DOCTOR MARITIME EXPLAINS IT ALL ....

GOOD NEWS MASQUERADING AS BAD NEWS.

A recent issue of TradeWinds, the "International Shipping Newspaper", contains two items of particular interest.  First, Germany's largest shipping bank has stopped new shipping loans for the rest of 2007, perhaps a precursor to tighter lending practices in the larger shipping financial world.  And second, Morten Arntzen of OSG estimates that "some 75% of newbuildings on order have not yet been financed".  These two factors fuel a pessimistic view of the future, with ambitious shipbuilding projects dying from a lack of available credit.

I believe this pessimism is wrong and that optimism should replace it.  Let me explain.  Everyone knows (or should know, even if they have forgotten) that the shipping business is strongly cyclical.  One of the main drivers of the shipping cycle is the ordering, and over-ordering, of new tonnage.  When freight rates are high, ships are ordered, and inevitably the influx of new tonnage drives down freight rates and the cycle begins anew.  There is no reason to believe that the current cycle will be any different, and, in fact, warnings of over-building have been heard (and ignored) for some time now.  But if the tightening of credit, not caused by the shipping markets, can lessen the over-building, then there is a chance that the coming down side of the shipping cycle will be moderated and some corporate failures and bankruptcies will be averted.

SUPER-HEATED RESALE MARKET!

Every so often it's instructive to review a little history.  Yesterday, July 11,2007, a batch of ship sale reports contained three sales that triggered references to past sales history:

(1.) The capesize bulker GRAN TRADER, built 2001, 172,259 DWT, was reported sold for $105.0 million.  On July 21, 2004, the GRAN TRADER was reported sold for $57.0 million.  This ship, three years older has increased in value by 84.2%.

(2.) The panamax bulker MEGA WISDOM, built 2001, 76,397 DWT, was reported sold for $51.0 million. On May 19, 2006, the MEGA WISDOM was reported sold for $32.0 million.  This ship, fourteen months older, has increased in value by 59.4%.

(3.) The handymax bulker MED CARRARA, built 1981, 43,300 DWT, was reported sold for $15.3 million.  On February 28, 2003, the MED CARRARA was reported sold for $3.5 million.  This ship, four years older has increased in value by 337.1% - even though it is now 26 years old!

I think that these sales are indicative of an overheated market that cannot long be maintained.  When the meltdown will occur is the big question, and I'd certainly tell you if I knew.

SOME SHIPS, LIKE FINE WINES, INCREASE IN VALUE AS THEY AGE!

Thers's another old broker's adage that seems applicable these crazy days - "strong markets make old ships new".

On March 27th, a couple of sales were reported that, in calmer days, would have had me calling a broker friend to ask if the reports had been screwed up in transmission.

First, the IKARIA, a 26 year old small caper was reported sold for US$19 million.  In September of 2005, when the ship was only 24 years old, it was reported sold for US$12.5 million.  So, while aging two years, the ship increased in value by 52%.

Then, the MOSTOLES , a 26 year old panamax OBO was reported sold for US$13 million.  In January of 1998, when the ship was only 17 years old it was reported sold for US$10.8 million.  So, while aging nine years, the ship increased in value by 20.4%.

What's going on here?  Clearly, this is a game based on the expectation of a strong and very long lasting freight market.  History says "no", but history also says that the market peaks when the smart money says that "this time it's different and the market will stay strong for the indefinite future".

Question:  How many 20+ year old capers and panamaxes would it take to trade even-up for a prompt new-building slot?

A SHIP SALE OFF THE CHART!

When strange things happen during the frenzy of a shipping bull market it may mean that the top is imminent and the inevitable decline will soon follow.  On the other hand, the craziness may just be one person's warped hopes and perspective.  We'll know soon enough.

An extraordinary ship sale was reported recently.  The SAMJOHN CAPTAIN, a 22 year old panamax bulker, was sold for 20 million dollars.  Just half a dozen years ago, 20 million dolllars would have bought you a new panamax bulker, not a ship of an age soon to be recycled into rebar and razor blades.

Since 1994, the price of a 22 year old panamax bulker has stayed in the 13 or 14 million dollar range, so the 20 million dollar sale is off the chart - literally.  If you look at a graph of the historical distribution of the resale prices of 22 year old panamax bulkers for the last twenty years (adjusted for inflation) you will see a big bulge at about 5 million dollars (the long term average), a smaller bulge around 13 or 14 million (average for the current bull market) and a very slim tail that extends up to 20 million where the sale of the SAMJOHN CAPTAIN sits in solitary splendor.

In a previous blog entry we reminded our readers of the old broker's adage that "you can't make money in the tramp business with a new ship".  This situation is so unusual that it probably doesn't deserve a pithy saying of its own, but it's hard to see how you can make money in the tramp business by paying too much for a ship  with a very limited life span.

"YOU CAN'T MAKE MONEY WITH NEW SHIPS IN THE TRAMP TRADES" - OLD BROKER'S ADAGE

A recent maritime publication contained the calculation, so claimed, of the break-even time charter rate over 15 years for a recently purchased 4 year old VLCC.  The project as outlined is a classic bank financing - $124 million price, 15 years at 7%, 35% equity,$9 million residual (scrap value).  Note that the price is about equal to newbuilding quotes.  The calculated rate for the 15 years was $31,500 per day.  This is the rate that would return zero to the investors and seemed uninteresting to us.

We tried something different and perhaps more meaningful.  First, we "fixed" the first five years at the rate of $40,000 per day, a rate and term reported in several recent fixtures.   Then we asked the question: For the remaining ten years of the vessel's life, what time charter rate would be needed such that the cumulative cash flow from the ship-owning project would be equal to the cumulative cash flow from simply investing the 35% equity at a modest 6%.  The answer to this question is that the needed time charter rate (for ten years!) is $63,700 per day.

If, instead of a 35% equity we assume 100% equity, as in using the proceeds from a stock offering, then the needed rate is even higher, $83,600 per day.

I believe there are two conclusions to be drawn from this scenario.  First, don't underestimate the power of compound interest, and second, when the old broker says, once again, "you can't make money in the tramp trades with a new ship", listen to him.

NET ASSET VALUE NOT A RELIABLE SAFETY NET.

We have received a number of inquiries lately from the securities community about ship valuations - how are they done, what do they "mean", what is their "shelf life", etc.?  Why all this interest in what has historically been a peripheral part of the shipping business?  We think these questions are motivated by the following reasoning:

1.) We (the securities community) are interested in the newly emerging group of public shipping companies.

2.) But we don't have a deep understanding of the marine business and we could get hurt if we choose poorly.

3.) However, these companies are all rich in physical assets - their fleets - and if the company we choose goes bankrupt, the underlying value of the ships will indemnify us.

Logical, but wrong, as follows:

1.) Shipping companies don't often go bust when freight rates are high.  Since ship values correlate strongly with freight rates, ships will have lost considerable value simply as a reaction to depressed freight rates - even before bankruptcy is declared.

2.) Bankruptcy will amplify the situation.  Every possible buyer will assume that that the ship owner has been deferring maintenance for some time and so the ships will be assumed to be in poor condition and therefore less valuable.

3.) If several ships are being offered for sale simultaneously, the market may have trouble absorbing those ships at the best prices.

4.) All in all, the ships will probably not sell for what the owner (or banker) wants but probably at a steep discount.

So the financial security that the physical assets of a shipping company seem to offer may be illusory.

MONTE CARLO SIMULATION OF THE FREIGHT MARKET (1/1/2007)

(The following information is excerpted from the SHIPPING MONITOR of January 1,2007 (www.shipintel.com))

The FREIGHT RATE of the Bulk Carrier Index Fleet will decline six months for now by 6.8% and one year from now by 17.1% from its current value.

The FREIGHT RATE of the Tanker Index Fleet will decline six months from now by 1.7% and one year from now by 4.8% from its current value.

COMMENT: In both segments, rates for smaller vessels will decline more sharply than for larger vessels.  The probability distributions for Bulk Carriers are wider than for Tankers, indicating a higher level of volatility.

MULTI-YEAR TIME CHARTERS AS FUTURE REVENUE PREDICTORS.

Several public shipping companies recently announced multi-year time charters of bulk carriers at very attractive rates.  This information was noted by equity analysts and the implications of the future revenue flows were integrated into their recommendations.

How dependable is this future revenue flow?  Well, it all depends.  If the freight market stays at the present level then the revenue will be assured.  But if the strongly cyclical freight market falls, as eventually it will, then nothing is assured.

If the freight market falls significantly, charterers will ask to renegotiate current charters.  Perhaps a lower rate for a longer period will be offered.  Owners are not obliged to accommodate charterers, but often will out of self-interest.  First-class owners and first-class charterers need each other and cannot afford to alienate each other.

While future revenue from signed time charters may appear to be certain, it should probably be reagrded as an upper limit and heavily discounted.

WHY ALL THOSE TIME CHARTERS?

There was a sudden increase in longer term time chartering for dry bulk carriers in June.  Specifically, for the first five months of 2006 the average number of time charters of six months or longer reported in each month was 54.  During the month of June, 103 such charters were reported.  Why the sudden increase in volume?  From an owner's perspective, this might be an effort to lock in a freight rate before an anticipated fall in the market; from a charterer's perspective, this might be an effort to lock in a freight rate prior to an anticipated rise in the market.  Obviously, they can't both be right.  The increase in chartering might itself bias the future result; removing a larger than usual number of ships from those available to charter would tend to increase charter rates.  Unless, of course, those recently chartered ships came back into the market as relets.   

FREIGHT RATES AS STOCK PICKERS

With so many shipowning companies going public, it was certainly inevitable that someone would ask "is there a maritime index that correlates with shipping company stock prices?".  Or more to the point, "how about an index that predicts shipping company stock prices?".  The answers to those two questions are, first, "yes and no" and, second, "not yet and maybe never".

To the first question, indices of freight rates should correlate very well with earnings and then prices of pure tanker or pure dry bulker companies.  Because the costs of such companies are fixed in the short run, only revenue (as reflected in freight rates) is variable; when the rates move, earnings should move as well.   For other types of shipping companies like container companies or operations with several types of ships, the picture becomes much less determined and freight rates do not tell an unambiguous story.

As far as predicting share prices, the correlation mentioned above is a kind of leading indicator that points to changes in earnings but is not sufficiently sensitive as to time to be of much help in a plan of investment or disinvestment.  As for the "not yet", I have an idea, and if it works out you'll be among the first to know, but don't give up your day job just yet.