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How to Navigate the Dry-Bulk Crisis

http://www.fool.com/investing/general/2011/02/16/how-to-navigate-the-dry-bulk-crisis.aspx

Christopher Barker
February 16, 2011

Some ships are designed to weather any storm. However, when it comes to the manmade tempest that has raged against the world's dry-bulk shipping industry since mid-2008, the dry-bulk stocks have virtually been dispatched to Davy Jones’ locker  with seemingly indiscriminate destructive force.

Korea Line, South Korea's second-largest dry-bulk shipping line, officially entered court receivership this week after filing for protection late last month. To an even greater degree than we witnessed following South Korea's prior shipping casualty in 2009 -- Samsun Logix -- Korea Line's fall from solvency has spooked a dry-bulk market that was finally beginning to glimpse some hopeful light at the end of the tunnel.

In familiar fashion, the spillover effect from the Korea Line debacle placed shippers with direct exposure under the market's microscope, and brought broader concerns over the nature of counterparty risk back to the forefront of investors' concerns. Eagle Bulk Shipping (Nasdaq: EGLE  ) bears the brunt of those direct exposures, with more than one-quarter of its ships reportedly chartered by Korea Line at the time. 

As of Tuesday, Eagle reported $7.3 million of total delinquent payments due, but it anticipates some payments forthcoming now that the line has entered court receivership. The newly constructed Supramax vessel Nighthawk, which was slated for imminent delivery to Korea Line, must now be matched with an alternate client or face the specter of idle time in an industry where time is most definitely money.

Providing a welcome counterpoint to counterparty risk, meanwhile, Navios Maritime Partners' (NYSE: NMM  ) own exposure to Korea Line's troubles has been effectively mitigated by insurance contracts designed to protect against just such an occurrence. Without such coverage, Navios Maritime Partners could have seen some 15% of its revenue stream at risk.

Beyond the immediate fallout
Suddenly, the best-case scenario envisioned by Diana Shipping (NYSE: DSX  ) -- in which the breakneck pace of growth in pan-Asian commodity demand seemed almost capable of absorbing the epic oversupply of newly constructed vessels joining the global fleet -- must now be demoted from a feasible forecast to a fantastical fairy tale.

So tenuous was the condition of the industry already, in fact, that the severe flooding in Australia's Queensland state could arguably have been the straw that broke shippers' backs, bringing more sobering scenarios for the industry into play. With massive volumes of coking coal exports by leading producers like BHP Billiton (NYSE: BHP  ) interrupted by the deluge, the unexpected idling of vessels exacerbated a critically oversupplied market condition. Charter rates for the behemoth Capesize carriers plummeted anew, dipping dangerously beneath the cusp of profitability.

Whereas smaller vessel categories provided some relative relief from the subeconomic rate structure that periodically blasted Capesize operators in 2010, anticipated charter rates now appear set to decline across the tonnage continuum. Cantor Fitzgerald expects Panamax daily rates to average $19,000 for 2011 (nearly 10% lower than the 2010 average), before deteriorating another 9.5% to $17,200 for 2012. The Baltic Exchange sees a troublesome 20% decline in average Capesize charter rates between 2011 and 2012. Relative to recent Capesize spot fixings beneath $5,000 per day, even those decidedly grim forecasts would provide some welcome relief.

Dahlman Rose analyst Omar Nokta recently downgraded a slew of dry-bulk operators -- including Genco Shipping and Trading (NYSE: GNK  ) and Eagle Bulk Shipping -- citing an increased likelihood that several will resort to share dilution to offset the group's badly diminished earnings profile and the danger of violating loan covenants. As veteran dry-bulk investors can well attest, prior rounds of dilutive equity offerings have poured sea salt into shareholders' widespread wounds.

3 cheers for a trifecta of stubborn selections
Under normal circumstances, I would close my analysis of a sector this steeped in structural crisis with a vocal plea for Fools to avoid the group entirely. When I renewed my warning against investment exposure to the residential construction industry last month, for example, I conceded that my stubborn refusal to avoid the dry-bulk sector represented something of a special situation (deploy air quotes).

The projected continuity of increasing raw material demand, I reasoned, presents a catalyst for vessel demand that will ultimately hasten the industry's return to relative equilibrium. In the short term, factors like China's stockpile of some 80 million tons of iron ore may pile on additional headwinds, but my long-term Foolish gaze remains fixed upon the "