The maritime shipping industry has been labelled as the ‘lifeblood of the global economy’. According to the International Chamber of Shipping, more than 50,000 merchant ships travel the seas carrying approximately $4 trillion of commodities like grains, iron ore, and crude oil every year. In light of its significance, the performance of the shipping industry is one of the leading indicators of the direction of the global economy.
Shipping companies have a powerful influence on the supply-and-demand dynamic of commodities. Government-imposed lockdowns and mandatory quarantine orders for port workers at key trading hubs like Bangladesh and South Africa have negatively affected the performance of commodity trading contracts, which in turn led to financial institutions suffering huge losses. But the question is – as it always is when an economic crisis hits – how long is it going to take shipping companies to recover? A combination of qualitative and quantitative analysis can give investors valuable insights on shipping companies’ recovery potential.
Qualitative Analysis – shipping companies’ business model
Shipping companies typically choose to focus on one of the following two markets: (1) spot market (2) time charter market.
Majority of companies that focus on the spot market are owners of dry bulk vessels and oil tankers. The former is a specialised ship that transport dry commodities like copper and iron ore, whereas the latter primarily focus on transporting energy commodities like gasoline and crude oil. Spot market participants generate revenue by leasing their vessels and tankers at the going market rate, the price of this market rate is contingent on the economic conditions of the shipping market. Thus, when the global economy is expanding and there is a strong demand for shipping capacities, it provides a perfect platform for shippers to generate profits because the market rate would continue to increase. But during a market downturn – especially under the influence of a global pandemic – shippers’ profit margins have been significantly reduced because they were forced to respond to the weakened shipping capacities demand by lowering the market rate to attract clients.
On the other hand, companies that focus on the time charter market are less affected by market downturns because they have a more sustainable business model that guarantees predictable, long-term revenue. While time charter market participants also transport dry commodities and energy commodities, they lease their ships to clients under long-term contracts at a fixed market rate, which can range from 1-10 years. By establishing a fixed rate, shippers’ revenue stream is not affected by market volatility, consistent long-term payments would in turn help shippers to insulate earnings during an economic crisis.
Before we move on to quantitative analysis, a short summary can help investors to formulate their investment strategies based on the current economic conditions: first, spot market shippers. Characterise by volatile market rates, particularly appealing during a bullish market when demands for shipping capacities are high. Second, time charter market shippers. Place a strong emphasis on sustainability, have long-term fixed rate contracts to safeguard their revenue stream, albeit operating at a smaller profit margin than their spot market counterparts. By analysing the stock performance of Star Bulk Carriers (SBLK) and Gaslog, investors can develop a better understanding on how the economic impact of COVID-19 has affected the shipping industry.
Quantitative analysis I – SBLK (spot market shipper)
Based in Greece, has over 100 fleets of dry bulk carrier vessels that transport coal, steel, and iron ore. SBLK took advantage of the bullish market before the emergence of COVID-19, which saw them recorded a 250.58% revenue growth in 2019 compared to the year before last. But predictably, SBLK’s bullish run stopped during the peak of COVID-19 as SBLK delivered earnings and revenue loss of 40.63% and 11.20% in Q2 2020, respectively.
The MA graph above provides further details on SBLK’s Q4 2020 bearish run. For example, the second-to-last candle in the graph is engulfed by the next long red candle, producing a Bearish Engulfing pattern that signifies a slowdown of price movement and an impending market downturn. Nonetheless, the Stochastic Oscillator graph does provide optimism, indicating the possibility of a rebound.
At the end of Q3 2020, SBLK recorded a stochastic range of 9.62 to 16.57, both below the 20.00 mark, which represents that SBLK is firmly in the oversold territory. This in turn highlights SBLK’s rebound potential because locating in the oversold territory indicates that SBLK is trading below its intrinsic value, future market adjustments can provide the upward momentum SBLK needs to return to the pre-coronavirus price point.
With China, SBLK’s primary revenue driver, recorded a 4.9% GDP growth in Q3 2020 despite the adverse economic impact of COVID-19, demands for shipping capacities would increase because China would be eager to import commodities like copper and aluminum to support its 5G and real estate ambition, respectively. Coupled with SBLK recorded a 136.4% y/y EPS growth compared to last year, it is my provocation that SBLK can break through the 6.20 level at the end of October 2020.
Quantitative analysis II – Gaslog (time charter market shipper)
Compare to SBLK, Gaslog has performed better in the stock market because of its robust revenue model. With S&P Global Platts Analytics predicted that the demand for liquefied natural gas (LNG) will rise at a 6% compound annual growth rate through 2025, Gaslog has made the strategic decision to focus on the LNG market by leasing its vessels under long-term, fixed-rate contracts with major LNG shippers like the Royal Dutch Shell. This helps Gaslog to reduce its exposure to the volatile spot market because Gaslog can still collect consistent revenue regardless of the economic conditions of the shipping industry.
The MA graph shows that having a sustainable business model characterise by long-term, contractually guaranteed earning is key towards generating bullish outlooks amidst of the COVID-19 pandemic. In the graph, the red short-bodied candle (7/10/2020) was sitting between a long red and green candle, which is a Morning Star pattern that signals the selling pressure is subsiding, indicating the possibility of a bull market re-emerging. However, the neutral range recorded on the Stochastic Oscillator graph shows that the Gaslog stock does have its own downside risks.
Gaslog’s recorded stochastic range at the start of Q4 2020 cast doubts on its growth potential – 44.80 to 54.57. A relatively neutral position in terms of overbought/oversold territory, but currently Gaslog is gathering more overbought momentum because both the red and blue lines are approaching the 80.00 overbought level. This indicates that Gaslog is trading above its intrinsic value, thus investors should not ignore the possibility of Gaslog facing a cyclical slowdown in the next quarter.
The weakened LNG market and China National Offshore Oil Corporation’s (CNOOC) decision to declare force majeure on LNG contracts reinforce the possibility of Gaslog facing a cyclical slowdown. In Q2 2020, the Japan-Korea-Marker (JKM) price for LNG fell to a record low of $1.938 per mmBtu, which is the first time in history that the JKM price has fallen below the $2 support level since the start of the LNG market. Moreover, CNOOC has declared force majeure on several LNG contracts, including its 5 million mt/year commodities contract with Royal Dutch Shell. This in turn reduces the likelihood of Gaslog securing more leasing agreements with Royal Dutch Shell because CNOOC’s decision to declare force majeure has created an adverse impact on Royal Dutch Shell’s 2020 earnings.
Although the MA graph shows that Gaslog’s sustainable business model has played a vital role in generating bullish outlook, but Gaslog’s decision to focus on the LNG market may harm its growth potential because key metrics like JKM has recently reached a historic low. From a short-term perspective, the likelihood of Gaslog reaching the 3.20 level (September 2020 high) at the start of November is low.
If history is any indication, the journey of recovery for shipping companies is not going to be a smooth sail – especially for shippers that operate in the spot market. When the global containerised trade growth slowed down due to geopolitical tensions between U.S. and the Middle East in 2016, the market rate for mid-sized containership dropped from $8,800 to less than $4,400 per day. With the current COVID-19 pandemic halting economic activities, demands for shipping capacities would inevitably collapse due to weakened commodities demand. But shippers that operate in the time charter market – protected by fixed-rate, long-term contracts – would have a better chance of surviving.
For readers that are interested in the field of insolvency, the demise of the shipping industry during COVID-19 has taught us a valuable lesson on operational risk management. Some shipping companies, who were being overly optimistic during the bull market period, decided to purchase more vessels to anticipate future demand. Now, they have hit an iceberg – having to pay for these new orders when their clients are declaring force majeure on commodities contract.
(N.B. This article was written and submitted on 24 October 2020)
Earnings per share (EPS): A company’s net profit divided by the number of remaining common shares. Thus, a high EPS percentage represents that the company in question is growing and is in the position of generating enough money to return to shareholders in the form of dividends.
Force majeure: A contractual clause that alters parties’ obligation and liabilities under a contract when an extraordinary, unforeseeable event (e.g. pandemic, labour strikes, civil war) occur that is out of the parties’ control.
Profit warning: A warning declaration issued by listed companies, which warn investors that the profit of the company in the coming quarter will significantly decline when compared with that of the same quarter of previous year, or the company may even make a loss.
Overbought/oversold territory: It is important to note that the overbought/oversold territories at RSI and Stochastic Oscillator are different. In RSI graphs, 70.00 or above is overbought and 30.00 or below is oversold. But in Stochastic Oscillator graph, 80.00 or above is overbought and 20.00 or below is oversold.
Japan-Korea-Marker (JKM): The LNG benchmark price assessment for spot physical cargoes.
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