner shipping services – rises quickly, which in turn forces down the price of ships and services.
Ideally, investors ought to enter a sector when supply is low and exit when supply is high, and disregard other, often more familiar, investment metrics, Mr Chancellor wrote.
“The capital cycle is really to look at companies not from the perspective of their valuation – whether they’re cheap or expensive on a PE (price/earnings) or a price-to-book basis – but to look at where the capital is entering or exiting an industry,” he said.
From that perspective, it is clear that 2016 was a year when capital began to exit the industry, as lenders finally began to realise that too much money had been sunk into newbuildings without a proper appreciation of the effect on charter and freight markets.
“What the investment banker really wants to do is to generate fees by raising capital. And if you raise capital and you throw it at any industry, the returns wouldn’t decline. So the investment bankers will serve as cheerleaders into the capital-raising process, and will tend to be blind until after the fact that too much capital has been misallocated,” Mr Chancellor added.
In the case of the container shipping sector, that was compounded by the heavy presence of state support for numerous shipping lines, which disrupted the natural selection that should have taken place as earnings declined dramatically during 2015 and 2016.
“When policymakers/governments/sovereigns interfere with the capital cycle, the market clearing process might come under stress. (In economics, market clearing is the process by which, in an economic market, the supply of the traded goods is equated to the demand, so there is no leftover supply or demand. The new classical economics assumes that, in any given market, prices always adjust up or down to ensure market clearing.)
“Container shipping industry is the perfect example of the diluted market clearing process, but we believe it has run its course,” DFRS said.