A ferocious run up in rates has left the dry bulk sector ripe for near term consolidation
‘Normalisation’ in the dry bulk sector will provide opportunity over the next two years, according to global maritime consultancy Drewry.
It bases its normalisation claim on multiple variables aligning in favour of the sector, including supply side rationalisation, scarce capital, easing bankruptcy risk, pessimism being at its peak, and the sector being out of favour and off investors’ radars.
Since its last stocks-related report in June 2016, Drewry says dry bulk stocks have been the best performer with outsized gains. Its top picks, Star Bulk Carriers Corp and Scorpio Bulkers Inc., have been outperforming and other stocks have followed up with decent gains.
Drewry adds that its DFRS Maritime Model portfolio, which remains heavily weighted to dry bulk, is up 18.4% since the start of the year.
“The dry bulk stocks are likely to enter a short term consolidation after a sharp rally that we have witnessed since the start of 2017. Even after the sharp rally, the current stock prices have factored in only 5% of the premium on the asset prices and are still below our target prices.”
Ripe for picking
Indeed, the run up in stocks has been ferocious, but that can be explained by “a return of strong investor interest, massive short covering in key US listed names and a reset of valuations”, says Drewry.
“Valuations in historical context do seem cheap but the ‘value play’ is mostly done in our view,” it continues. “Optionality, however, still remains very high.”
For the first half of 2017, Drewry believes that with most of the factors having played out well over the past six to nine months, the dry bulk sector is ripe for near term consolidation as returns have already been front loaded.
The consultant expects another rally to follow in the second half of 2017, “as freight markets catch up and expectations for a better 2018 starts getting discounted in the price”, it adds.
In the long term, Drewry expects to see cost structures rising again. For many companies, it says, lower interest costs have been achieved by way of debt restructuring and interest payment moratoriums. As losses narrow and profitability returns, Drewry also expects the covenants to kick in in the near future.
Calls for 2017
Plenty of shipping companies in the dry bulk sector have benefited from the run up in stocks. However, Drewry highlights a handful among them as stable prospects in an otherwise unstable market.
Pacific Basin has been one of Drewry’s top picks in the dry bulk sector for some time and it continues to maintain its positive stance on the company, not least because of its ability to deploy its fleet at higher than market rates. In addition to reasonable valuations, Drewry says the company has no concerns on its balance sheet. It says that Pacific Basin has a “rich pedigree” and maintains its leadership position in the handysize and supramax segments.
Drewry also sees Star Bulk Carriers Corp as an attractive company. “Multi-prolonged actions in 2016 have considerably eased liquidity risks and the company has managed to restructure its balance sheet on multiple counts,” it says. “On earnings, we believe cost management will support operating earnings in FY17.” Drewry adds that Star Bulk has one of the lowest average operating expenses for its vessels and a favourable freight rate environment will positively impact Earnings before interest, tax, depreciation and amortization (EBITDA).
At the same time, Scorpio Bulkers Inc. addressed debt and liquidity concerns in 2016, and continues to negotiate with shipyards and lenders to supplement liquidity, says Drewry. “It has also taken advantage of the rise in freight rates and has contracted 17 vessels on short-term charters, with most of the contracts expiring by second quarter,” it adds. “With the majority of its fleet deployed on the spot markets, the freight rate recovery post the seasonal weakness in 1Q17 will be a key catalyst.”
The consultant has also assigned an attractive rating to Golden Ocean. It believes the company will benefit from improvement in the dry bulk market. Added to this, Golden Ocean has a large exposure to the capesize segment, says Drewry, which has led and will continue to lead the recovery in rates.
Both Diana Shipping and D/S Norden have received a neutral rating. Diana Shipping has improved its liquidity and lowered its capital commitment, however the increase in its topline aided by freight rates will be capped as the company has fixed most of its vessels on charter, says Drewry.
D/S Norden has lowered its future commitments and has one of the lowest net gearing in the industry. However, it has significant exposure to the tanker segment which has been trending down and that will largely offset the improvement in the dry bulk business, in Drewry’s view.
A strong start
In summary, the consultant says the sector has gotten off to a strong start in 2017. It concludes: “Dry bulk stocks are likely to enter a short term consolidation after a sharp rally that we have witnessed since the start of 2017. Even after the sharp rally, the current stock prices have factored in only 5% of the premium on the asset prices and are still below our target prices based on a premium of 10% on the current asset prices.
“In a very bullish scenario, which is not our base case, there could be significant upside if the asset prices rise faster than our expectations. We note that changes in asset values have an amplified effect on stock prices due to high optionality of the dry bulk companies.”