Silver linings for tankers and plummeting iron ore outlook

Tanker analyst Jonathan Chappell, in his report “Oil Tankers: The Struggle is Real” lays out a stark set of realities for the sector, which has been plagued by disappointing investment valuations, in spite of still strong fundamentals. Specifically, he points to most equities are trading at large discounts of stock prices to NAV and to EV/EBITDA multiples earned in similar periods of prior cycles.

Chappell, a veteran analyst, writes in his report: “We believe the next 6-9 months are incredibly important for this industry…”, citing the concern of a looming supply build-up. There is a silver lining to the dark cloud, maybe, one which might lead to “buy” recommendations later in the year. The report goes on to say: “continued restraint from ordering new ships could generate a reverse inflection point for capacity within 18 months, rendering current valuations too good to pass up.”

The report takes the view that capacity, the result of vessel deliveries, will continue to build through late 2017, and rates and earnings will be “unfavorable”, compared to the recent past. However, the material decline in available ship finance might offer a hoped for salve for that dreaded malaise of over-ordering; the report suggests that ordering is down some 90% due to unavailability of funding.

So, in the views of Evercore ISI: “Unless stock prices jump 30-40% to a level where large P/NAV premiums exist again, it is hard to see where new capital will come from, with forced ordering restraint potentially setting the industry up for another large upturn in the medium term.” In other words, if stock prices were to rise sharply - relative to the value of the steel, the companies could issue more share capital.

Within the fine print, the analysts suggest that the product tanker sector will outperform in the next 9 -12 months due to a favorable demand picture in the face of an orderbook heading towards a 15 year low. The two players with “Buy” ratings are Scorpio Tankers and Ardmore Shipping.

In contrast to the strong fundamentals in the tanker arena, which investors have chosen to ignore when valuing stocks, the drybulk arena continues to struggle with what Evercore ISI’s China Research team, led by Donald Strazheim, pegs as a slowing demand for steel.

Following a recent surge in China’s economic activity, which brought rebar prices up to a two year high and iron ore prices up to Summer, 2015 levels, “industry fundamentals, in China and out, of excess capacity and sluggish demand indicate this spike will be reversed in the coming months.”

Delving further into this research note, the picture gets gloomier. Citing an emerging trade fight, the analysts express an expectation that 2016 production and consumption of steel in China will be flat with 2014 and 2015. Shipping is not discussed explicitly, however, economic charts in the report reveal that 2015 iron ore imports were up 2.2% over those of 2014, with a burst late in the year, that carried over into early 2016.