Morgan Stanley analyst Fotis Giannakoulis is taking a bullish stance on the dry bulk shipping industry. He believes that rates for shippers will rally over the next two years as demand for iron ore and grains overtake supply, and that companies such as DryShips Inc. (NASDAQ:DRYS), Diana Shipping Inc. (NYSE:DSX), Safe Bulkers (NYSE:SB), and Star Bulk Carriers Corp. (NASDAQ:SBLK) will benefit from the rally. But hedge fund manager Jay Goodgal, who is focused on the transportation sector and a regular columnist on gCaptain.com, has an entirely different view that you may find startling.
The Morgan Stanley upgrade
Giannakoulis cited several reasons for the dry bulk shipping upgrade, which has fueled the rally in shares of DryShips, Diana Shipping, and Safe Bulkers. He mentions low supply growth of ships in the industry, China's strengthening economy, increased growth in import demand into China, no cuts in Chinese steel capacity until at least 2015, and high fuel prices all contributing to higher rates ahead.
It seems like virtually every analyst and dry shipping CEO are all seeing and repeating the same thing. This is why it's always important to hear a contrarian view, especially from an industry professional such as Goodgal. In an article on gCaptain.com, Goodgal gives his own opinion that tears the Morgan Stanley report apart, bullet point by bullet point.
First, Goodgal believes newbuilding delivers will increase, rather than decline, as Morgan Stanley believes. As evidence, Goodgal points out that the order book has been "relatively stable" over the last year, currently at around 121.9 million tons of deadweight compared to 122.7 million tons last year or an immaterial decline of less than two-thirds of 1%.
Second, he shows that during that same time, the industry supply in tonnage has increased 5.4% to 708.8 million tons which includes supply taken out of the market due to scrapping, conversions, etc.
Next, he points out that the current industrywide fleet is quite young now overall, and most of it is more efficient and much less in danger of scrapping.
Finally, Goodgal believes easy money from the government(s) plus low interest rates will encourage more credit to flow to the industry and cause further order book growth.
While Goodgal agrees with Morgan Stanley that the Chinese economy remains strong, he believes this is mostly due to loose money policies from China's central bank, designed to spark artificial construction demand rather than being based on actual long-term required need. He refers to this as the building of "ghost cities," resulting in entire metropolises with nobody living or working in them yet. The implication here is that this construction trend can't last forever.
Everybody seems to agree that there will be increased capacity and production exporting from Australia and Brazil and heading to China going forward. However, Goodgal points out the obvious: Australia is much closer to China than Brazil, and much of Brazil's new capacity isn't expected until the year 2017.
Goodgal does acknowledge that domestic iron ore production may fall in China. But he says Morgan Stanley failed to point out that Mongolia is "a significant new iron ore production source." Since Mongolia has a land border with China, it won't have any effect on the shipping industry.
Declining steel capacity
While Goodgal agrees that steel capacity in China won't begin to slow until at least 2015, he disagrees on what the implication of that means. He points out that the steel mills aren't going to wait until the last minute to suddenly respond and slow down their orders. As an example, when the Chinese central bank enacted a stimulus plan in August 2013, mills quickly reacted to stockpile iron ore well in advance of anticipated demand increases. Likewise, Goodgal's logic follows, the mills will cut back in orders well in advance of declining demand
With demand is expected to decline in early 2015, Goodgal believes it's logical to assume a slowdown in ordering will begin in first half of 2014 in anticipation of upcoming slowing demand. In other words, orders for iron ore, like the stock market, are thought to be a forward-looking beast that adjusts based on a six-month-and-higher outlook.
Final foolish and fuel-ish thoughts
Finally, Goodgal believes oil prices could be in for a tumble due to "relief from sanctions and with nearly 37 million of barrels of oil stored on National Iranian Tanker Company tankers" that may hit in the second quarter of 2014. Cheaper oil prices would mean cheaper operating expenses for ships. This means that they can travel faster at less efficient "gas mileage," and therefore the same ships can make more trips in a given timeframe. More trips equal more global supply and less shipping rates
While I agree with most of what Goodgal has stated, or at least have been driven to rethink my positions on a number of issues, I disagree with any attempts to forecast where oil prices will be in six months. If history is any guide, you have a better shot at guessing the weather patterns no matter what your expertise. Overall, Fools interested in DryShips, Diana Shipping, or Safe Bulkers should at the very least jot down each of Goodgal's concerns and watch for each of them very closely. If he's correct, things can get very ugly for the stocks of many dry shippers that are ending the year with a lot of positive speculation priced into them.