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The Collapse Of A Super-Cycle
Perspective | 16 January 2009
By: Xavier Lim
Articles (51) Profile

Forget about unemployment, inflation or even the oft-quoted gross domestic product. As most such indicators lag economic developments, their numbers shed little light on what the future holds. If you want to know when the global slowdown that has erased $28 trillion in wealth so far will finally reverse, pay attention to the Baltic Dry Index (BDI).

BDI is a figure issued daily by the London-based Baltic Exchange. The index provides an assessment of the price of moving major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers the four main classes of bulk carriers: Handysize, Handymax, Panamax, and Capesize that carry a range of commodities including coal, iron ore and grain.

GLOOM, DOOM AND RUST
One cannot overstate the importance of steel production to the global economy. Being the world’s fourth largest industrial activity, the Financial Times reported that historically, steel output has tracked economic growth cycles remarkably well.

The proportion of iron ore and coal (raw materials used in producing steel) transported points to potential economic activity. As both elements form more than 40% of the total demand for dry bulk shipping and 80% of the world’s five main dry bulk cargoes transported, demand for seafreight is heavily dependent on the underlying demand for these materials.

Burgeoning world trade has boosted the dry bulk industry into what has been dubbed as a super-cycle, with the rise of China a main reason for the BDI’s rise to such unprecedented levels. China’s relentless drive has already propelled her to be the number one steel producing country in the world, overtaking the US, and accounting for about 37% of world output of crude steel in the first 11 months of 2008.

However, the collapse, when it came, was just as dramatic. Weakening economic numbers from China and fears of a supply of newbuilds set to hit the market started the precipitous drop. As financial panic gripped the world in September 2008, the BDI fell 52%, followed by another 70% the following month. In less than 6 months, the BDI had tanked to 20-year lows.

HIGH AND DRY
The IMF has forecasted for growth in the global economy to slow to 3% in 2009, from 2007’s 5%. With trade set to fall, the demand for commodities will soften. Cutbacks in steel production, already underway, will hit iron ore and coke production hard, with knock-on effect on dry bulk shippers. And when shipping companies look to the financial crisis to dampen the expected oversupply of new tonnage, the situation could not have turned more desperate.

Investment in spare capacity during boom time has led to a slew of orders for new carriers being cancelled or delayed, with unchartered vessels being laid up. Dry bulk shippers also operate within a fragmented market structure. With little influence over freight charges, the industry faces possible consolidation. In such an environment, the only way in which operators can maintain profitability is through cost controls and commercial management of its fleet (see accompanying article).

The BDI is expected to remain weak, with expected range between 780 – 1,800 levels, as shown in the 10-year period chart.

chart11

COURAGE IN THE FACE OF ADVERSITY
You get the feeling that Courage Marine Group’s (CMG) business model has been inculcated with philosophical sensibilities: one that has the ability to ride on booms and survive a bust. Even when the shipping cycle was at its height in 2007 and 1H08, CMG has maintained its fleet size at eight. Having recently disposed of a Panamax-class bulk carrier, it has returned to that seemingly auspicious number: 3 Handysizes, 2 Handymaxes and 3 Panamaxes.

Of course, track records are never built on superstitions. In July 2008, Marine Money International named CMG as the world’s best shipping company in 2007, edging out the likes of AP Moller-Maersk and STX Pan Ocean. And CMG snagged top rankings based on ROA and financial strength.

CMG has opted for an asset-light base, looking for acquisitions of second-hand vessels rather than newbuilds. The higher operating, repair and maintenance costs associated with an older fleet, however, have not eroded savings. In fact, its fleet of second-hand vessels has enabled it to generate higher profit margins due to lower capital investment and depreciation expenses.

FINANCIALLY STRONG
The table shows that CMG’s revenue and earnings has from FY05-07 grown at a CAGR of 23% and 32% respectively. However, earnings in 3Q08 has been hit by significant drop of the BDI, which averaged about 6,400 in 3Q08.

Nevertheless, CMG’s cash and balances stood at US$65.55m as at 3Q08, and with no debt – which in itself is remarkable, given the capital intensity of the shipping industry. While CMG has obtained a new bank loan for an amount of US$10m for the acquisition of MV Zorina in Oct-08, financing is still backed by a strong balance sheet.

FY05

FY06

FY07

3Q07

3Q08

Revenue

48,381

56,734

90,411

24,244

18,208

Pre-Tax Profit

26,318

27,830

60,380

20,082

8,626

Net Profit

26,318

27,798

60,359

20,078

8,624

Cash from Ops

29,236

29,535

58,523

20,168

10,018

Net Profit Margin (%)

54.40

49.00

66.76

82.82

47.36

Financial highlights
 

CMG’s shares, which has shed about 65% since a year ago, is trading at a tight range between $0.10 – $0.15, with support levels at $0.11. Stock price variations, over the year, have a insignificant correlation of 0.31 with the BDI.

CMG has, over the years, maintained dividend payout at an approximate 55% of earnings. Its dividend yield of about 35%, at current prices, outstrips even those of shipping trusts. While the plunging BDI would sap earnings, we believe that CMG is unlikely to slip into the red in 4Q08 and FY09 on the basis of ability to maintain low operating expenses. Assuming unchanged dividend policy, the stock should still generate a good yield at current prices over years.

The impact of BDI on CMG
The impact of BDI on CMG

Armed with an arsenal of investment knowledge, Xavier is the Senior Research Editor at Shares Investment.

Please click here for more information about this author.


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