MSI predicts more pain for shipyards amid the deepest industry slump, as problems with excess capacity and a slowing orderbook persist
The three main shipbuilding nations are expected to experience significant difficulties in 2017, forcing utilisation to drop to around 70% in Korea and Japan and close to 50% in China, according to the latest MSI Forecast.
Looking ahead to 2018 reveals a dearth of orders with Korea and China currently having only 20% output when compared to the historical maximum. “It is our belief that yards need around two years’ orderbook forward cover to give them pricing power,” says independent research and consultancy firm and Baltic Exchange member Maritime Strategies International (MSI).
“Any lower than this and that power switches to the owners. Even the big three Korean shipyards are feeling the pain this time, with HHI and Samsung’s current scheduled deliveries for 2018 at exceptionally low levels, although DSME’s orderbook is bolstered by healthy LNG cover.”
MSI does not expect to see a significant upturn in contracting levels any time soon. Instead, it says, there will be only a gradual increase in ordering levels over the next three years – not enough to offer shipyards immediate salvation.
“There will be only a gradual increase in ordering levels over the next three years – not enough to offer shipyards immediate salvation.”
The report also suggests a strong relationship between yard forward cover and vessel prices. Yard forward cover stood at four years in 2008, with fateful consequences for newbuilding prices. This will fall to just over two years in 2016; 1.75 years in 2017; and 1.6 years in 2018, which will have a weakening effect on newbuild prices. The other driver of newbuilding prices is yard costs, which will help pull newbuilding prices up in 2019.
However, MSI expects newbuilding prices for most sectors to bottom out in 2017 and remain there on an annual average basis through to 2018, with newbuilding prices for specialised ships only hitting the bottom of the price cycle in 2018.
The current glut of shipyard capacity means that many shipyards are underemployed. Consequently, if any sector shows a sustained recovery, the yards will be in a good position to take orders and deliver a large number of ships within two years.
This could result in something of a structural change in the shipping cycles going forward, says MSI, with shorter, sharper cycles and any bull run culled by the relative rapid delivery of legions of ships via the new dynamic shipyard capacity landscape.
“The speed at which shipyard capacity is able to react to increased contracting volumes was witnessed during the eco ship boom of 2013,” it adds. “After the Chinese-led contracting explosion which ended in 2008, shipyard capacity was shown to be very elastic and responsive and increased again to meet the requirements of owners wanting to place new orders.” This elasticity will act to dampen the outlook for earnings, which in many trades are expected to show improvement over the next five years as the demand side improves, compared with the last five years.
“Looking at Compound Annual Growth Rates based on MSI’s assessment of demand in a number of major shipping sectors, crude tankers, containers and chemical tankers all have better prospects over the next five years,” says MSI’s director, Adam Kent. “Convert this into growth in shipping requirements by factoring in distances, speed, port times, waiting time and ballast ratios, and the picture becomes even more positive for crude tankers and containers, chemical tankers and LNG carriers.”
Casting a shadow
However, the supply side remains the source of most problems and, despite some recent corrections, the existing orderbook still casts a long shadow over most sectors. Indeed, across all the main commodity sectors the orderbook significantly outstrips the ageing fleet. Multipurpose, ro-ro and pure car and truck carriers are the only types where there is a better balance of replacement tonnage requirements, says MSI.
The impact of all of this on second hand prices, independent of newbuilding and scrap prices, is best seen from net replacement value depreciation (NRV), which not only normalises second hand prices for movements in newbuilding prices but also nets out the scrap steel value enabling capture of the intrinsic value of the vessel and providing a very good correlation to earnings.
MSI explains: “Where earnings are strong the depreciation approaches a straight line – as recently seen in tankers and a number of specialised sectors. However, in weak markets the depreciation curve exhibits more of a convex shape and at the same time life expectancy is also reduced.”
MSI expects the NRV metric to improve from today’s position. Bulk carriers, it says, will see around a 20% improvement by 2018. “Although we expect the tanker markets to soften over the course of the next two years the actual reduction in NRV will be limited to around 5%.”
Follow the money
According to the MSI, positive returns can be expected across a wide range of shipping sectors. For sectors currently at the bottom of their respective shipping cycle, buying vessels cheap will eventually pay dividends, although MSI says it will be a “waiting game”.
Also, with earnings only marginally above operating expenditure for some sectors, investors must be prepared for the distinct possibility of further cash burn before an improvement in earnings gains traction. The risks are more mitigated and the returns greater for the specialised vessels. Small chemical tankers and LPG carriers, for example, can all expect internal rates of returns in the mid-teens, says MSI. The car carrier sector is perhaps the biggest winner, however the problem then becomes both finding a suitable vessel and, subsequently, securing a charter.