Buy the Biggest and the Best Dry Bulk Ship Owner for the Improving Dry Bulk Market in 2021
Although we saw major disruptions to global dry bulk trade this year, the dry bulk market has been surprisingly resilient. With Chinese economic stimulus causing double-digit growth in steel output in recent months, and further stimulus elsewhere in the world expected in the form of infrastructure investment, demand for dry bulk’s #1 commodity iron ore is expected to rise meaningfully in 2021. This, combined with higher demand for dry bulk’s #2 commodity coal due to growing energy demand in Asia along with surging grain and minor bulks trade, will ensure that overall dry bulk trade sees meaningful growth in 2021 that could exceed expectations. Increasing demand with constrained supply from a multi-decade low shipbuilding orderbook is sure to tighten the supply demand balance further and could even lead to a rate surge similar to the one we are currently seeing in container shipping.
Star Bulk Carriers (SBLK) has been on a torrid expansion run in recent years that has earned it the title of the largest publicly traded dry bulk shipping company with one of the youngest fleets. In an industry full of suspect management, SBLK management has shown it can and will continue to fund accretive growth at the bottom of the cycle and generate superior returns. Great management, best of class corporate governance, and its scale make this one of the safest and best ways to play the improving dry bulk market.
Iron Ore to Lead the Charge of Dry Bulk Trade Expansion in 2021
Iron ore prices are making new decade highs due to surging Chinese steel production and demand for the mineral that has exhausted worldwide supply:
With Chinese steel production ramping up to an amazing 12.7% year-over-year increase in October due to stimulus measures, and Vale (NYSE:VALE) slow to bring back production capacity, seaborne iron ore supply simply can’t keep up with worldwide demand, and inventories of both iron ore and steel in China are decreasing rapidly from already low levels:
Days of inventory on hand at Chinese ports are at 5+ year lows and declining rapidly with inventories dropping by 1.5% in the latest week and expected to continue declining into Chinese New Year.
The Solution to High Prices is High Prices
The market has bid up the iron ore price to find a solution to insufficient supply. This makes shipments from swing producers at far distances like the US and Canada suddenly economical. It also incentivizes producers to pull out all the stops to bring on new supply more quickly. Just 1 week after lowering its 2021 forecast, Vale announced a restart at their Samarco mine within the month of December. In addition to the known sources of swing supply, I believe that iron ore trade and shipment forecasts for 2021 are understated at these prices with millions of dollars of extra profit incentive at work right now to uncover and bring forward every ounce of potential supply and ship it to China. I see trade volumes surprising in the near term and analysts revising estimates upwards accordingly which will be supportive of dry bulk rates and dry bulk equities.
Coal Also Seeing a Price Surge Due to Increasing Demand
Coal prices recently hit fresh 52-week highs:
(Source: Trading Economics)
China, which causes distortions in the coal market due to a quota system that incentivizes coal traders to bring in coal early in the year and prevents imports after quotas are filled late in the year, has been forced to increase quotas due to extremely high domestic coal prices and low coal stocks. With a dire need to restock and demand exceeding expectations based on quotas set before pandemic, coal demand and trade will be well supported throughout the first half of next year as coal traders get a fresh set of quotas to work with. High coal prices will incentivize suppliers to bring back capacity to meet demand which could cause coal trade to exceed current estimates. As coal is the #2 dry bulk commodity traded by volume, this will be very supportive of dry bulk shipping demand and rates.
Grains and Minor Bulk Trades Also Surging
Grain trade has surged to fresh record high volumes this year despite the pandemic to meet China’s insatiable appetite and meet the needs of its recovering pig herd with a structural shift toward industrial producers consuming more imported grain. In addition to grains, minor bulks are growing steadily and expected to continue the trend in 2021. For further reading on dry bulk trade outlook, Klaveness Research has put together a great series of articles covering iron ore, coal, grains, bauxite, and other minor bulks.
Overall Dry Bulk Trade Well Supported and Likely to Exceed Expectations in 2021 On Surging Commodity Demand and Prices
Commodity prices are signaling late in the year that Chinese led global demand is extremely strong and likely stronger than forecast. Demand and prices have caught industry participants by surprise with suppliers working quickly to increase supply. For that reason, I believe models have not yet been updated to reflect the improved outlook. As these models get updated, dry bulk freight futures and equities will increase to reflect their improved outlook. I believe this process is just beginning with the Breakwave Dry Bulk Shipping ETF (NYSEARCA:BDRY), which tracks the dry bulk freight futures, up 18% in the last 10 trading days.
Dry Bulk Ship Supply Shrinking with Multi-decade Low Orderbook and Restrained Ordering
Historic low ordering in 2020 has led to the lowest dry bulk orderbook in 16 years:
(Source: SBLK Q3 earnings presentation)
Ship ordering is likely to pick back up with an improved market, but finding capable shipbuilding capacity and willing ship finance going forward is going to be much harder than it was in the past. This is best summed up in a recent research report by Danish Ship Finance:
“There are several factors constraining production capacity. Just 65 out of 287 yards have the capacity to build vessels larger than 100,000 dwt and only 60% of global capacity has experience implementing a non-fuel oil engine. While product assortment will be important, yards must build up track records, as vessel owners cannot afford to make wrong decisions.”
(Source: Danish Ship Finance)
Not only will it be hard to find shipyards technologically capable of building the next generation of ships required by new IMO regulations, but shipbuilding capacity is also likely to be constrained in the large sizes that all sectors are favoring right now.
With uncertainty over what type of ships will be required in the future to meet environmental regulations, along with limited finance and shipbuilding capacity, new ship ordering is likely to be much more restrained than it has been in the past, even if rates go crazy. Strong demand into limited supply means high rates, high profits, and high returns for shareholders.
Star Bulk Has the Biggest and one of the Best Fleets
Star Bulk has doubled its fleet size, adding 47 ships over the past 3 years, making it the largest Dry Bulk operator on a deadweight tonne basis (DWT) with one of the youngest fleets:
(Source: information compiled by author from company filings)
Golden Ocean (GOGL), another great company to be discussed in a future article, is the only other company that comes close to SBLK in size and is the only listed company with a younger fleet (excluding Scorpio Bulkers (SALT) that is rapidly exiting the dry bulk business). SBLK’s scale and modern fleet has made it one of the most bankable companies in the business and given it access to capital markets while its smaller peers struggle to obtain financing at competitive rates.
SBLK’s scale also allows it to spread its overhead across more ships and to have some of the lowest operating costs in the industry on a per ship basis:
(source: SBLK Q3 earnings presentation)
Lower OPEX per ship means lower breakeven rates and higher profitability under the same market conditions relative to its peers. As SBLK expands its fleet, it has shown that it will continue to lower opex per ship and increase the profitability of its fleet.
Scrubber Investment Still Paying Attractive Returns
Although there was much debate about investing in scrubbers to meet the IMO 2020 mandate, the obvious choice for any company that could fund the capex was to install scrubbers with fuel futures pointing to payback periods of less than 3 years and as short as a single year for large vessels. SBLK, having a sophisticated management and strong balance sheet, made the smart decision to install scrubbers on all of its vessels which it completed in Q2 this year. Due to COVID destroying worldwide refining demand, thus lowering the cost differential of refined VLSFO vs. lower cost unrefined HSFO burned by ships with scrubbers, the scrubber thesis has not played out as planned. Instead of the single and two-year payback periods expected, SBLK is still enjoying a lower but still good ~5-year payback period on its scrubber investments. SBLK’s entire fleet will continue to earn a meaningful scrubber premium in the market and higher profit levels than its peers that elected not to install scrubbers.
SBLK Management Making All The Right Moves
Star Bulk management continues to impress. Rapid expansion at the bottom of the cycle over the past 3 years while asset prices were low has set SBLK up for success with great operating leverage on its assets. Its latest deal to buy 3 capesize vessels tells me that management has its foot back on the growth gas pedal after a long pause to assess the uncertainty in the market brought by COVID. This aligns with my view of the market that now is the time with the outlook becoming very bullish.
Intensifying of global trade tensions could negatively affect global trade volumes.
Unseen future demand shocks like that caused by COVID could negatively affect trade volumes.
Trade is especially sensitive to changes in global GDP. Any global recession would likely cause a loss of trade volumes and reduction in dry bulk rates.
The dry bulk market is improving and is likely to surprise to the upside in the near term as recent commodity prices are signaling more robust trade demand than built into current models. Restrained ship ordering will help keep supply and demand more balanced into the future and support rates. There are many ways to capitalize on the improving dry bulk market including my favorite value play Navios Maritime Partners (NMM) that you can read about in my Seeking Alpha article here. But shipping, and dry bulk especially, is not for the faint of heart with volatile rates and cycles of boom and bust. If you are new to dry bulk or looking for the highest quality and lowest risk company in the sector, look no further than SBLK with the largest fleet, access to finance, top tier corporate governance and a management team that has proven it can navigate the ups and downs of the cycles to unlock shareholder value.
Disclosure: I am/we are long NMM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.