Macquarie :Asia Shipping Pulse: All bulked up and nowhere to go

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Asia Shipping Pulse
All bulked up and nowhere to go
Event
 The global fleet of dry bulk vessels continues to grow by leaps and bounds.
Increasingly it is hard for the bulkers to find a load to carry. We look at the
supply outlook for the major bulks versus projections for new capacity.
 Orders for new containerships have picked up steam, but confirmed orders
are still less than 4% of the existing fleet. While the anticipated Maersk order
for ten 18,000teu (as reported by Bloomberg) would distort this, we continue
to believe that new orders will remain well below deliveries.


Impact
 Hangover of binge ordering: Dry bulk owners and operators are just
beginning to feel the effects of binge ordering of dry bulk capacity in 2007-
2008. Some have even indulged in a night-cap, ordering more vessels. We
are currently in a period of what should be seasonally strong demand, yet the
BDI has skidded down 30% from its recent peak in mid-September.
 Order books at high level: The Capesize order book is 65% of the existing
fleet, while overall the tonnage of bulk vessels on the books equals 52.5% of
the existing fleet. Even with slippage in the order book, these numbers
suggest that the hangover could be a bad one as growth in bulk volumes is
likely to average well below 10% pa.

 Three scenarios: We offer three scenarios of how the market could respond.
The most painful but quick fix would be a sharp decline in bulk rates bringing
the BDI back below 1,000 for an extended period. Losses would stimulate
scrapping – ideally at the rates seen in the mid-1980s or late-1990s/early
2000s, bringing supply and demand closer to balance. A decline that induced
moderate scrapping of about 3% of the fleet per year would do the trick but
the pain would be drawn out. A continuation of the current situation – Drift –
would ensure little profit is made from dry bulk for years to come.

 Containership orders gather steam: Over the past two months we have
seen an acceleration of new orders for liners, mainly from operators. They
have tended to be either large post-Panamax vessels or smaller ships geared
to the intra-Asia market.

Outlook
 While some of the dry bulk specialists represent well-run companies on low
valuations – the basis of our current positive recommendations for several – if
the dry bulk market were to crash, we believe these companies would be sold
off indiscriminately. There is also a good chance that the Japanese diversified
shippers would be sold/shorted due to their high liquidity despite other parts of
their business that are likely to remain attractive. It is a risk that should be
borne in mind when investing in the sector.

 While the near-term outlook for containership profits is weak due to the slack
season, the convincing rebound in earnings year-to-date suggests a return to
health for the industry. Alphaliner estimates that profits for the top firms could
total US$13bn this year, just US$2bn short of the US$15bn losses in 2009.
 Top pick: Orient Overseas (316 HK, HK$78.25, Outperform, TP: HK$95).
 Second choice: CSCL (2866 HK, HK$3.22, Neutral, TP: HK$3.50).