Tuesday, July 10, 2012

Banks distorting vessel values by keeping zombie shipping companies on life support, possibly delaying market recovery

According to Scorpio’s Robert Bugbee, bank deals like the recent Royal Bank of Scotland (RBS) equity for debt swap keeping their lame duck client Eagle Bulk (EGLE) on life support may actually be prolonging any meaningful market recovery. Instead of fleet renewal with this second hand tonnage moving to financially healthier and more efficient operators, this may encourage another round of speculative ordering for ‘econ-type’ tonnage financed on favorable terms by Asian banks to promote vessel exports and delay any recovery in rates for another two years.

“The problem is that the banks cannot afford to take write downs and private equity provides no better solution than the present operators,” Bugbee said. This keeps asset prices artificially high in markets where underlying cash flow from operations simply does not support these price levels. “This is combined with little available credit to buy second-hand tonnage and relatively low pricing for more efficient newbuildings, which will deliver at a later date and thereby avoid the present weak market. And these may have access to Asian finance.” Bugbee’s conclusion: “The result is that it’s probable that — on a ‘relative-return’ basis — fresh industry equity will continue to order newbuildings, thus lengthening the recovery process.”

What is ominous presently is the Chinese slowdown in growth rates, falling steel production and lower scrap prices. This may impact negatively vessel values. Not only will there be more fuel efficient designs, but replacement cost will fall.

Generally, commodities prices are soft and falling. This does not bode well for freight rates and cargo volume.

The stronger healthier shipping companies may adopt a similar strategy to some of the large liner companies like Maersk where they look to move into new technologically advanced tonnage that allows them to operate at lower cost than their beleaguered and financially-stretched competitors in a war of attrition. In this manner, they keep and expand their market share maintaining their earnings margins by efficiency and low financial cost, letting their competitors slowly bleed to death as they are slowly marginalized under their crushing debt stock and heavy financial expense in a prolonged weak freight market.

The only thing that could turn around this downward spiral is increased demand. Indeed so far, demand has been relatively firm as opposed to the shipping crisis of the 1980’s and the main issue is over-ordering. The wager in RBS lame duck support deals like Eagle restructuring is a speedy market recovery than brings up asset prices and improves cashflow.

Asset inflation has been a driving force in the shipping industry for many years now along with the Chinese double digit growth story. Should this environment change structurally, the industry (and its bankers) would be open to some severe readjustment shocks.

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