Shipbrokers and the long shipping cycle

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lessons from economic history

I urge you to read this *lecture (pdf) to the Royal Institute of Naval Architects, given by Dr Martin Stopford of shipbroker Clarksons two years ago. Not just if you’re interested in shipping, but economic history and globalisation. It’s convinced me to put his acclaimed book on my reading list.

Stopford describes the persistent trend in global development since the 1940s resulting in 50 years of GDP growth at an average annual rate of 3.6% and an average annual increase in seaborne trade of 4.3%. You’d have thought shipping would have been a tremendous business.

In fact the fortunes of shipbuilders, ship owners, and perhaps shipbrokers have been tied to to a long-cycle. It peaked in two bubbles in 1973 and 2009, and describes long periods in the 1980’s and the 1990’s when earnings from various types of ship were stuck in the doldrums.

It’s tempting to quote the text, and reproduce the charts at length, but I shall restrict myself to one quote describing the state of the shipping industry in the years leading up to 1973 because it is such a succinct description of an investment bubble:
By the late 1970’s, the independent ship owners were becoming more adventurous and started to order ships on their own account without tying themselves down to a charter. The shipping banks supported them because the ship mortgage came to be seen as sufficient security since ship prices always went up. This broke the link between supply and demand and resulted in a spectacular shipbuilding bubble which peaked in 1973.
The shipping bubble had firm foundations; the end of colonisation and growth of free trade, improved communications, the opening up of new energy sources and financial markets, reconstruction in Europe and the emergence of Japan. By 1973 though there was overinvestment and the oil crisis punctured the bubble.

It took two decades in which ships were scrapped at a fraction of cost before the demand for shipping once again overtook the glut created in the early 1970’s.

Replace China with Japan and the oil crisis with the financial crisis and we’re in a similar situation in 2009. Stopford believes the globalisation trend has further to run, but we’re entering a downswing in the long cycle and the results are likely to be relatively low returns from shipping for the rest of the decade.

That’s the awesome backdrop to any decision to invest in Clarksons or Braemar, both shipbrokers.

I don’t know if profits from shipbroking are as cyclical as profits from owning or building ships. So far profitability at Clarksons and Braemar has not fallen dramatically, but Stopford’s scenario seems to be playing out in Braemar’s most recent results. A decline in freight rates resulting from the oversupply of ships, and a subdued sales and purchases market, explain declining shipbroking revenues.

The likelihood we’re in a downswing in the long-cycle for shipping, and confirmation that shipbrokers are affected by it, leads me to question whether the 20% or more return on equity Clarksons and Braemar have achieved over the last decade can continue. Since that’s the basis for my earnings yield calculation, which makes both companies look very cheap, I’m disregarding it.

Defaulting to book value, Clarksons shares are on a multiple of 1.7. That looks expensive considering the uncertainty and, since I don’t like the big bonuses paid to executives, I’m most unlikely to add it to the Thrifty 30.

Braemar, though, is considerably cheaper. The shares cost 1.1 times book value and its diversification strategy may prove prescient.

I prefer to add companies (or remove them) soon after they have published their annual reports, but if Braemar’s trading around book value (305p), or better still below it, next May, I’ll be tempted.

Curiously, Duncan, aka Kelpie Capital, seems to have come to a similar conclusion.

_

* Thanks to John Kingham, aka UK Value Investor, for telling me about it.

Comments

Glad to help Ricard. It will be interesting to see if this is the end of the cycle or not. From the share price it looks like that's what everyone thought was going to happen in 2008/9 and they were wrong. Will they be right in 2011/12?

Wikipedia says: "Stochastic (from the Greek στόχος for aim or guess) refers to systems whose behaviour is intrinsically non-deterministic". Sounds familiar!

I seem to have changed your name to Ricard.

My renaming could have been worse:-) I wouldn't go by the share prices, but the industry fundamentals (which I only have a hazy grasp of).

Rather like a tanker turning it seems tome the long-cycle should take a long time to turn and it might not be possible to determine a precise 'peak'.

For example, because it takes a long time to commission and build a ship, shipbuilders go on adding to the supply of ships long after demand has peaked and freight rates start coming down. I think that's one of the reasons the cycle in shipping is so much more pronounced than the economic 'long-cycle'.

Bearing in mind the shipbrokers are reporting an over-supply of ships, and in fact their earnings appear to have peaked in 2009, and freight rates are coming down I think we have evidence that we are in the early stages of a down swing, which we can add to the economic fundamentals - the financial crisis - stagnation in consuming countries and speculation about the robustness of Chinese growth in that context, to at least say the situation now is very different to the situation ten years ago.

That being the case relying on the profitability of shipping companies over the last decade in valuing them now would seem to be unwise.

That's all I'm saying! I'm not getting into the prediction game :-)

[...] that sits in firm value territory at the moment - shipbroking. Richard Beddard's posts on the shipping cycle, Braemar and Clarksons will see me taking a look at the businesses over the weekend, as it looks [...]

Richard,

My congrats on the blog! A regular read for me these days. Thinking about Shipping stocks a lot recently (plus Fish Farming stocks which are (suddenly) in the same kind of boat...), and have been monitoring Clarkson for a few years now. I believe there will eventually be an amazing once in a generation investment opportunity presented by shipping stocks, but this article and paper remind me that this opportunity may not turn up for many years to come...the very definition of once in a generation I guess! Patience, patience, patience, sometimes the best investment decisions revolve around not investing.

I've tried, but still haven't figured out the level of correlation, if any, between Clarkson and the BDI. In the event, if I ever believe we've reached the nadir I'd prefer to bet on the leverage potential of shipowners rather than ship brokers. I have Diana Shipping (DSX:US) earmarked currently as my preferred stock. Now I just need to wait until absolutely everybody has given up in disgust on talking/writing/thinking/investing in shipping stocks - the perfect buying opportunity!

btw I recently started a new value investing blog - I hope you'll take a look when you have a chance - and all comments/links/etc. are v welcome. Here's the address:

wexboy.wordpress.com

Regards,

Wexboy

[...] interessanter Post zum Thema Schiffebroker Gefällt mir:LikeSei der Erste, dem dieser post gefällt. Dieser Eintrag [...]

Thanks Wexboy. Sometimes I get frustrated when an investment idea doesn't turn into an investment and just have to remind myself the work isn't necessarily wasted - there may come a time... maybe you'll alert me to it on your blog :-) It looks very good and I've added it to the list of blogs I follow on Google Reader. I like the way you mesh the big picture with value investing, though I'm not sure I could do it myself.

[...] …but they could get cheaper. [...]

Hi .
The difficulty of attempting to find a correlation between the BDI and certain or any shipping stock may be due to the distinct difference between the actualities of the real market per the charter rates and ship sales etcetera and those of the perceptions of a host of investors .
Just my humble opinion , you understand .
Another observation if you will allow one , shipping stocks quoted on the exchanges in the Far East are much more volatile and thus give more bang for the buck than the London or New York equivalents .
Kazumi .

All things being equal of course , per the jargon ; which , of course , they never are .
Kazumi .

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