Global fund flows are pouring rapidly into “virtue” stocks that “help the planet” and away from “vice stocks,” including anything to do with fossil fuels. Shares of tanker companies carrying oil and gas and dry bulk companies carrying coal are seen as squarely in the vice zone, which could put downward pressure on stock prices but spur high dividend yields if freight rates rise, according to speakers at the Marine Money forum in New York on Nov. 13.
Peter Hermanrud, chief strategist at SpareBank 1 Markets, dubbed the trend toward environmental, social, governance (ESG) investing “the biggest change in investor perspective since the internet boom and bust around the year 2000.”
“Investors are not just saying they want to maximize returns. They’re also saying they don’t want to do anything that’s bad for the world and they do want to do something that’s good for the world — either because that’s what they actually want or because they’re just telling someone it is.
“Funds are actively exiting fossil-fuel investments. It’s like the tobacco industry 20 years ago. Anything to do with fossil fuel is in the line of fire. That includes shipping companies freighting ‘toxic fuels on dirty ships with high emissions.’ Freighting oil is clearly seen as a climate-change risk,” he maintained.
“At the same time, we see money pouring into sustainable ESG funds. There is also a ‘greenwashing’ element. If you are managing a fund, you need to be able to say, ‘Yes, we have a position in a solar company, or a wind-power company, or a renewables company, or whatever. Yes, we care about the world.’ You need that in your brochure. Everyone needs at least one stake in one company that’s going to save the world,” Hermanrud said.
Self-fulfilling prophecy
“This creates a self-fulfilling prophecy. ESG funds are getting more money. What do they buy? More ESG shares. What happens when funds buy more ESG shares? The share prices go up. What happens to the performance of ESG funds? They do great and get more money. What do they do? They buy more ESG shares. It’s an upward spiral.
“The shares of ESG companies are all going through the roof, and shares of oil companies are down — and we could be in just the early stages of this trend,” he continued.
In the energy sector, this is leading oil companies to focus much more of their capital allocation on share buybacks and dividends, not capital expenditures for new production. Furthermore, a portion of that slimmer capex is now focused on renewables.
For ESG investors in the virtue stocks, Hermanrud believes this process could someday lead to “a great boom and a big crash,” as occurred with internet stocks around the turn of the century.
“You’re going to have some pretty poor capital-allocation decisions being made when you’re allocating just based on ESG across the world,” commented Robert Bugbee, president of Scorpio Tankers and Scorpio Bulkers.
For vice stocks including energy equities, Hermanrud believes this misallocation of capital could lead to big returns. “Production could slow more than demand, leading to higher oil prices. Energy shares are now the cheapest I’ve seen them in my whole career, and it’s the first time I’ve seen dividend yields [at this level],” Hermanrud said.
The “dividend yield” is the ratio of the annual dividend to the share price. Stock investors don’t merely benefit from share-price appreciation. They benefit from the “total return,” which includes both share appreciation and dividends. A stock could have an artificially capped share price due to ESG fund flows but a high total return due to dividends.
Total returns for shipping stocks
The same pattern could play out for the stocks of ocean shipping companies. Shares face pricing pressure not just from ESG concerns, but also from negative sentiment related to the trade war. Meanwhile, market fundamentals are improving, freight rates are rising, and owners appear poised to generate positive returns. Listed ship owners also seem much more likely to pay back those profits via dividends as opposed to reinvesting profits into newbuildings, due to uncertainty over how to “future proof” designs against yet-to-be-finalized carbon-emission regulations.
According to Hermanrud, “In the first phase, people won’t want to invest in ‘dirty’ tankers transporting ‘toxic’ goods, pushing share prices lower than they would have been. In the second phase, investors will demand more dividends. In the third phase, because so much money went back to dividends and not enough went to building new tankers, there won’t be enough tankers, making for a very tight market.”
Among NYSE- and NASDAQ-listed shipping names, dividends have played a minimal role over the past decade because these companies have generally been logging losses and have been restricted by loan covenants. With their shares trading at a discount, public ship owners instead focused their capital allocation on share buybacks. Now, with profits finally visible and financial leverage lowered, they’re turning their focus to dividends.
“Dividends are going to be a very powerful driver of the story, although we’re not there yet — shipping first needs to validate the consistency of the cash flows,” said Vance Brown, portfolio manager at William Jones Wealth Management.
J Mintzmyer of Value Investor’s Edge maintained that a shipping company’s prior share buybacks will pay off after a shift to dividends, assuming profits are sustainable.
“If you’ve bought back shares and earnings are high and the stock doesn’t move up, that’s a good thing because it means you can buy back more shares and reduce your float [the number of outstanding tradable shares not owned by insiders]. Then, in six or nine or 12 months, when rates are really good and you’re paying a dividend, you can pay an even higher dividend [per share] because you have less shares [in the float],” Mintzmyer said.
In general, the stock pitch at the Marine Money event — and there is always a pitch — was that shipping shares will likely face downward pressure from trade war and ESG sentiment, yet if rates do improve on better supply-demand fundamentals and excess cash is indeed returned in the form of dividends, then total returns should be strong. More FreightWaves/American Shipper articles by Greg Miller