Once upon a time, the ocean-shipping sector was a darling of Wall Street. That era has long since passed into dust, and current events within the shipping analyst community call to mind the Agatha Christie novel “And Then There Were None.”
FreightWaves interviewed one of the last men still standing: Randy Giveans, lead shipping analyst and vice president of equity research at investment bank Jefferies LLC (NYSE: JEF). Within shipping circles, Jefferies is known as a stalwart presence throughout the ups and downs of the investment cycle.
Giveans spoke at length with FreightWaves on the challenges facing shipping equities, how hurdles can be overcome and the opportunities he sees in specific vessel segments. The following is an edited version of an interview conducted on Sept. 24:
Thinning of the analyst ranks
FW: There have been an unusually high number of very prominent shipping analyst departures over a short period of time. To what extent do you think this is structural to the analysis profession, driven by issues like MiFID2 (the European rule that requires clients to pay for analysis), and to what extent is this a reflection of cyclical investor distaste for shipping equities?
Giveans: “It’s a combination. Structurally, you’re seeing fewer and fewer research jobs, not only because of MiFID2, but also because there’s more passive investing. Trading commissions are down across The Street. If you’re a hedge fund, you have to ask yourself, ‘Do I need to pay 20 different firms [for analysis] or do I call 10?’
“Secondly, energy in general represents much less of the S&P [index]. There are many fewer energy investors and fewer dollars in energy. Within energy, shipping is just a sliver. So shipping has become a small sector within a smaller sector relative to other sectors like health care and tech.
“In the shipping analyst community, because three or four of the biggest banks lost their analyst either by their own decision or the analyst’s decision, people think, ‘Oh, this is a trend.’ But I don’t know about that. Each of those departures had its own unique circumstances.”
You don’t take this rapid disappearance of Wall Street analysts as an indictment of shipping investment viability?
“No, I don’t think that because this all happened at around the same time that the banks said to themselves, ‘OK, we’re all going to get out of shipping right now because shipping stinks.’ I don’t think so because the timing would be very questionable.
“Maybe that might have made sense a few years ago, when there weren’t many catalysts and the investors weren’t there. But today, with IMO 2020 [the fuel sulfur cap effective Jan. 1] and how that’s going to play out for tanker trades and with the BDI [Baltic Dry Index] hitting nine-year highs and with LNG [liquefied natural gas] shipping starting to turn, there’s a lot to talk about. There’s renewed [investor] interest in this space. Anecdotally, of the 50 analysts at Jefferies, I’m in the top five over the last few months in terms of client interactions. I’m seeing interest from investors I’ve never spoken to before and investors I haven’t spoken to for five years.”
Rebuilding shipping’s stature on Wall Street
But the reality is that the current stature of ocean shipping in the public markets is nowhere near what it was before. Its downfall has really been dramatic. Market caps and trading volumes of shipping stocks are way, way down. How can shipping recover its Wall Street stature, particularly given how many times its investors have been burned over the past decade?
“I think there has been a lot more focus in recent years on passive investing and on growth stocks – on health care and technology. But in recent months, we’ve seen more active investors coming back, meaning there’s at least a little bit of a turn from passive to active. Also, in recent weeks we’ve seen a rotation toward more economically sensitive value stocks. When you think about economically sensitive value stocks, shipping is certainly ripe for that kind of investment. For those two reasons, I see things turning back slightly in shipping’s favor.
“But it’s going to take earnings sustainability. People have seen the short-term rallies and head fakes where rates go up for a few months and turn back down. Investors certainly need to see a couple of quarters or even a year of strong earnings. That would bring them back.”
What about all the exchange-traded funds and passive investing and how it relates to market capitalization? Do you think there’s a bias against smaller-cap companies that didn’t exist before? Shipping is extremely small-cap. Won’t listed shipping companies need to become much larger to attract trading interest, given the way stocks are being traded today?
“You would like to have a couple of $3 billion to $5 billion market-cap [shipping] companies. It’s very hard for investors to trade in something that’s $200 million [market cap]. You’d want to see more consolidation into larger market caps with more trading liquidity – but that’s easier said than done given different private-equity backers and different management styles. It’s certainly a barrier to some of the big long-only funds getting into this space.”
I also wanted to ask you about the trade war and the Trump tariffs. It seems that investors look at shipping and think “trade war” and will ignore these stocks until this is resolved. Is that true? Does this negative sentiment overhang exist?
“For sure. It’s certainly there. When you think trade wars and slowing global trade, you think shipping companies. Shipping companies are very levered to global trade – they facilitate global trade. If Trump tweets tomorrow ‘We had a great meeting with China and they’re onboard!’ you’ll see these stocks go way up. There’s certainly an overhang right now with the trade tensions. That’s why you’ve seen the massive earnings-to-equities [value] dislocation, which is why I think 15 or 16 of the 29 [shipping] companies we cover have repurchased shares.”
I still don’t get the share repurchasing by shipping. You’re spending cash in a highly volatile, cyclical business in a way that reduces the number of tradable shares and therefore your trading liquidity. The whole argument against shipping stocks has long been that the trading liquidity is way too low, and by making it even lower, you’re rendering the shares even less attractive. What am I missing?
“Well, you’re decreasing the trading of your shares but you’re increasing your NAV per share [net asset value; the market-adjusted value of ships and other assets minus debt and other liabilities] if you’re buying your shares at a discount to NAV. The balance sheets of a lot of these companies are in much better shape than they were three to five years ago. If you have a lot of cash on hand and you don’t want to order newbuildings, what else is there to do? You could pay dividends or special dividends, but I for one like the share repurchasing. Yes, you reduce your free float, but in terms of your return on equity, it’s usually very accretive if you’re buying your shares at a 30-40% discount to NAV.”
Reviving capital-market activity
The discount-to-NAV situation for shares brings up the issue of proceeds from capital-market offerings. According to our stats, the volume has totally collapsed. On one hand, that’s not necessarily a bad thing, because there were years when shipping companies were effectively forced to sell heavily discounted equity by their lenders as part of debt extensions. On the other hand, shipping companies generally want to tap capital markets for growth funding. Do you think U.S.-listed shipping companies want to increase their operating leverage (exposure to market rates) today by tapping capital markets to grow fleets, but they can’t because investors refuse to give them acceptable valuations?
“Absolutely. No owner wants to buy ships at NAV and sell shares at a 30% discount to NAV. The dearth of share offerings over the past year is because pretty much every company is trading below NAV. There’s not a lot of S&P activity [sale and purchase of second-hand vessels] because the bid-ask spread is too high. The sellers want to sell assets at 20% higher than they are today because that’s where they think values will be in a year, and the buyers want to acquire assets at where values are today, or at a discount.”
Let’s say that shipping equity valuations do increase and finally rise back above NAV. Given that owners are interested in growing fleets, will we see a resumption of capital-market offerings?
“Yes. If you get a ratio of the share price to NAV of 120-130%, expect to see share offerings again. If you can sell shares at a premium to NAV and buy ships at NAV, that’s a good transaction.”
This brings us back to the analyst community. If shipping equity pricing rises above NAV and there are more capital-market offerings, that equates to more fees for investment banks. Would that in turn compel investment banks to start hiring more shipping analysts again?
“Yes, if there’s suddenly a huge investment banking need for anything – let’s say T-shirt printing companies – and all these T-shirt printing companies go public, there’s going to be a need for more T-shirt printing company analysts. The analyst’s compensation is no way tied to this [investment banking activity], but if there are clients who own stocks from these offerings, there’s going to be the need for more analyst coverage.”
Crude tankers post-Saudi attacks
Let’s turn to specific shipping sectors and specific stocks you cover. The big news is the attacks on the Saudi Arabian oil infrastructure. There was a lot of fear about crude-tanker fallout in the immediate aftermath, but as it turns out, rates for very large crude carriers (VLCCs) have surged. How do you think this could ultimately play out?
“It certainly has been a positive for tankers in the short term. If there were a longer-term outage, it obviously wouldn’t be good for tankers. Then again, with all of the U.S. barrels hitting the water – with the new pipeline capacity coming out of the Permian Basin to the Gulf Coast, the dredging of Corpus Christi and LOOP [Louisiana Offshore Oil Port] – U.S. exports would certainly help bridge the gap, as would exports from Latin America, West Africa and the North Sea. There are other areas of production that could compensate for Saudi production. That’s one thing.
“The second thing is that you’re going to see a risk premium around Mideast tensions. Vessels going into the Middle East are going to require some hazard pay. The third thing is you’re going to see all the importing nations around the world increasing their inventories. They’re going to ask, ‘What if there’s an even bigger supply outage next month or six months from now?’ To offset that risk, they’re going to build their inventories.
“Our top two picks in crude tankers are International Seaways [NYSE: INSW] and DHT Holdings [NYSE: DHT]. Both have spot-exposed VLCCs with scrubbers [exhaust-gas scrubbers that allow for the use of cheaper high-sulfur fuel after the IMO 2020 deadline]. Both have solid management teams and solid balance sheets.”
Dry bulk shipping and its hiccup
In dry bulk, we’ve had that fantastic run-up in rates this year, especially for Capesizes (bulkers with capacity of 100,000 deadweight tons or more), but everything sort of peaked in early September and rates have been sliding – albeit not precipitously – ever since. Given all of the disappointments in dry bulk over the past decade, market watchers are understandably anxious, particularly because a lot of Capesizes were supposed to be out of service for scrubber installations, which should have pushed rates even higher. Why have rates come off their highs in the past three weeks?
“What happened was that rates surged [until early September] because there was a shortage of Capesizes in the Atlantic Basin as Vale ramped up production [Brazilian mining company Vale produces iron ore and ships it to China; its production was unexpectedly curtailed by a mining accident in January and subsequent weather issues; there were not enough Capesizes in position to handle its sudden resumption of exports, causing rates to temporarily spike]. It takes about 45 days to get a ship back to the Atlantic from Asia. Now that time has passed, more Capes have returned, and there’s no longer a shortage in the Atlantic.
“As far as scrubbers, there are actually a lot of ships out of service right now for installations, but this will be more of a six-month phenomenon. We’re going to see ‘peak scrubbers’ maybe in November or December, and it’s going to last through the first quarter.
“In dry bulk, our top picks are Star Bulk [NASDAQ: SBLK] and Genco [NYSE: GNK]. Similar to our thinking on the crude side, both have spot-exposed Capesizes with scrubbers and very strong balance sheets.”
LNG shipping market in flux
Yet another sector that’s performing very well this year is LNG shipping. Rates aren’t quite up to last fall’s lofty peaks of $200,000 per day, but they’re high. There’s a lot going on with the underlying commodity in this sector. LNG itself is now extremely cheap and a lot of analysts believe it will remain so for quite a while. Nevertheless, new liquefaction (export) projects continue to secure final investment decisions. This all looks positive for shipping rates, except for the fact that there were an awful lot of newbuilding orders placed last year. What’s your view?
“Our top picks in this space are GasLog LNG Ltd [NYSE: GLOG] and Golar LNG Ltd [NASDAQ: GLNG] and we see the next 18 months as very strong for LNG shipping. You have a pretty steep contango in the short term in LNG pricing and then over the next nine to 12 months you have a lot of liquefaction capacity ramping up in the U.S. – at Cameron, Freeport and Elba Island. We’re pretty bullish.
“There’s not as much new liquefaction capacity coming online in 2021-22, so there might be a soft patch [for shipping rates] then. But after that, you will start to see the next wave of liquefaction projects. The fact is, you have an overabundance of domestic natural gas in the U.S. and a shortage in importing nations in Asia, and European demand is also going to rise.”
IMO 2020: fact or fiction?
Finally, no shipping interview would be complete without the inevitable IMO 2020 question: fact or fiction? I’m not asking whether it’s going to happen. What I’m asking is whether it will be all it’s cracked up to be for shipping rates and equities. This has been talked about ad nauseum at ship-finance conference for years, but as we know, there are pitches made at ship-finance conferences by people hoping to earn fees that do not actually come to pass. There have been claims that we should have already been seeing the tanker demand effects of IMO 2020 by now, and that timeline seems to have been oversold.
“I think what’s happening now is that there are short-term headwinds in the bunkering ports around the world as they are drawing down their inventories of HSFO [high-sulfur heavy fuel oil] because they need to clean out their tanks and refill their stocks with MGO [ultra-low-sulfur marine gas oil] or some of the VLSFO [very-low-sulfur fuel oil] blends. That’s what’s crimping some of the tanker demand right now, especially for refined products. We think this will reverse in October or November at the latest, because that’s when all the ships without scrubbers – which will be 80% of the market – will have to switch over to compliant fuel. IMO 2020 is a short-term headwind now, as bunkering ports deplete inventories, but we think it’s a long-term tailwind thereafter.
“Beyond the effect of ships pulled from service for scrubber installations, we think there will be dislocations in tanker markets [that could increase demand measured in ton-miles]. And for all asset classes, we think there will be higher fuel prices, which usually lead to higher day rates and likely slow steaming. We also think the floor for scrapping will be higher [the level rates have to sink to to convince owners of older ships to scrap them]. Will there be much scrapping if rates are $50,000 a day? No. But instead of a floor at $5,000 or $10,000, it might be at $15,000 or $20,000 a day. This means there could be increased scrapping and slower speeds [both of which reduce capacity and support higher rates].
“I don’t think IMO 2020 is going to be a panacea. I don’t think it’s going to be a silver bullet that fixes all the shipping markets and rates are going back to $50,000 per day in perpetuity. But I also don’t think it’s going to be a Y2K. It won’t be a complete dud that doesn’t go anywhere. It’s going to be somewhere in the middle. To which degree, who knows?” More FreightWaves/American Shipper articles by Greg Miller