- For certain investors, willing to invest with highly variable durations, shipping has the potential to be quite lucrative.
- In contrast, investors who expect their returns to steadily reflect the risks will find most firms in shipping uninvestable.
- Many investors should only touch shipping via preferred stocks, and should do even that with caution.
An article in Seeking Alpha reviews the dividend strategy of maritime shipping, as explained by Paul Drake.
Crude tanker sector
The VLCC tankers cost close to $25k per day to operate, and the other sizes cost somewhat less. For most of 2018 and the first half of 2019, none of them were profitable. Rates were very profitable for 12 months ended this past September.
A big ship averaging a rate of $50k per day over that year would have cleared something like $10M in profits, more than 10% of its value new and a much larger fraction of the value of a ship of average age.
The flip side is that rates drop through the floor when ships are oversupplied. During the preceding lean year that ship would have lost a few million dollars.
The stock prices also fluctuate greatly. They tend to follow rates more strongly than would make sense if these were businesses generating long-term, predictable cash flows.
The fluctuations reflected the ever-changing, short-term fundamentals of the markets. An example is the unanticipated spike in rates this past spring, when disruptions in the oil price created large demand for ships to store oil on the water.
An investor who could anticipate the cycles by correctly grasping the fundamentals, and who was willing and able to shift directions on a dime, could do very well. Some folks manage to do this. More power to them.
The interaction of the instability in markets for any commodity, combined with the cycles of the supply of the ships themselves, combined with frequent and unpredictable interference by governments, introduces extreme volatility and also risk to any long-term thesis.
What’s more, the ability to rapidly gain or lose on operations has consequences. Net Asset Value itself does not play the same role in shipping as in real estate and is much more rapidly variable. And ships genuinely do depreciate too.
But it gets worse. There are major problems across the sector with the alignment of management actions and shareholder interests. There is more on that below.
The Long-term themes
The crude tanker supply story is pretty compelling. In short, this is not a good time to order ships thanks to some forward regulatory uncertainty.
These vessels take years to build. We seem to be guaranteed at least a couple years with very few new vessels coming in, even as aged ones continue to be scrapped. This could extend to 5 years or more, as the impediments to ordering will not be resolved soon.
This in turn has the potential to create several years of very high crude tanker rates. And if it does, shareholders have the potential to be rewarded.
One big risk is that some government, unconstrained by economics, might decide to order a whole bunch of ships. China, for example, might do this to keep its shipyards open.
A bigger picture risk is that at the end of the good period stock prices will rapidly come back down, just as they did this year. Unless the firms reward shareholders when they make the profits, one is left trying to time the cycle even on a long-term investment.
Returns to Shareholders?
Shipowners have a continuing need to renew their fleets. Negative events out of nowhere frequently occur. The combination has an impact on shareholder returns in shipping.
Yet shipping firms are in no sense candidates to be growth stocks. If well-run and lucky, they can make money cycle over cycle in their industry. But I see no path for them to compound their gains.
The contrast here is not just with Apple (AAPL), but also with firms like net-lease REITs. Such REITs are in a position to generate far more rapid compounding of value than a shipping firm can hope to. They have access to a large untapped market; shipping does not.
The implication of the above is that every shipping firm should be providing steady returns to investors, either as dividends or buybacks. Yet many of them do not. It is amazing to me that they get away with it and still attract investors.
Buybacks
In capital allocation theory, there is no difference between dividends and buybacks. In the real world, there is a huge difference.
One reason is that buybacks alone only affect the supply of the stock. They don’t move the needle on demand. If for some reason demand is inelastic, then the buyback can make no difference.
Shipping is not a sector like consumer-facing major corporations, where one can expect demand to respond quickly to changes in value. But that is not the only problem with buybacks.
Buybacks take too long to play out. The firms must wait for a window when they are allowed, and ideally should try not to move the market too much. So they are usually spread over time.
This gives the firms time to get nervous about the future, see an “opportunity” to grow their fleet, or just regret their proposed largess. Quite a few buybacks end up falling far short of what was initially promised.
One of my remaining holdings in shipping when I began writing this article was Dorian LPG (LPG), a firm with a sky-high reputation. It is making money hand over fist at the moment. But Dorian does not pay a dividend. It does hint at buybacks. But take a look at what it says.
In its most recent earnings call, Dorian made a typical statement, “Though the significant rate volatility caused us to curb our buyback activity, we remain committed to returning cash to shareholders and note that we still have approximately $50 million remaining under our share buyback at the authorization. And we also remain interested in accretive growth opportunities that meet our risk reward criteria.”
Dividends
In view of the issues with buybacks, dividends are by far the best way to induce investors to put money into shipping. Share the earnings when they happen and deal with the cycles by good management.
Almost no firm in shipping can afford to pay a steady dividend, because profits are so variable. So what one sees is more often variable dividends driven by profits.
Two firms that do this in crude tankers are DHT Holdings (DHT) and Euronav. Both have set dividend policies. The Euronav policy also includes buybacks, which they carry through on.
On its last earnings call, a DHT Co-CEO said, “expect us to continue to give 60% to shareholders and invest the rest in the balance sheet.”
Conclusion
Overall, here in 2020, this is not a poor outcome in context. The conclusion is that the common stock of most shipping firms is not investable.
Historically, shipping firms have not hesitated to massively dilute the shareholders of common stock in order to avoid bankruptcy. But today they are not generally near bankruptcy.
The consequence is that in many cases the preferred stocks of shipping firms are investable. They can represent a path to pretty decent income for those willing to accept the relatively small bankruptcy risk.
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Source: Seeking Alpha
