gestion maritime
The
Industry
the industry
The Shipping
Market Structure
The ‘total risk’ faced by shipping companies (and those that lend to them) can be sub-divided into three parts.
Economic, Operational and Shipping Market Risk.
Economic Risk
Economic risk within shipping emanates from a shipping company’s exposure to global economic fluctuations. Demand for sea freight is naturally connected to commodity output, global trade, and by extension geopolitical relations.
The two deep recessions which hit the shipping market in the 1970s and 1980s were partly caused by corresponding global recessions, and this will likely always be an important factor when managing risk exposure within the shipping markets.
Operating Risk
Shipping Market Risk
Shipping market risk encompasses risk specific to the shipping industry itself and, in particular, the shipping market cycle. It is noteworthy that the shape of each cycle is uniquely determined by the subtle interplay between exogenous freight demand and endogenous supply side factors,
Supply side factors are themselves related to the direct action of shipping market players, from the supply of credit for vessel purchases to the construction, secondary purchase, employment and demolition decisions of the owners themselves
It is with the shipping market risk that we are particularly concerned here.
This risk, which often seems to arise from the lack of foresight and market discipline by shipowners, lies at the heart of the shipping business. Gestion Maritime Group actively manages these risks within a structured data-driven framework.
It poses a particular problem because any view of the future depends on the expectation of whether past mistakes will be repeated.
If Shipowners become wiser and better informed, it is a small step to the expectation that past mistakes will not be repeated in future, making shipping less cyclical.
However, this view misses the point of shipping cycles.
Shipping cycles have a purpose. The shipping market uses them to control supply and demand in an unpredictable world.
From this perspective, the guiding light for shipping investment professionals is a detailed, data driven understand of the shipping cycle.
Shipping Market Cycle
click play to see the flow
Each shipping cycle, much like each shipowner, has its own character. Shipping banks place great value on “name lending”, in which they get to know and trust the clients they lend to.
It is a logical step to apply the same principle to shipping cycles.
Just as familiarity with the client reduces risk, so does familiarity with shipping cycles.
As they progress through each cycle, investors must ask “what is its character?” “it is trustworthy?” this approach leads to an understanding of the unique character of each cycle as it unfolds, and an opinion on how to manage the imbedded downside risk within it.
Historically, banks have pro- cyclically lent, and investors have pro-cyclically invested without employing a robust data-driven process to cycle downside-risk evaluation.
In so doing, these capital allocators have fallen victim to of their own actions, hazard by exacerbating the magnitude of the down cycles and frequently prioritizing new buildings to second hand vessels; the latter seldom being seen as equivalent to the former in many cases.
This is in fact not the case.
the industry
Implications of Volatility
for Portfolio Management
The implication of shipping downside risk is substantial for both investors and lenders alike.
Over the past 30 years, it has been customary for large banks to set up dedicated shipping departments which operate large portfolios of shipping assets – with risk capital amounting to $15-20 billion in many cases in the early.
This seemed a logical response to the ravenous demands of an ascending China, it is runs contra to the core tenets of sound risk management within volatile, cyclical markets.
The accepted practice is to use a well diversified portfolio of high risk assets to remove the “ideosyncratic risk” attached to individual assets
Portfolio theory can be applied to portfolio of vessels much in the same was as with all other pools of assets.
However, in order to do so in shipping, one must use data and analytics to construct optimal shipping portfiolio that achieve pre-defined risk and return targets, over a set timeframe.
the industry
The Ship Finance &
Shipping Market Dynamics
The actions of lenders within the shipping space warrant particular attention, as they are a key ingredient in the understanding of cycle development.
The mechanism that drives investment in the shipping market has been likened to a switchbox directing cash between the four shipping markets, newbuildings (supply expansion), second hand (vessel liquidity), chartering (income) and demolition (supply contraction). During cyclical upswings cash is sucked into the market and increasing credit availability liquidity encourages shipowners to order new ships.
As these vessels are delivered, supply overtakes demand, freight rates fall and cash is flushed out of the market, forcing owners to sell ships for scrap in order to raise funds.
The figure below shows the cashflows which underlie this market mechanism. The focus of the diagram is the square showing shipping cashflows, with net payments into the shipping industry’s coffers shown by the dotted lines, and payments out by the solid lines. As before there are four markets involved, each of which plays an important part in the “financial pumping” mechanism.
However we have now introduced shipping banks, who are prepared to lend on new and second hand transactions. They are shown in the centre of the diagram. Their loans to second-hand buyers are shown as a dotted line because the cash they advance is paid to a shipowner.
However, loans on newbuildings are shown as a solid line because the money is, in effect, paid to the shipbuilder and does not become part of the shipping industry’s cashflow. It does, however, result in the debt service cashflow, also shown by a solid line.
In addition to banks we have equity investors who are located at the top right of the diagram. Cash flows in as equity and out as dividends.
Cash Flow Model of the Shipping Market
click play to see the flow
The ability of the ship finance industry to reschedule cashflows is of great interest when it is taken in conjunction with the cyclical nature of the business.
Cash paid to the newbuilding market is shown as a solid line because money spent on new ships leaves the shipping industry.
The full price of the ship is paid to the shipyard, which then pays it out as materials, labour and profit. This is where ship finance becomes important.
If the ship is bought from equity, the cash outflow is immediate, but if it is bought with a loan, the outflow is spread over the period of the loan repayment
This has 2 consequences
01
First, newbuilding contracts placed at the top of the market commit investors to cash payments at a later date when market conditions will have changed. Secondly, the availability of debt finance “multiplies” the ordering capacity of the industry for a given equity level.
For example, if the bulk shipping industry is holding liquid assets worth $10 billion and there is no leverage, it can order 100 VLCCs at $100 million each. If 80% credit is available the industry can order 500 VLCCs.
This does not mean that it will order 500 VLCCs, or that bankers would agree to so many loans, but the opportunity is there.
On both accounts the among of newbuilding during a cyclical peak and the way it is financed has consequences for the recession which a study of cycles suggest is likely to follow.
02
Lending on second-hand ships plays a different part in market dynamics. A second-hand sale just transfers cash from one Shipping bank account to another.
The industry cash balance is unchanged so the cashflows in the schematic above are shown as hatched bars. Or at least that in the case if there is no bank lending. If purchasers borrow, the short-term liquidity of the shipping industry increases.
For example if an owner borrows $6 million to buy a $10 million tankers the industry’s cash balance increases by $6 million.
If we look at the industry balance sheet as a whole, the effects of this sale and purchase transaction is to increase the current assets by $6 million, offset by a liability of $6million.
It is easy to see how the availability of debt finance accentuates the cash pumping effect of the market. In a rising freight market the sale and purchase of ships at increasing prices pumps cash into the industry balance sheet. The industry becomes more and more liquid, allowing owners to pay ever higher prices for ships, which eventually spills over into the newbuilding market.
At the same time, highly leveraged owners are building up liabilities and their break-even cashflow, including debt serves, is increasing. As the market moves into downswing the whole process is reversed. The volume of second-hand activity reduces as prices fall and the cash inflow from banks drops sharply, just as the cash injection from freight rates shrinks.
Those owners who built up balance sheet liabilities at the top of the cycle now find that the incoming cashflow is inadequate to meet their day-to-day obligations. They are forced to sell ships on the second-hand market.
This is the point at which the asset-play market starts for those shipowners with strong balance sheets, or external investors. Buying ship cheap in recession is one of the ways that shipowners top up the poor returns from carrying cargo. Some of the best bargains are to be had when bankers foreclose and force distress sales.
In the right hands, ship finance is a valuable service which spreads the substantial cash cost of investment in ships over a period of time. For lenders and investors, the key is to accurately evaluate the risks of the cycle, given an understanding of the system.
At Gestion Marime, we make it our business to understand the system, and use data and analytics to both measure and manage the inherent shipping risks, in order to exploit them in a contrarian way.
the industry
Key Numbers
shipping
90%
of global trade by
volume is carried by sea
total cargo fleet
56k
units registered in
over 150 nations
total cargo fleet value
670
billion
USD
total ship owners
26k
top 50 owners
control 40% of the fleet
seaborne trade
13
billion
tonnes a year
seaborne trade
60
trillion
tonne-miles
a year
seaborne trade value
26
trillion USD
a year
seafarers
1.65
million
people
shore staff
500k
people
Gestion Maritime SAM
Operations
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98000 Monaco
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