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Why the Shipping Industry is Finally Ready to Reverse Course

"Rock bottom" is one of the gloomy cliches recently associated with the shipping industry. The industry's profitable boom from 2006-2008 was followed by 2009's dramatic fall in shipping rates and billions of dollars in company losses.

Shipping line operators bled money due to decreased trade, shipyards were flooded with order cancellations, banks tightened up lending regulations, and shipping companies' stocks plummeted.

But with the global economy on the mend, shipping industry stocks could be some of the biggest movers in 2010.

There is an undeniable need for a robust shipping industry wherever there is economic activity. And while economies around the world return to prosperity, thus reviving the shipping industry, investors may not have another opportunity to buy shares at such bargain prices.

So where should investors look for these opportunities?

A good place to start would be China.

Smooth Sailing in China

China's aggressive $586 billion stimulus plan breathed new life into the shipping industry. China's economy grew by 10.7% year-over-year in the fourth quarter and by 8.7% for the full year, fueling trade activity throughout Asia.

Beijing's recent moves to tighten monetary policy and curb lending to keep the economy from overheating have raised doubts about whether or not this growth is sustainable. But here are three signs that China is ready to bring global shipping back from the brink:

  • China needs raw materials to expand infrastructure. China's major planned developments for railways, airports and power plants will keep capesize vessels – ships that are too big to fit through canals, and instead use the Cape of Good Hope or Cape Horn – busy carrying iron ore from Australia to Asia. Iron ore accounted for 27% of dry-bulk trading last year. China also upped its coal imports by 179% in the first three quarters of 2009.
  • Overseas export markets are recovering. The China Federation of Logistics and Purchasing said its official purchasing managers' index (PMI) rose to 55.2 in December from 54.3 a month earlier. That's the biggest increase since April 2008, and it was aided by an increase in exports. The gauge of export orders rose to 54.5 and the reading for imports climbed to 52.8. That indicates that global demand and trade is coming back and China is poised to overtake Germany as the world's largest exporter.
  • China is developing Shanghai to be a major center for global shipping. The central government has already leveled an island near the city to construct a terminal in deeper waters to allow large tankers and container ships. Beijing plans to add 30 terminals able to process 15 million containers per year by 2020. And despite shipyards dealing with cancelled orders and inactivity, the country wants to overtake South Korea as the biggest shipbuilding nation.

How BDI and CCFI Spell Recovery

The Baltic Dry Index (BDI) has been a leading economic indicator since it was introduced in 1985. It measures the demand for shipping capacity against the supply, and represents the daily average of prices to ship raw materials.

In May 2008, the BDI hit a record high of 11,793, but seven months later it had dropped by 92% — a preliminary sign that 2009 was not going to be a year of trading, manufacturing and profiting.

Now, the BDI has climbed back to over 3,000, meaning customers are paying more than they were a year ago to ship materials across the globe. Transpacific shipping lines, mostly consisting of container ships servicing trade to and from Asia, are already reporting vessel use in the mid-to-high-90% range and expect a significant increase in volumes for 2010.

So let's take a more narrow focus on global shipping prices, one that accounts specifically for container ships: The China Containerized Freight Index (CCFI).

The CCFI measures shipping prices on routes from China to all over the globe, including Australia, Europe, Japan, and the Western U.S. Currently the CCFI has been trending upward since mid-2009. As China's economy paves the way for shipping industry profits, look for the CCFI to keep heading north.

As demand rebounds from hitting painful lows, the long-term winners in the shipping game will be those who aren't debt-ridden by oversupply.

Finding Profit in a Choppy Market

Shipping is cyclical and usually operates in three-year highs and lows as shipping rates rise alongside commodities prices. Currently, the optimism that was sown in the prosperous period from 2006-2008 has come back to haunt shipping companies – in the form of new build deliveries and payments coming due to shipyards. Now, the bears believe overcapacity will gut shipping profits in 2010.

But companies who kept orders to a minimum during the growth period will be able to avoid lost money on cancelled orders, and those that are in the market to buy can take advantage of quick, cheap vessel sales.

One company staying afloat is Diana Shipping (NYSE: DSX). The Greece-based dry-bulk company is regarded as conservative – some even say dull – which may save it from meeting the fate of its more frivolous rivals. Diana's balance sheet boasts a 25% debt-to-capital ratio, beating out some overleveraged competitors.

As most companies are trying to get out of ship orders, Diana has been buying vessels in accordance with its fleet-expansion project. Diana wisely balanced itself to prepare for volatility in shipping rates by securing about two-thirds of its fleet in long-term charters for 2010, leaving the rest able to take advantage of rate increases.

Although Diana isn't exactly a risky bet, investors who want to take an even more cautious approach to the shipping sector should go with Claymore/Delta Global Shipping exchanged-traded fund (NYSE: SEA), whose performance corresponds to the Delta Global Shipping Index.

This index consists of 30 shipping companies, including both dry-bulk and container. The fund is up close to 10% year-to-date and more than 83% from last year's lows.

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Join the conversation. Click here to jump to comments…

  1. John | February 3, 2010

    Not a chance that world container shipping companies will recover in in 2010, 2011, or 2012.
    New order vessel deliveries (ordered some 3 years ago) will out pace demand through these years adding over 60% of the current capacity to an already under utilized global fleet. The 90+% utlization factor of current container capacity is hogwash. With over 12% of the current world capacity at anchor in the far east and the flood of new tonnage coming on line over the next 3 years, it would be a miracle to see a full recovery before 2013. Although true that freight rates are increasing, keep in mind that they have hit historical lows so that any increase is an improvement over what can be considered lousy income for the container lines.

  2. Michael | February 3, 2010

    A client works for Maersk. The other day he told me the industry as a whole dropped 250 Billion in revenue last year. Maersk alone was out 50 Billion. Its hard to tell the truth from stories but he works for the company! For what it's worth!

  3. Brad | February 3, 2010

    There are NO capes to go around or canals to pass through from Australia to asia.

    • Dave | March 4, 2010

      Learn to read Brad. The article was explaining the namesake of capesize vessels.

  4. Devin | August 2, 2010

    Very informative article, thanks for the right up. I'm going to have to use this when my investment club discusses the Shipping Industry tonight.

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