Stay Away From The Bulk Shippers…For Now

If you have been an active investor in the markets, chances are you have come across the insane volatility surrounding the bulk shipping companies of the world. As an industrial-minded investor myself, it’s hard to look away when you see a fundamentally strong company 60% off its highs, and offering a 25% dividend yield (or more!). It might come as a bit of a shock when I say: stay away from the bulk shippers!

Expect Third Quarter Earnings to be a Mixed Bag

Most of the (formerly) big shipping companies release earnings later this month, and I fully expect there to be some positives. However, these are companies that just don’t pop on good tidings… and playing a bulk shipper could perhaps be one of the worst ideas for the defensive trader. From a second quarter that had many big names like Diana Shipping (DSX) producing doubles in net income and revenues year over year, things simply can’t look as bright heading forward.

The shipping industry, particularly bulk shippers, are driven by volume. In a recessionary environment… you need to almost completely disregard the constant bickering among corporate CEOs claiming that fleet utilization is still up around 100%. The bottom line is: companies like DryShips (DRYS) and Genko (GNK) are not in a very safe spot as the global economy weakens and people are, when it gets down to it, shipping less goods and materials.

The Baltic Dry Index

In this market, a lot of emphasis is placed on the Baltic Dry Index for tracking the actual dry bulk shipping rates over time. This is a daily survey that is literally given out to Baltic brokers every morning, asking how much it would cost for them to ship various raw materials across different routes. A bit rudimentary, but it seems to get the job done. In particular, this Baltic Dry Index follows commodities like coal, iron ore and grain.

Let’s have a look at how the 5-year chart looks:

Obviously, things haven’t been too pretty as of late. The shippers were all over the news this summer, as things collapsed and the shippers took off along with energy, a sector they are highly correlated to for obvious reasons (see raw materials the BDI is tracking). Does anyone really expect a massive rebound in energy? Not especially. Following along with this thesis, the shippers are actually getting hit 2x on bad commodity ties and poor volume in a deteriorating macroeconomic environment.

The Dividend Yield May be a Trap

After reading through a write up from Charles Petredis entitled “What’s Next For The Bulk Shippers?“, I can’t help but question how he is certain that dividends will stay where they are. While I can’t throw a hard-hitting statistic at you on investor sentiment toward dividends (nobody actually measures this), I believe that it is fairly safe to say that somewhere around 85% of investors don’t consider dividend cuts an actual possibility when placing bets in the market. But when you look at a bulk shipping company like Frontline (FRO), currently offering a 31.20% dividend yield, or Eagle Bulk (EGLE), with an 18.20% yield, this is not something that is sustainable in the real world.

These companies aren’t REITs, get real!

As a slew of downgrades have come in, many multi-billion dollar companies are now multi-million dollar companies. Don’t expect a company that claims to be re-investing in new carriers, expanding their contracts and reinvesting in efficiency improvements to hold their dividend up high enough to give you those kinds of gains forever. It is much safer to stick to a shipper that understands reality, and has a dividend closer to 5%. Any shipper with a yield over 10%… I just don’t trust. Be fearful of a dividend cut that could wreck havoc on your portfolio.

Solid Companies, Stuck in the Mud

Before you consider me the arch-enemy of all things shipping, understand that I actually adore the business model driving these transportation companies. Heck, I almost bought up a few long positions in my two favorite names (DryShips and Genko) when things looked like they couldn’t get worse about a month ago. Lo and behold, things got worse.

If you are an experienced (and aggressively-focused) investor that can handle the risk, I wouldn’t have a horrendous objection to investing at these ultra-low levels. Let’s face it, many of these companies have substantial cash positions that they have been using to expand their fleets and isolate themselves from a bad macro environment. However, never underestimate the trend in volumes… which may have a considerable amount of room to fall, especially in the short term (Q408 and Q109).

I’d love to see how things look after earnings roll through, but before then I cannot advise any activity in the sector, which is clearly “hands off” at this point in time. Stay cautious, and keep your eyes on the future prospects of this high-flying industry… but don’t let a bulk shipper sink your portfolio.

Disclosure: None.

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