China's Next Big Bailout May Target Shippers
It's been four years since the global financial crisis put the breaks on runaway markets, but while major asset markets have bounced back,the shipping industry continues to linger in the doldrums.
The Baltic Dry Freight index, which measures the forty key export routes around the globe for dry bulk goods, has fallen back to around 740 in recent months, a far cry from the record high of nearly 11,800 in May 2008.
The index is unlikely to make any meaningful breakouts this year because of the excess supply of new ships and anemic demand for cargo, according to both Timothy Ross, managing director of equity research at Credit Suisse and Jon Windham, head of Asia ex-Japan industrials equity research at Barclays.
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The general malaise in the industry continues to plague the biggest shipping companies, particularly those who signed long-term contracts with ship charters when rates were much higher. In 2012, the Chairman of China Cosco warned about "chronic overcapacity" and called upon the industry to act rationally.
More recently, on January 28, the world's second biggest shipping conglomerate warned about posting significant losses in 2012 after losing $1.7 billion in 2011.
Two days later, China Shipping Development Co, an oil and dry bulk shipper flagged a massive drop in profit to a range of $0-$8.04 million for 2012 from $168 million in 2011.
The tide of red ink over the years for Chinese shippers has decimated their balance sheets, which look "blown out", according to Windham. He said many companies are in desperate need of recapitalization.
Windham believes a bailout for the largest companies will likely come from the Chinese government, which could inject funds through equity placements.
In terms of leverage ratios, China Cosco's net debt to equity level catapulted to 63 percent in 2011 from minus 8 percent in 2008, according to Barclays data. China Shipping Development's numbers are worse, with the ratio rising to 87 percent in 2011 from 22.9 percent in 2008.
(Read More: China COSCO Shares Slump After Profit Warning)
Windham said there was a precedent for such recapitalizations. Singapore state investor Temasek threw its clout behind a massive $1.16 billion rights issue in 2009 by Neptune Orient Lines (NOL), Southeast Asia's biggest shipping company, which encouraged other shareholders to take part. Temasek took up its full entitlement and threw in the icing by pledging to take up any unsubscribed portion of the rights issue.
Despite all the gloom, Windham believes equity raisings by Chinese shipping companies would send a positive message to the markets.
But it isn't just Chinese shipping companies, ship builders are potentially in deep trouble too.
According to Windham "the lights are almost out for the shipyards", as orders have evaporated over the past few years, and they too will require some form of rescue or policy help from Beijing.
Windham said what's likely to happen is the bailout of Chinese shipyards will tie back to the recapitalizations of major shipping companies.The idea goes – you recapitalize and boost the balance sheets of shipping companies so that they have the capital to make new orders to keep the shipyards going.
According to Windham, history may repeat itself, as the Japanese government engineered a similar rescue of its own shipyards back in the 1980s and 1990s to prevent its own industry from going belly up.
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So as the seas remain choppy for the industry and with the outlook cloudy, do the share prices of the shipping firms accurately reflect the current fundamentals? Both Ross and Windham say no, and add that any recovery has been more than priced in at the current levels.
While times are tough for the shipping companies, there is a silver lining on what is a rather dark cloud, according to the analysts. The better way to play the global recovery story is to get exposure to the port operators, which aren't impacted by the overcapacity of ships entering service. At the end of the day, the ships still need to dock somewhere to load and offload their cargoes. Port fees are not contingent upon shipping freight rates, but rather shipping volumes, which for now look like they are on the mend as the global economy recovers.