Demand remains benign. On demand, Kerr-Dineen is above consensus, forecasting flat to a 20m tonnes decline for iron ore, and small falls for both coal and grain, while China coastal shipping should grow at 5%. We broadly agree with these estimates, with the exception of China coastal shipping, which we expect to contract as coal shipped from northern ports to southern power plants suffers with weak power generation. The risk to our view remains that there is little import substitution if iron-ore prices remain high, permitting Chinese mines higher on the cost curve to remain viable.
Oversupply still a key concern. The Baltic Dry Index (BDI) traded in a normal range of 1,000-2,000 band from 1985 until 2003, when the supercycle took off. At the bottom of the range, vessels cover cash operating costs as utilisation rates fall to 80-82%, and then fully cover buildup costs (including depreciation and interest) as utilisation hits 95%. Kerr-Dineen flagged that the massive supply/demand disjoint will take a long time to balance, resulting in the market reverting to the long-term trading range of 1,000-2,000 in 2009 (we forecast 1,650), but without major cancellations/delays in deliveries and scrapping the market is likely to head down to below 1,000 in 2010 (we expect an 1,120 average for 2010).
Short-term squeeze to end. The short-term BDI bounce is driven by Chinese ore traders restocking and with idle vessels hitting 130 at year end it created a shortage of available tonnage in February. However, we believe the actual underlying demand in China remains subdued given the gloomy outlook for property projects, which account for 40% of steel usage. KerrDineen expects capacity to become available in March easing supply constraints allowing freight rates to decline again.
We could head back to 1986 asset-price levels. Asset price deflation for ship values will be dramatic if the market is going to head back down to below 1,000, with vessels then being valued at scrap. At the other extreme, a premium to new-build value and in a normal cycle, values should reflect the mean cost of building a new vessel less straight-line depreciation of 4% per annum. So, we could be potentially heading back to 1986 levels if 2010 results in a sub-1,000 level again and cash costs struggle to be covered.
Japan shippers remain a conviction SELL because earnings will collapse from FY3/09 onwards, as 45-60% of their recurring profits came from the dry-bulk spot market in FY3/08 during the super commodity cycle in 2003-08. The commodity super cycle is petering out as supply increases to meet past demand expectations of high perpetual growth. Meanwhile, performance of Japan’s container-shipping businesses (second-largest segment in sales terms) will remain weak with no recovery until 2010, given slowing global demand and excessive capacity in the market. We have a SELL rating on Mitsui OSK (9104 JP - ¥577 - SELL) (30% downside, 0.8x FY3/10CL PB), and Underperforms on Nippon Yusen (9101 JP - ¥457 - U-PF) (23% downside, 0.7x FY3/10CL PB) and Kawasaki Kisen (9107 JP - ¥362 - U-PF) (12% downside, 0.5x FY3/10CL PB).
Regional - SELL China Cosco and U-Ming. Regional shippers’ share prices will also come under pressure as spot freight rates decline and with the realisation that asset prices will continue to plummet. With 80% exposure to the spot market, 43% of capacity in capesize vessels, high charter costs and an expensive new build programme, China Cosco (1919 HK - HK$5.11 - SELL) sees 35% downside potential to our target price of HK$3.34. Elsewhere in Taiwan, we remain bearish on U-Ming Marine (2606 TT - NT$44.0 - SELL), which carries 40-50% spot-market exposure and sees 34% downside to our price target.
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