The Forgotten Shipping Market Making a Killing
Shipping rates are down. Way down. Having dropped 54% in the last three months, the Baltic Dry Index suggests that something is out of whack with supply and demand in the shipping industry.
And whenever prices of any product move that much – and that quickly – there must be some dislocations in the markets that offer an opportunity for profit.
With shipping rates falling off a cliff, there’s one part of the shipping industry that’s actually benefited, posting profits higher than it did during the 2008 economic peak. Even more important, it looks like these profit trends should only continue.
You see, while the decline in shipping rates suggests a slowing of the economy, the other economic numbers we’ve seen suggest otherwise.
Part of this discrepancy comes from the supply side of the equation – i.e., there are too many ships, as opposed to too few goods needing to be shipped.
In fact, if you look at a particular type of ship – containerships – you’ll see that shipping activity is up substantially.
According to data from the Port of Los Angeles – the most active port in the United States – the loads on containerships for December jumped 7.32% over the previous year.
Here’s the interesting part: While containership rates are down and container shipping volumes are up, the supply of the containers themselves hasn’t grown. And, in turn, the rates to lease those containers have risen.
Standardized shipping containers – also known as “intermodal containers” – have had a greater effect on your life than you’d expect.
Prior to the standardized container, unloading a fully packed cargo ship could take a week. Now, a crew of six can unload 3,000 containers from a ship in 48 hours. And a ship’s space can be used much more efficiently, to boot.
Without shipping containers, global trade and manufacturing would be a fraction what it is today – roughly 90% of goods shipped today are shipped in such containers.
As for the actual ownership of these containers, shipping companies themselves own 60% of the containers in use. The other 40% are owned and leased by a handful of container-leasing companies.
Fortunately for those companies, the shortage of containers has made for good business.
The “box to slot” ratio, which measures the number of containers versus the spaces on container ships, has fallen from 3-to-1 to 2-to-1 since 2000, an all-time low, according to data from Alphaliner.
If two containers for every slot seems high, remember that this includes every container not only on ships, but sitting in ports, on trucks, at factories and more.
In the last two years, container-leasing rates have risen 40%. The cost to buy a container has risen 130%, according to numbers from TAL International Group (NYSE: TAL).
Accordingly, the CEO of TAL told Bloomberg, “We’re seeing perfect conditions.”
As such, the stocks of the few companies leasing containers have posted strong gains over the last year. Take a look:
Even assuming new containers will be built and enter the market, these conditions should persist if the global economy maintains any sort of growth thanks to a multiplier effect. According to analyst, Helane Becker, an increase in global GDP leads to container demand growth by two or three times.
You essentially can’t go wrong with the stocks of any of these container companies. Each has utilization rates – the number of their containers in use – of over 98%. Typically these companies lock customers into long-term contracts, so sales are highly predictable.
Here’s a rundown of the relevant stock figures:
Now, there’s two different ways I suggest you play this industry…
With expected net income growth of 107% over the next year and one of the highest profit margins, CAI International (NYSE: CAP) has the highest chance to post a big gain over the next few months. Of course, it doesn’t have dividend and is more volatile, being a small-cap stock.
Also expected to double earnings over the next year is TAL International. As a much bigger company with a hefty dividend, consider TAL as the safer play, with a little less upside but less downside, too.
As long as the global economy doesn’t tank, shipping containers should deliver healthy growth on the back of this worldwide shortage.
Ahead of the tape,
Matthew Weinschenk
Related Topics: Commodities, Economy and Politics, Think Contrarian
Hi Matt,
Interesting points you raised on the container leasing companies.
One of the pitfalls of the BDI is that much of the drop we have seen recently can be attributed to the overcapacity of vessels in the dry bulk sector, which is also true for containers and the tanker shipping industry. So the overcapacity and the structural problems on the supply side is distorting the index immensely. The global benchmark appears to be the Shanghai Containerised Freight Index, which is a weekly index tracking the freight rates on fifteen trade routes ex-Shanghai.
The increase in imports we saw in the Port of LA in December 2011 was not seasonally adjusted. Chinese New Year came much earlier this year than previous years (Jan 23rd) and many shippers were rushing to have their cargoes shipped out of China prior to the two week factory closures., hence one of the reasons for the significant increase in import volumes. If you look at how volumes at Port of LA did in 2011, they were only up 1.39% and according to Alphaliner, Transpacific volumes shipped in containers actually fell by 0.2% last year on 2010 volumes.
The GDP multiplier effect we have witnessed previously no longer sticks either in the container shipping sector. Both the US and Europe markets have matured and the rising costs of outsourcing in China over the past few years has eroded the significance of this metric.
Also, China manufactures approx 97% of containers and speaking to the two largest container manufacturers, there appears to be quite a lot of inventory sitting in the warehouses waiting to be picked up. If the container leasing companies only own/lease 40% of global containers and return a profit margin of 107%, I wonder why the carriers aren’t doing the same given that they have been writing losses for the year as they were all so caught up in the market share/rate war they self-created.
The container leasing companies operate in a different way to other parts of the container industry and appear to be the only ones in the industry to be making any form of profit right now!
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Thank you for the knowledgeable and in-depth color on some of those statistics.
Data on Chinese inventory of new, unsold containers was unavailable, but would be very valuable. Based on the rising prices of both new and used containers, it seems that if there is a pile-up in inventory. There’s a problem getting it to market.
One minor clarification, the 107% doesn’t refer to profit margins for shipping companies. Analysts consensus estimate for earnings growth is 107% for CAI International.
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Thanks for this article.
It should be noted that some of the key drivers for the improved profitability of container leasing companies are:
. Shipping lines are relying more on leasing cos since 2008, because their own financial challenges make it more difficult for them to ourchase the containers.
. With the 2008 recession, as well as the high cost of bunkers (i.e. heavy fuel oil for ships engines), lines have considerably slowed down their services so as to save on fuel, typically down from 23-25 knots to 15-18 knots. As a result, container “turn around times” are longer on any given trade (Asia-Europe, Asia-USA…etc), which results in higher container fleet requirements for a given service 9typically weekly, fixed day sailings).
. Capital costs to finance new investments in containers have remained relatively low.
There is also more market concentration in container leasing than in ship leasing and shipping lines.
It should also be noted that the Shanghai Container Freight Index covers new rate filings, but it does not reflect the actual total evolution of lines’ revenues, since about 60% of the lines’ volumes are covered by so-called “service contracts”, i.e. contracts under which shippers (= exporters or importers or freight forwarders/logistics services providers) commit a significant part of their volumes for a quarter or even a full year to a given line, which in turn grants discounted volume rates which are fixed for the duration of the contract, at the exception of a couple of cost based variable factors which adjust monthly or quarterly, mainly the Bunker Adjustment Factor (“BAF”) which varies with actual bunker costs, and the Currency Adjustment factor (“CAF”) which varies according to the US Dollar rate of exchange versus several currencies of reference on each trade lane (freight rates are mostly expressed in US Dollars).
These operational and commercial factors are important to know, as well as others, if one wishes to understand how container shipping markets work.
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