Capital Link 2nd Annual Shipping Conference Part One: Containers and Order Books

This is the first of a series of reports I hope to write on some of the issues and companies covered at the Capital Link Shipping Conference. The conference was very well attended. The agenda and a transcript will be available at Capital Link Shipping. The purpose of the conference is to increase the awareness of shipping as an investment class, and the opportunities the class provides. CEO’s from the participating shippers presented on behalf of their individual companies, participated in panel discussions, and met one on one with attendees.

There are several shipping sectors, and within each sector, important distinctions between the various companies. Frequently the investing public does not appreciate or understand the differences between and within these sectors. In this article I will address both the issue of delivery of new builds on the order book in all sectors and classes as well as the container sector.

Two presenters stood out in the container sector. Danaos (DAC) and Euroseas (ESEA). Danaos has an existing fleet of 40 container vessels (growing to 72 with newbuilds), which are chartered out to the top liner companies for multi-year fixed rates. DAC has 100% coverage of its ships through 2010, with 75% coverage until 2017. The charters are staggered throughout the next 20 years. The average charter duration is more than 8 years, increasing to 11 years by 2011.

DAC sports a 7% dividend and has had dividend growth of 6% per year. It pays out about 66% of its income in dividends. It is a stable boring stock that should provide steady returns year in and year out, recession or not. It has a net asset value of $33 per share, yet trades at $25.

Euroseas, on the other hand, has smaller vessels which take up the slack. This company is and should be more volatile. Its charters are of 6 month, 1 year and 3 year durations, while DAC has nothing short of 10 years. Therefore ESEA may be impacted by more short term events. The Company has a fleet of 15 vessels, including 3 Panamax drybulk carriers, 2 Handysize drybulk carriers, 2 Intermediate container ships, 5 Handysize container ships, 2 Feeder container ships and a multipurpose dry cargo vessel.

Euroseas’ 5 drybulk carriers have a total cargo capacity of 277,316 dwt, its 9 container ships have a cargo capacity of 15,321 teu and its 1 multipurpose vessel has a cargo capacity of 22,568 dwt or 950 teu. The stock trades at $11.34, carries a 10% dividend, and a P/E of 6. Charter rates are up 25%. ESEA sees fleet size increases of 13% a year for the next 3 years.

Why are container rates still high in spite of a recession and reduced U.S. imports? Several reaons. First, “slow steaming.” Container ships are run at reduced speeds to save fuel. The result is that more ships are needed to carry the same goods. The reduction in US imports has been picked up and exceeded by gains in imports in the Middle East, Africa and Europe.

There is a fallacy held by some in the investment community that higher fuel prices hurt ship owners. It is those who charter the vessels that pay for the fuel, not the owners. Fuel costs are passed through. And in the case of slow steaming, high fuel costs actually help the shippers since the reduced speeds increase the demand for vessel capacity.

Finally, the future order book for container ships is in line with historic growth. There is no blip in future years, no supply shocks ahead. Container vessels cannot be built at “greenfield” yards (those which have not yet been built) because of the technology involved. Even so, the container shippers see significant slippage in deliveries.

The inability of the shipyards to crank out all the newbuilds on the order books permeated all of the discussions of supply in all of the sectors. There was a consensus that there will be some slippage in deliveries greater than the 5-7% slippage seen in 2007. But no one could say exactly what the slippage would be.

There is a significant chance that some of the greenfield yards will not be built because of lack of financing. And ship owners are having trouble getting financing for their newbuilds. Finally there are legitimate concerns about the ability of the shipyards to get delivery of critical components like engines and propellers, and adequate trained crews, for which there are already shortages.

So while no one can say for certain how much of the new order book will not be built, everyone agrees that it will not be 100%.

The recent credit crunch may also have unforeseen effects on the orderbook. Even the South Korean yards are being impacted by the increased problems of ship finance. And increased steel costs coupled with a falling dollar will similarly hurt ship builders, since the contracts are dollar denominated.

In conclusion, while the order book does appear to be significant, there are several important factors which will result in less than all of the scheduled ships being built. And the container shippers present an interesting investment opportunity that may not have the risks which many believe exist.

Next: The Tanker Sector and the impact of the weak dollar on shipping…..