Sunday, July 18, 2010

Is the Chinese eldorado that fuels shipping investments coming to an end?

This year has seen considerable new investment in large block speculative shipping deals. Peter Georgiopoulos did a US$ 886 mio deal in May to buyout the Metrostar fleet, and now a US$ 545 mio deal for 16 bulkers from Bourbon. Metrostar paid a record price of US$ 180 mio for five container vessels. The driver is anticipated economic recovery driven by Chinese export growth. Good times again as if the 2008 meltdown never happened. Yet already there are signs of a slowdown. Will China save the day?

Global growth since the 1980's has depended increasingly on monetary easing to induce asset inflation for stimulus, each dose of monetary stimulus resulting gradually in weaker recoveries with increasing joblessness. Wages in Western countries have remained fairly static and the government authorities have encouraged consumer lending to prime consumer spending with households becoming increasingly indebted. As an example, much of the growth in the US since the meltdown of 2000 was due to easy money that fueled a real estate bubble and led to the subprime mortgage crisis and massive foreclosures. The housing market in the US remains moribund.

The Asian emerging market countries since their financial crisis in the late 1990's moved to a neo-mercantilism whereby they kept their currencies undervalued to generate large trade surpluses through aggressive export policies. They recycle the money into developed western countries keeping down their exchange rates and financing their trade partners' deficits. One of Ben Bernanke's major speeches a few years before he become FED chairman was characteristically entitled "The Global Saving Glut and the U.S. Current Account Deficit" as a sign the times.

Eerily reminiscent of the defunct investment craze, China has become the rage with investors as an eldorado of unlimited growth potential. This optimism fueled interest for shipping issues on Wall Street, especially for dry cargo vessels to transport iron ore and coal for the steel production with the increased demand created by the real estate boom in coastal areas. Likewise investors went wild over the container sector where the only concerns of Seaspan (SSW) CEO Jerry Wang were whether Los Angeles could expand its port facilities to cope with the insatiable demand for Chinese goods.

Since the 2008 meltdown, there has been a modest recovery in both the US and EU but there remains a huge sovereign, corporate and household debt overhang in a balance sheet style recession. The most robust growth has been in emerging markets where there are much lower sovereign debt levels. The Chinese could finance their stimulus out of their trade surpluses, but there is growing evidence that the stimulus money has resulted in commodities inventory stocking as well as an over-heated housing market that is causing a serious real estate bubble.

Growth in the US seems to be slowing now that we are moving to the second half of the year. The EU has been confronted with serious sovereign debt problems in their weaker members of which Greece is now under a joint IMF-EU workout. Bad management of the Greek crisis and serious structural deficiencies in the Euro system resulted in contagion in other member countries, which led to a massive emergency EU bailout facility funded by member states and IMF participation. The ECB balance sheet is filled with toxic EU government securities.  It even suspended minimal ratings standards for Greece. The weaker PIIGS members are all under strict austerity programs. The UK, whilst in a somewhat better position free of the Euro albatross, has also voluntarily started an austerity program to address its fiscal and debt problems.

In this environment, Chinese capital surpluses are becoming harder to export. The weaker EU members were the second largest importer of these surpluses, but now austerity programs make this unsustainable. There is is already evidence of falling trade volume on western bound container trade lanes from the Far East. Meanwhile dry cargo freights as represented by the BDI have plummeted to levels not seen since the fall of 2008. The dry cargo pundits feel that the drop in dry bulk rates is only temporary due to Chinese contract renewal negotiations with producers. Likewise, container operators like Maersk, euphoric over recent transpacific rate increases, are projecting a surge in profits that match 2008 levels. External signs, however, are troubling.

What we see is that China has an increasingly volatile economy with large swings. The real estate is showing signs of decline. Non-performing loans are on the rise. Dependence on the US to export trade surpluses has risen since EU sovereign debt problems and austerity programs. The next tension is likely to be between the US and China on trade surpluses, especially if US unemployment remains at present levels. The last thing that China wants is to import the surpluses domestically because this would lead to currency appreciation and risk bankrupting the exporting companies.

All hopes at present are on another Chinese stimulus program to shore up the output gap. There appears a growing internal debate on how to manage their housing bubble and overheated economy, but the other major issue is the sustainability of the export model and how to deal with the shock from the EU and US taking measures to address defensively their large unemployment problems in a time span that is out of their control.

As FT's Walter Munchau put it:

The pessimists believe that a strong global recovery is unlikely given the persistence of financial stress, and the deleveraging of the private and public sectors across the industrialized world.

The optimists divide into two groups. There are those who have difficulties counting to zero, who cannot add up the global private, public, and foreign balances, which must equal zero by definition.

And then there are the rational optimists, whose expectations of resurgence in private sector demand must surely rest on the assumption of a return to even greater global imbalances than before the crisis, to which the eurozone will this time contribute actively. But this is surely not a sustainable position.

The pessimists would argue that global demand growth will not be sufficiently strong to support a selfsustained recovery in the eurozone. Even the rational optimists, who believe that this is possible, would probably conclude that these imbalances are not sustainable, and may trigger another financial crisis down the road. And if that is what you expect, you are not really an optimist.

What we know is that some of our societies are deeply over-leveraged, and that de-leveraging them means running trade surpluses, not deficits. That is not good for China nor the 'smart money' in shipping!

A prolonged, sluggish global recovery with high levels of unemployment in Western consumer economies and possibly a series of sovereign defaults of which the restructuring of the Greek public debt is high on the agenda would lead to renewed stress on the banking system, particularly in Europe. Overleveraged companies having already negotiated covenant extensions with their banks may be forced to sell assets at distressed prices that everyone has been trying to avoid the last few years.

We see a lot of 'smart money' in shipping assets. The new IPO's earlier this year like Baltic (BALT), Crude Carriers (CRU) and Scorpio (STNG) are all trading at discounts.  Albeit these companies have bought marked down assets and have low leverage, it is unlikely there will be appetite for further issues unless the discount is closed. It will be interesting to see what levels, Genco (GNK) obtains in raising equity and debt funding to close the 16-vessel Bourbon deal. Generally, Wall Street remains soft and shipping issues have generally never recovered to pre-2008 levels. Many of them are trading below US$ 10.

Is the container sector really out of the woods yet?

Investors have been euphoric over the rate increases in transpacific annual contracts. The container sector attracts keen investor interest due the long term employment with large liner companies like Maersk (OMX: MAERSKB) considered too big to fail. As a result, the sector has been plagued by huge order book overcapacity. The demand driver is the proverbial Chinese export machine. Yet container earnings may be peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

The global financial crisis hit Maersk and other liner operators very hard. They had aggressively ordered new tonnage as well as chartered in vessels from non-operating owners like Seaspan and Danaos , who had order books as large as their existing fleets. 

Maersk sank to a loss of US $1.02 bn in the historically low rate environment of 2009, overturning a profit of US $3.46 bn a year earlier. The liner operation fell to a $2.09 bn loss for the full-year as income from its containerships collapsed by nearly 30%. Aside from the container losses, Maersk also made a dreadful timing mistake in acquiring the Broström tanker fleet at top of the market prices shortly before the 2008 meltdown.

In this difficult environment, the liner companies fought back earlier this year by slow-steaming to try artificially to reinflate demand and reduce their losses from the dramatic drop in cargo volume. Industry consultants AXS Alphaliner estimate 78% and 53% the Asia-Europe and Transpacific routes strings are still running in slow steaming mode currently. Maersk also became a leader in cost cutting.

During 2010, the container shipping market was been positively affected by growing demand, primarily due to inventory restocking in the US and Europe and, to a lesser extent, growing consumer demand. Growth was seen mainly on the head haul routes and Intra Asia, which increased by 18% and 70%, respectively. Average rates in the first quarter were $2,863 per FFE, up by 18% compared to the same period of 2009 as a result of improved market conditions and higher bunker surcharges.

Maersk banked US $639 mio in the first quarter, overturning last year’s US $ 372 mio loss and smashing the US$ 225 mio consensus among analysts.

Citigroup analyst Ally Ma feels that the return to profitability for many lines may mark the beginning of renewed capacity woes as they begin taking delivery of deferred new building orders placed prior to the global financial crisis, against a backdrop of weakening demand. She reckons that the 3rd quarter rate hikes may indicate that container earnings are peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

Most new building deliveries to date are directly being employed in strings running on slow steaming effectively dampening the supply growth. The German KG market has for the past decade been a major asset provider to the container operators, owning the vessels and chartering out to the liner companies. KG participants are still facing insolvency issues and despite the recent market surge in charter rates, payments are insufficient to cover the payment of interest and principal in 2010 and 2011.

Non-Operating owners to continue facing financing issues as bank credit remains tight. Danaos Shipping (DAC) announced cancellation of three new buildings of 6,500 TEU which were ordered at Hanjin Heavy Industries and initially expected to be delivered in the first half of 2012. Seaspan (SSW) in a filing to the stock exchange stated funding shortfall for its remaining capex commitments and hinted at further cancellations on the cards.

The future of the container industry hinges on the quality of the economic recovery ahead. The US recovery seems to be slowing down and the EU is facing a serious sovereign debt crisis where austerity measures in Southern European countries are likely to dampen severely demand.

The temptation to buy speculatively container tonnage today has led to a rise in asset prices as each new deal brings new highs. Indicatively, Metrostar is said to have shelled out some US $180 mio to buy five 10-year-old 3,500-teu ships from German owner Claus-Peter Offen. This is double what the vessels might have fetched at the start of the year.

This is driven by the expectation that container rates will soon regain historic norms and present rates are closer to 50% of this level leaving room for improvement. Yet this counter-cyclical investment could prove self defeating in dealing with the overcapacity should the recover stall and we face a longer period of sluggish growth as opposed to the forecasts of politicians and pundits.

Wednesday, July 7, 2010

Peter G's big gamble

Peter Georgiopoulos has been aggressively scaling up his 3 publicly listed companies: Baltic (BALT), Genmar (GMR) and Genco (GNK) with massive block vessel acquisition deals. Whilst asset prices are down from boom year levels, bulk carrier prices have risen considerably off the meltdown lows. Bulk carrier freight rates have fallen sharply. Economists like Nouriel Roubini predict a weaker 2H 2010 and a sluggish recovery ahead, with potential public debt defaults ahead. Does Peter G's timing make sense?

Baltic was conceived in late 2009 as a pure dry cargo play based on opportunistic vessel purchases, spot employment and low leverage with a high dividend payout. Baltic's IPO was successful, but at a larger discount than anticipated. It was priced between US$ 13-14 but it is currently trading at US$ 9-10. It is a captive company of Genco (GNK) who manages the vessels and earns commissions on its fixtures and S+P transactions.

Genco (GNK) crashed in 2008 to US$ 6,50-7, but then made a modest recovery in 2009. Lately it has been under pressure, trading around US$ 14-15.

Genmar (GMR), the oldest Georgiopoulos company concentrating on tankers, is trading around US$ 5,40, which represent new lows for the year. In 2009, it underwent debt restructuring with its senior lenders, which it partially refinanced by a bond issue that cost more than originally anticipated. The successful US$ 200 mio equity raise for the Metrostar 7-vessel block deal was priced at US$ 6,75, only a modest discount. Investors are presently under water, but the increased equity strengthened the company balance sheet by lowering the leverage to 70% down from 75%.

The latest Platou market reports makes subdued projections for the drybulk sector that would indicate that Peter G's timing may not prove to be the best in making his bulker acquisitions. The tanker market is looking better, but Genmar remains with fairly high bank leverage. This would generate exceptional returns if the tanker markets continues to improve, but it also means further covenant violations with senior lenders in a poor market.

The investment thesis depends on China and emerging market growth. China slowdown in construction has sent dry bulk rates southwards lately. Supply-demand conditions and cyclicals are more favorable for the tanker sector but projected demand growth in crude oil transport is low in coming years.

Time will tell whether Peter G's was overly aggressive in his massive block deals of 2010. I think that analysts may have been overly optimistic on the timing. At least, the market has been pricing the shares differently from the analysts.  The next test will be the forthcoming equity raise for Genco to support the 16-vessel Bourbon block dry bulk acquisition deal.