Friday, May 22, 2009

Future Dry Bulk outlook mixed

Whilst dry bulk rates crashed hard last fall, this winter there has been a nice rebound that is now meeting resistance and looking choppy. Some like Omar Nokta of Dahlman Rose think there could be a big jolt in the second half toward the upside based on Chinese stimulus and rising steel prices. Since vessels for 2009 are well advanced in construction, cancelations will play a bigger role in 2010 and 2011. HSBC believes that two thirds of dry-cargo newbuildings penned for delivery next year could be axed or delayed by shipowners reducing the total world order book by as much as one-third. Short-term Chinese stimulus will boost demand but longer term, the Chinese are likely to cut supply. This is likely to mean a longer recession for the dry bulk sector than anticipated despite some short term recovery.

The positive thing about the dry bulk sector is that second-hand values now seem to be in balance with three-year charter rates. Values have plummeted 60% for this result albeit still US$ 5000 per day above long term (1992-2008) average rates. Despite the cancelations, the order book situation is alarming. If 66% of the 2009 and 79% of 2010 orderbook never reach the sea, annual deliveries will still average those of 2008!

Whilst the Chinese have hard cash and can cover fiscal expansion without increase in public debt, this cannot keep China running at 8% growth for more than a few years. The big problem is that China is an export-driven economy and EU/ US markets are not likely to rebound quickly. China will have to take measures to restructure and increase domestic consumption. This will not be easy as the banking system is very underdeveloped and there are renewed risks for non-performing loans.

Chinese steel production is down 18% and iron ore demand fell by 22%, Steam coal was the only commodity to maintain momentum in 4th quarter 2008. Global Insight expects China dry bulk demand to hit a 10-year low in 2009. Whilst there may be some increase in demand as we have seen already this year and even unexpected surges due domestic stimulus, the longer term likelihood with Government policy shifts to cut supply and boost domestic demand bode ill for dry bulk shipping even with substantial order book cancelations.

Most publicly listed dry bulk companies are recent enterprises without large reserves from past years. Many expanded their assets bases at top of the market prices in the boom years and took on substantial bank leverage. They been through the first round of renegotiations with their senior debt creditors on loan/ asset covenant defaults. Many have raised additional capital often by 'at the market' issues.

If there is not a robust recovery and the market continues weak over time, pressures will mount for further industry consolidation. Bankers will be increasingly tough on terms and may start to press to liquidate their losses. For these reasons, a cautious approach is still required for this sector.

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