Wednesday, 15 August 2012

The link between consumer spending, housing, credit and shipping.

"Confidence is contagious. So is lack of confidence." - Vince Lombardi

Back in March in our conversation "Shipping is leading deflationary indicator", we argued that shipping was in fact an important credit and growth indicator, but most importantly a clear deflationary indicator. We also indicated that consolidation, defaults and restructuring were going to happen, no matter what in the shipping industry. We discussed at the time the restructuring process involving one of the biggest container shipping companies of the world CMA CGM. We followed up on this shipping discussion in April in our conversation "Shipping is a leading credit indicator", where we indicated that the deterioration of credit would accelerate the demise of some shipping companies due to many banking institutions paring back drastically funding or pulling-off completely from structured finance operations such as shipping : "For us the Baltic Dry Index is another indicator in the deterioration of credit as well as an indicator in deteriorating credit conditions leading to a surge in Non-performing loans on Banks' Balance Sheets."

It was therefore not a surprise to read on the 13th of August 2012, Ambrose Evans-Pritchard's column in the Telegraph entitled - World shipping crisis threatens German dominance as Greeks win long game where he indicates the following:
"Germany’s shipping industry faces a wave of bankruptcies over coming months as funding dries up and deepening economic woes across the world cause a sharp contraction in container trade."

We foresaw credit contraction would indeed trigger waves of bankruptcies and restructuring in the shipping industry, indicative of the deflationary forces at play in global growth which Ambrose Evans-Pritchard indicated in his article:
"Container volumes arriving at European ports plunged in June, dashing expectations of a summer rebound. Imports fell 7.5pc from North America and 9pc from Asia. Flows into the Mediterranean region crashed by 16pc, reflecting the violence of the recession in Greece, Italy, Spain, and Portugal."

We also warned in our previous conversations that credit contraction would accelerate the demise of the weaker players in this game of survival of the fittest, because major banking institutions are indeed pulling the plug from shipping structured finance, confirmed yet again by Ambrose Evans-Pritchard in his recent article:
"Commerzbank – the world’s second-biggest provider of ship finance, and reluctant owner of a flotilla of foreclosed ships – said it is shutting down its €20bn (£15.7bn) ship funding operations entirely to “minimise risk and capital lock-up” under tougher EU banking rules."

The latest results from German bank Commerzbank validate our  April call in relation to rising non-performing loans and the fact that banks such as Crédit Agricole, Danske Bank and Commerzbank were retreating from structured finance operations such as shipping as clearly indicated by the serious drop in syndicated lending in Europe in the first quarter of 2012 (see our April conversation on that point):
"Commerzbank said its asset-based finance unit, which comprises its commercial real estate and lending to shipping companies, will drive a “significant” increase in the funds the firm needs to set aside for risky loans in the second half. The bank’s second-quarter loan-loss provisions rose to 404 million euros from 278 million euros, while the ABF unit set aside 300 million euros in the period compared with 233 million euros a year earlier." - source Bloomberg - Commerzbank Forecasts Second-Half Net Below First Half - 9th of August 2012.

As a reminder from our April conversation:
"Commerzbank’s 2008 takeover of Dresdner Bank AG increased its stake in shipping lender Deutsche Schiffsbank to 92 percent, doubling the size of its maritime-loan portfolio, just before the industry entered its biggest crisis since World War II." - source Bloomberg.
In this specific conversation, we would like to look at the shipping industry and the long term trends identifying in the process the most likely survivors in this deflationary play, as well, as indicating the very important impact consumer confidence and consumer spending have on shipping and the importance of housing for shipping given the recent "green shoots" witnessed in the US housing markets.

Back in April we indicated the following relationship with the housing bubble: "The surge in the Baltic Dry Index before the start of the financial crisis was a clear indicator of cheap credit fuelling a bubble, which, like housing, eventually burst. In the chart below, you can notice the parabolic surge of the index in 2006 leading to the index peaking in May 2008 at 11,440; with the index touching a low point of 680 in January 2012" - source Bloomberg:
 Today, the recent deterioration of the Baltic Dry Index is yet another sign of the deterioration in the world growth outlook with the index falling back again towards the lows of March 2012. - source Bloomberg:
"The Baltic Dry Index, a gauge of rates to transport dry-bulk commodities including grains and coal by sea, is down 55 percent this year and on course for a fourth annual slide in five, data compiled by Bloomberg show." - source Bloomberg.

Dry bulk cargo represents the largest part of the $350 billion shipping industry:
"The marine shipping industry is roughly $380 billion, according to the United Nations. Publicly traded carriers account for some 67% of the market. About 8.6 billion tons of cargo were shipped via seaborne trade in 2011. Dry bulk cargo accounted for about 43%, followed by tankers (40%), and containerized traffic (12%), according to IHS Global." - source Bloomberg.

The recent demise of the world's oldest shipping company Stephenson Clarke founded in 1730 is symptomatic of a global surplus of vessels and overcapacity (which is as well plaguing the European car industry as a side note).

As far as the shipping industry is concerned, and in terms of our theme of survival of the fittest, size matters:
"The shipping industry is aiming to utilize larger ships in order to generate bigger economies of scale. The containership industry has evolved to include ships with capacity reaching 15,500 twenty-foot equivalent units (TEUs). The only barrier to container capacity increasing to 20,000 TEU-vessels is port loading and unloading infrastructure." - source Bloomberg.

Size matters and so do Bunker fuel prices for shipping company margins:
"Bunker fuel prices have increased 11% after reaching a 17-month low of $560.20 per ton in June. Prices are still 15% lower than the March high of $735.30 per ton. Higher prices can squeeze margins for shipping companies due to the lag effect. NYK Group expects its bunker fuel prices to be mostly unchanged for the year ending March 2013." - source Bloomberg.

Bunker fuel prices affect profitability of shipping companies because they constitute the bulk of expenses:
"Bunker fuel is fuel oil used in ship engines, stored at or near major ocean ports and primarily sold and delivered under contract to shipping companies. Prices vary widely from port to port. Bunker fuel constitutes the bulk of voyage expenses for shipping companies. Higher bunker fuel prices can adversely affect earnings and vice versa." - source Bloomberg.

Falling margins for shipping company are also affected by the fall in Dry Bulk rates which have continued to fall from Mid-July led by Capesize according to Bloomberg:
"Dry bulk spot rates for supramax and handysize ships have fallen 21% from their June-July highs, yet are still 70% and 51% higher respectively from their February lows. Panamax rates have fallen 21% from mid-July and are 41% above February lows. Capesize rates are down 45% since July 9, yet 29% above June lows and 87% lower than the December 2011 high." - source Bloomberg.

Vessel prices declined courtesy of the credit binge which led to overcapacity in similar fashion the housing bubble was led by cheap credit:
"Prices of seaborne vessels have been steadily declining since peaking in 4Q08 as excess capacity slowed the new build backlog, along with cheaper builds in China and tight credit markets. Chinese shipbuilders have been using price in attempt to win share. Price pressure has come on less sophisticated dry-bulk ships relative to LNG tankers." - source Bloomberg.

In similar fashion to housing in the US and Spain, the shipping "overhang" is leading to a rise in ship scrapping:
"Excess capacity and depressed charter rates have increased the number of container ships sent to be scrapped by 584% since June 2005. This is creating a more efficient fleet as older ships are replaced by newer models. Triple-E ships consume about 35% less fuel per container and are able to carry 16% more containers, according to Maersk." - source Bloomberg.

The excess capacity is leading to strongest player such as Maersk to add new efficient ships to their fleet as indicated by Kyunghee Park in his article - Maersk to Add Prius of the Seas With Fuel-Saving Ships:
"A.P. Maersk-Moeller A/S’s planned fleet of the world’s largest container vessels will be as
groundbreaking for their shape as their size.
The 20 ships will be the first cargo-box carriers with rounded hulls rather than streamlined V-shaped ones, according to Daewoo Shipbuilding & Marine Engineering Co., which is developing the 18,000-container vessels. The change reflects a shift by operators away from designing ships to go as fast as
possible to instead emphasizing fuel economy
. “These vessels will be the Prius of the seas,” said Lee
Jae Won, an analyst at Tongyang Securities Inc. in Seoul, referring to Toyota Motor Corp.’s distinctively-shaped hybrid car. “They’re fuel efficient and environmentally friendly.”
The fatter hulls will let Copenhagen-based Maersk install a fuel-efficient two-engine setup that’s too wide for current ships. It will also recover cargo capacity that is lost with tapered hulls, letting the ships carry 16 percent more boxes than vessels only a few meters smaller. Combined with other technologies, the ships will use about 35 percent less fuel per box than vessels now used on Asia-Europe routes and produce around 50 percent less carbon emissions, according to Maersk."

There you go, survival of the fittest and creative destruction "à la" Schumpeter impacted by the rise of Bunker fuel prices leading for a reduction in speed as indicated by the same article:
"The higher costs have already prompted shipping lines to slow vessels 18 percent over the past three years to an average speed of about 10.4 knots. That has cut fuel bills and eased global overcapacity that caused industry wide losses last year.
Reducing the speed of container ships by 10 percent can pare fuel consumption by as much as 30 percent, according to ship assessor Det Norske Veritas. A 25 percent reduction can cut carbon emissions by more than 350 tons a day per ship, the Transpacific Stabilization Agreement, a shipping group, said in 2010."
- source Bloomberg.
Given the container shipping industry market is already dominated by the top 10 carriers, A.P. Maersk-Moeller A/S appears to us as the strongest contender in winning this deflationary contest:
"The top-ten container liners have about 60% of the market, according to data from Alphaliner. Supply and demand dynamics drive financial performance. Consensus forecasts call for containership demand to increase in the range of 4% to 6% in 2012. North-South trading routes are expected to outperform, while Asia-Europe routes are anticipated to slow." - source Bloomberg.

"A.P. Moeller-Maersk A/S said its container line, the world’s largest, returned to profit in the second quarter after freight rates jumped. Net income for the container unit was $227 million in the three months ending June 30 compared with a loss of $95 million in the same period a year earlier, the Copenhagen-based company said on the 14th of August in a statement." - source Bloomberg:

If you want to pick winners in this survival of the fittest contest, you have A.P. Moeller-Maersk A/S investing in fast and fuel efficient vessels (Maersk vessels are designed to operate efficiently at both high and low speeds),  and so is Evergreen Group, owner of Asia's second biggest container line is as well adding more fuel efficient vessels to its fleet as well as Neptune Orient Lines Ltd:
"The Maersk vessels, which will also feature a waste-heat recovery system, will still be able to go as fast as 23 knots. That compares with a top speed of 25 knots for the Emma Maersk, the largest container ship afloat. The new vessels will be 59 meters wide and 400 meters long.
That’s about 3 meters wider and 4 meters longer than the Emma, which holds 2,500 fewer boxes. The limited size increase means major European ports will be able to handle the ships without having to buy new cranes and other equipment. U.S. ports aren’t big enough for such vessels."
- source  Kyunghee Park, Bloomberg - Maersk to Add Prius of the Seas With Fuel-Saving Ships

Moving on to the relationship between container shipping and consumer spending, traffic is indeed driven by consumer spending:
"Consumer demand drives Asia-originated containerized traffic and freight flows to Europe and North America. Auto parts, furniture, apparel and textiles, and appliances and kitchenware are some of top containerized product types imported into the U.S. and Europe. Any changes in consumer spending will directly impact global containerized traffic volumes." - source Bloomberg.

While many pundits are discussing the on-going "green shoots" in US housing, the impact on the Containership industry led by consumer spending and consumer confidence is very significant:
"Containerized traffic is dominated by the shipment of consumer products. A resurgence in international container volumes will be dependent on the housing markets improving. Furniture and appliances are some of the top freight categories imported into the U.S. and euro zone from Asia in containers. Furniture demand collapsed with the housing market." - source Bloomberg.

Unfortunately for container shipping the recent US drought is very bad news for their earnings as well as for world growth as indicated by Bloomberg in their article - Grain Cargoes Seen Slowing Most in 19 Years on Drought
"The worst U.S. drought in more than a half century and dry weather from Europe to Australia will mean the biggest contraction in grain cargoes for 19 years and unprofitable rates for owners of Supramax commodity carriers. Global trade in grains will drop 4.9 percent in the 2012-13 marketing year, according to the U.S. Department of Agriculture. Forward freight agreements, handled by brokers and used to bet on future costs, anticipate a fourth-quarter rate of $9,117 a day, 17 percent less than now, Baltic Exchange data show. Shares of Eagle Bulk Shipping Inc., the largest U.S. operator of the vessels, will slump 30 percent in the next 12 months, according to the average of six analyst estimates compiled by Bloomberg. Corn and soybean prices rose to records this month as U.S. farmers plowed under ruined fields and heat waves across Europe wilted crops from Italy to Russia. The fourth quarter is usually the most important for Supramaxes hauling grain as it coincides with the Northern Hemisphere’s harvests. The period generated the best average returns in four of the past six years."

Although population and diet trends bode well for Dry-Carrier demand, given the US is the largest net exporter of major agricultural products such as wheat, corn and oats, the recent US drought represent additional headaches for the already struggling container shipping industry:
"The U.S. is the largest net global exporter of major agricultural products such as wheat, corn and oats. The net amount of imported products appears to be growing for many emerging economies due to changing diets. The demand for animal feed increases with the demand for protein, which should help drive dry-bulk service demand." - source Bloomberg.

Could Jim Rogers be right after all, that on the long term farmers will be the ones driving Lamborghinis, not bankers? We wonder.
"If the world gets better, I know I'm going to make money on commodity demand. If it doesn't get better I'm going to make money on commodities because they're going to print money. In the seventies, most stocks did badly, the only stocks that did well were commodity stocks. That's going to happen again. The farmers are going to be driving the Lamborghinis." - Jim Rogers

"Beware of little lending. A small leak will sink a great European ship." - Martin T. - Macronomics

Stay tuned!

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