Shipping is almost incomprehensibly vast and covers a myriad of sins. Just about everything is transported by sea - there are at least 20 million containers crossing the world at this very moment!
All sorts of products are shipped and each sub-sector has its own very specific drivers. There are, however, many common threads. At its most basic the cycle is led by economics lesson one, supply and demand; how much paraphernalia there is to be moved (and how far) set against how many ships there are around that can do it. This drives the rates that ship-owners can charge their customers and, with it, the P&L of shipping companies. When more needs to be shipped, and when there are fewer ships, companies make more money.
Companies are valued in a variety of different ways, some commonplace and some unique to this industry: traditional P/E multiples or free cash flow yields are supplemented by NAVs or fleet values, in turn often dictated by replacement rates allowing for ages of ships.
While the biggest sub-sector of this industry is dry bulk - transporting raw materials - we are more intrigued by the oil tanker market. Oil is being found in ever more remote places and needs to be taken to where it is consumed. This produces longer term growth. The bulk of this sub-segment is the mass transportation of oil in large supertankers, aptly named, Very Large Crude Carriers (“VLCCs”). (The average VLCC can carry 2 million barrels of oil). But, we have identified an even more compelling niche in the oil transportation market: product tankers. These ships are traditionally used to ship refined oil or oil products. Refining capacity is even more geographically spread than the oilfields themselves. This, combined with the higher volatility in the price of refined oil products than crude oil means even more structural need for transportation.
In the short term things look particularly exciting. Most people might intuitively feel that the dramatic fall in the oil price at the end of last year would be a negative. In fact, the opposite is true. The forward curve of the oil price is now in contango rather than in backwardation, meaning that you are paying more for oil in the future than for immediate delivery – as the market anticipates a recovery in the future oil price.
This phenomenon is so extreme that people are buying physical oil, chartering a VLCC and using it as “floating” storage. This in turn is sucking capacity out of the supertanker market, and people are now having to turn to product tankers to ship not only refined product, but also crude oil. This is causing an enormous boost to demand for product tanker ships and day rates are sky-rocketing (as the graph below demonstrates). This could be exacerbated even further by OPEC deploying spare oil production capacity in order to limit non-OPEC supply growth, thus adding yet more incremental demand.
The largest player in this industry is DS Norden (market cap: €5.8bn), but it is far from a pure play: product tankers represents less than 10% of its fleet, most of Norden’s exposure being to dry bulk, in which activity is fairly straightforwardly highly correlated with global GDP.
But there is a pure play. This is in the form of d’Amico International Shipping (market cap: €277m), a company we have known for many years. The company is 60% owned by the family and is run by industry veteran Marco Fiori, with whom we have met at least 3 times a year over the past decade (what patience he has shown in educating us on the industry!). He has managed the company very skilfully through both positive and negative cycles, always showing the utmost financial prudence. The company has “kept its powder dry” in difficult times, has the highest quality clients chartering their ships and has a very young fleet – all of which are key defensive features for us when investing in this cyclical industry.
The company controls 52 ships, primarily Handymaxes but also 9 larger Panamaxes. Of these, 23 are owned outright. Management carefully adjust their coverage ratio (the percentage that are out on longer term leases) according to how they view the cycle. They also actively manage the size of the fleet and we believe they will continue to be adept at adding capacity (buying in or building ships) when it is advantageous to do so, or downsizing as asset values eventually turn in the other direction.
Given that d’Amico is still in a fundamentally cyclical industry, the big question, as ever, will be when to sell the shares…