I’ve been involved in the public markets for over a decade and have built my primary base on Seeking Alpha where I offer public content to over 11,000 followers along with exclusive research via Value Investor’s Edge to a private group of nearly 500 members and affiliates. I’ve partnered with James Catlin who does exceptional macro research and industry update reports for our research platform and we’ve also launched a research newsletters, ShipBrief, which offers bi-weekly industry commentary and exclusive stock ideas. Over the past few years our focus has turned to the shipping sector and I often get questions from investors asking why I would dedicate my efforts to such a challenging area. This latest blog addresses my investment approach and outlines the basics of why I believe now in an excellent time to allocate money to shipping stocks.
Through my nearly 15 years of market experience, I’ve learned that if the market cap is over $10B, there’s very little chance I can consistently outperform the giant research shops like Goldman Sachs or Morgan Stanley. In these large and megacap stocks, there are thousands of brilliant analysts and traders engaged in trades with names such as Tesla (TSLA), Apple (AAPL), and Amazon (AMZN). However, when we look at stocks in the sub-$1B range, there is often a dearth of research and stocks tend to trade on extremely superficial things like dividend yield and trailing earnings. This opens up the opportunity for us to discover deep value opportunities and to avoid or short overvalued traps.
The shipping sector has been particularly appealing because it regularly happens to trade extremely inefficient and we’ve developed a clear market edge over the years, especially due to shorting high-fliers and picking up deep values when everyone else hates them. I have a passion for the sector, but I’ve been negative on many segments at different times when the supply/demand balance calls for it. Right now, as I’ve also explained in recent blog posts, I believe it is broadly time to be bullish and I’ve positioned myself in that way. For those who are interested in a balanced market approach, it might make sense to also look for pair trades or add market-specific hedges.
There are three specific reasons I am bullish on the majority of shipping names at this time:
- Unprecedented Regulation: IMO 2020 as catalyst
- Noise over Facts: Trade war distracting from surging rates
- Valuations: Many firms trade near record lows
IMO 2020 refers to the upcoming regulations, effective 1 January 2020, which will require all ocean-going vessels to switch from a maximum of 3.5% sulfur content fuel to a significantly lower 0.5% maximum (compliant fuel or very low sulfur fuel “VLSFO”). This will almost certainly lead to surging fuel costs and will drive an even larger wedge between modern ‘eco’ vessels and older outdated tonnage. Shipowners can also choose to install scrubbers at a cost of roughly $2-$3M per vessel in order to still burn the high sulfur fuel (“HSFO”).
At first glance this seems negative as costs will rise; however, shipping costs are typically based onto the end-users and what will more likely happen is that newer tonnage will earn significant premiums over older vessels, which will force higher levels of outdated tonnage to the yards. Only the firms with the best vessels and strongest balance sheets can afford the scrubber investments, which will further cull weaker players from the herd. This combination will likely lead to a smaller supply of available ships, which increases expected rates for the surviving ships.
The last time we had a regulation this large was the transition from single-hull to double-hull vessels in the mid-2000s. During the transition we saw a major rationalization of supply and a super cycle for associated crude tanker rates.
Trade War Distraction
Trade Wars are never good for shipping, but in today’s market the US-China flows are miniscule for almost all shipping sectors except for containerships. The negotiations between the United States and China along with associated tariffs implications and threats are constantly garnering headlines, but the actual impact to shipping demand has been minimal. I don’t see the potential for escalating trade disputes as a near-term positive; however, the related uncertainty has caused investors to balk at funding expansion plans and banks are also turning more conservative.
This means that already tepid orderbooks have been very slow to expand over the past year and will likely continue to trend in this direction. Typically, when rates are surging, owners climb all over each other to order new ships, but this time around we aren’t seeing this activity. If the orderbook remains small and we continue to see rising rates, there’s a potential we could run into another multi-year supercycle, such as the last one we witnessed from 2004-2008.
Valuations Near Record Lows
Capping off the investment case is the fact that despite rates in almost all segments setting multi-year highs (including nine year highs in dry bulk and eight year highs for midsize containerships), stock market valuations are sitting near record lows in terms of price to net asset value (“NAV”) and also in terms of forward EBITDA multiples. The risk/reward proposition is very attractive because these stocks are already priced for disappointing results. If rates continue to run, several of the best names have upsides ranging from 50% to over 200% depending on the level of operational and financial leverage.