Maritime Shipping: High Hopes into 2020
The majority of shipping stocks entered 2020 on a strong note. 2019 was one of the best years for freight rates we’d seen in the past decade and enthusiasm was high ahead of transformational IMO 2020 regulations. The global economy was also strong, led by an exceptionally strong US economy. We also were enjoying a rapid fade of the peak global trade tensions from 2017-2018 along with a ‘Phase 1’ US-China trade deal.
The IMO 2020 regulation in particular had the potential to be a supply/demand game-changer. This global ordinance required all ships to switch to bunker fuel with sulfur content not to exceed 0.5% (Very-Low Sulfur Fuel Oil, “VLSFO”), a significant drop from the previous 3.5% limit (High Sulfur Fuel Oil, “HSFO”). This regulation was expected to significantly increase fuel costs by $200-$300/ton. Although this might sound like a negative for shipping companies, the majority of publicly-traded firms own modern tonnage, so the pain of the regulation was expected to fall primarily on older vintage fleets. Stronger spreads would lead to a significantly tighter supply balance as older ships were forced out of the market and modern ships generated significant returns. All of this on the back of a strong global economy with increasing US-China trade flows. Or so was the plan.
COVID-19: Disaster for Shipping Stocks
COVID-19 threw all of this into a loop. Not only was the global economy in question, but collapsing oil prices led to dirt-cheap bunker fuel prices. Additionally, the complete collapse of jet fuel markets combined with the weakest diesel demand in more than a decade meant that HSFO-VLSFO spreads would be much closer to $50-$100/ton than the $200-$300/ton initially expected. Modern tonnage wouldn’t deliver outsized earnings and older tonnage wouldn’t be pressured out of the global fleet as fast as hoped.
Additionally, beyond all the actual market impacts, shipping stocks fit into a horrendous basket into a global pandemic:
- Small Cap
- Value Stocks
- International Stocks
- Commodity Linked
- Higher Leverage
- China Exposure
Unsurprisingly, Q1-20 was an absolute disaster. The average return of the entire shipping market (index of 50+ stocks) was close to -50% through the end of Q1, compared to a loss of about 31% for the Russell 2000 (RUT) and the Nasdaq (QQQ) down about 11%.
Shipping Stocks: Zero Recovery Since March
However, the worst part of the deal is actually the performance since March. From the end of March to early-August, the average shipping index (50+ firms tracked by Value Investor’s Edge) has returned close to 0%. This compares to gains of 43% from the Nasdaq and 37% from the Russell 2000.
The Nasdaq is now up a surprising 26% YTD and the small cap Russell 2000 index is down just 5%. The average shipping index is still off by 50% YTD. These are small cap stocks, but the sample size of companies is significant and we’re reviewing at least 6 different segments (i.e. dry bulk, LNG, LPG, crude tankers, product tankers, and containerships).
COVID-19 Recovery Play: Maritime Shipping
If you’ve been flustered by the market running up and watching folks buy everything in risky baskets ranging from energy to airlines to hotels to borderline (or actually filed) bankrupt firms and are looking for a catch-up trade, I believe maritime shipping is the most attractive sector in the market.
Additionally, if you’re more concerned about a potential inflationary environment, global shipping also makes great sense. Both shipping rates and asset values are likely to increase with inflation whereas the real value of fixed debt will decline. This could lead to exponential growth in both earnings per share (“EPS”) as well as net asset value (“NAV”). Forget Gold (GLD) or Silver (SLV), buy steel assets with real underlying earning power. The best part is that the majority of these stocks trade at the lowest valuations we’ve seen.
Five Key Sectors & Top Five Picks
I believe there is significant post-COVID trade and investment upside potential across at least five segments of maritime shipping. I’ve also identified a top stock pick in each segment. Shipping has an unfortunate reputation for weak corporate governance, so I’ve went out of the way to only select the best firms for this selection.
I’ll include the list below along with our current ‘fair valuation estimate.’ Over the coming two weeks, I’ll also publish a public focus review of each of these five companies. These focus reviews will include the latest commentary from Q2-20 earnings results as well as market rates and relevant valuation metrics.
Without further adieu:
- LNG Sector: Flex LNG (FLNG), Fair Value: $12.00 (104% Upside)
- LPG Sector: Dorian LPG (LPG), Fair Value: $18.00 (100% Upside)
- Containerships: Global Ship Lease (GSL), Fair Value: $9.00 (73% Upside)
- Dry Bulk: Star Bulk Carriers (SBLK), Fair Value: $10.00 (34% Upside)
- Crude Tankers: Euronav (EURN), Fair Value: $13.50 (31% Upside)
I believe these top picks have upside of 31-104% (68% average) to our current fair value estimates. Keep in mind these estimates already include the full market impacts from COVID-19 and are based upon the information we have available today, as of 12 August 2020. If we see a true global market recovery into 2021, upsides are likely significantly higher yet. Conversely, if things turn out to be worse than expected, investors should expect further volatility in these markets.
Recent Webinar Review
As part of our partnership with the MoneyShow, I presented at their Virtual Expo in early August. The video of the full presentation and follow-up Q&A is now available on our YouTube channel and is embedded below.
This video reviews the general points covered in this article as well and adds additional color to each segment, ranging from containership rates and the consistent recovery to why we like crude tankers for the longer-term. This video also includes a review of the market conditions in 2019-2020 and adds additional details on performance.
Please feel free to review the video for a more thorough and interactive outline of the content in this report. I’m also happy to address any further Q&A in the comments section below.
Focus Reports Out Soon
As part of this “Post COVID” series, I’ll be posting a focus report on each of the top five picks mentioned above over the coming weeks. I’ll review Q2 earnings along with recent market dynamics and company valuations.
I’ll also be writing several reports about corporate governance and capital allocation in the sector. Maritime shipping has been a graveyard for many investors due to a disastrous combination of weak governance and poor capital allocation. We’ll aim to help investors understand how to identify the good firms and steer away from the weak ones.
Join the Discussion
Maritime shipping stocks have always been an unfavored sector, but we’ve been able to significantly outperform in this industry over the past decade due to frequent dislocations and wild volatility. Investing in deep value doesn’t come without risks and challenges. I doubt this report will be very popular at this time and there’s a very similar sentiment from Q1-2016 and Q4-2018.
2016-2017 and 2019 were both amazingly profitable runs for investors in this industry. I believe mid-2020 to 2021-2022 will make those runs pale in comparison. What do you think? Please join the discussion in the comments below.
Ride the Recovery Surge & Avoid Landmines
These markets are offering unprecedented value investment opportunities and recovery trade setups, as volatility remains high and buyers are still scarce. Maritime shipping is a challenging sector and in these turbulent times, strong research is more important than ever to select quality firms and avoid the plentiful landmines floating around.
We’ve identified top-tier setups for the global recovery. We’re in the midst of Q2-20 earnings season and will be rebalancing our top picks soon to best take advance of these setups. Free trials are open for the next week.
Disclosure: I am/we are long EURN, FLNG, GSL, LPG, SBLK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.