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Industry Analysis: Maritime
Volatility is a characteristic of the Maritime Industry, especially since the sector is both cyclical and seasonal. The group can be subdivided into a number of segments, according to markets served and assets owned. Although we present our reports in the standard industrial format, there are several nuances that investors must take into consideration.
Income Statement Factors
Bulk-commodity carriers generate revenue through relatively stable, long-term contracts, called time charters, and short-term agreements in the highly erratic spot market. Waves of global freight demand fall over tides of vessel capacity. Ship construction orders pick up when the business climate is fair, but deliveries may take up to three years, a period over which the economic trade winds can shift direction. It's not unusual for spot rates to move by 90% within a year, interspersed with seasonal fluctuations.
The Baltic Dry Index (BDI) is a good barometer of shipping rates for such goods as iron ore and grain. BDI figures can be found in many financial publications, including, sporadically, the Wall Street Journal. Clarkson Research is one of the best sources of rates charged by carriers of oil and other wet commodities by tanker.
Elsewhere, containerships serve several customers on a single voyage over regular liner routes. Per-container rates are typically negotiated once a year. Pricing information for this segment is best gleaned from individual company financial reports.
Vessel operations are capital-intensive, meaning that profit margins can vary dramatically, even on small changes in asset utilization. In addition to shipping with their own vessels, most companies will charter in tonnage. Time charter terms vary, but vessel expenses are usually paid by the shipowner. Carrier profit margins differ from time to time, depending on the ratio of owned-to-leased assets. Net revenue, or gross revenue less voyage expenses, may provide a better picture of a shipper's operating performance.
Below the operating line, other income is highly unpredictable, especially since we classify most gains and losses on ordinary ship sales, derivative instruments, and foreign exchange (even when unrealized) as recurring. The effects of currency translation can be quite significant, given many companies' large international operations.
Interest-rate, foreign-exchange, and fuel hedging activities are common in the industry. In fact, even if debt outstanding remains unchanged, interest expense can differ, quarter to quarter, because of foreign exchange gains and losses. Debt instruments may be denominated in several currencies.
Income taxes are not a factor for overseas business. Each ship operating in international markets is treated like a foreign subsidiary, and is usually registered (flagged) to a country where income taxes are very low or nonexistent. Moreover, since 2004, the United States has allowed the deferral of taxation on non-repatriated foreign shipping income.
Over the past few years, within the Maritime group, the act of spinning off certain segments into publicly traded companies or master limited partnerships (MLPs) has become popular. The parent company usually retains a controlling interest. This monetizing of assets improves financial flexibility. "Daughter companies" may also have an easier time raising funds either by issuing equity or debt. Their loans are typically non-recourse to the parent. The spinoffs may be attractive to investors wanting to limit exposure to risky sectors. Buying units in a liquefied natural gas shipping service partnership is an example of such an investment. These partnerships often produce steadier cash flow, especially if they are in fixed-rate businesses.
A vessel pool is another organizational strategy with a long history of financial benefits. It involves two or more carriers massing ships of a single class into one fleet. The pool provides big customers with a high level of service, while improving scheduling efficiency and vessel utilization plus reducing overhead costs for the carriers. Partners often share investment in ships, thereby helping to conserve capital outlays.
U.S. companies have one additional option. They can carve out a separate segment that only serves the domestic market and is subject to the Jones Act. The Act requires operating vessels to be American built, crewed, and owned. It's more expensive to operate within these constraints, but the benefit is that foreign competition is prohibited. Though the domestic market is, of course, economically sensitive, carrier earnings and cash flows are more stable than in the international market.
Price/earnings multiple comparisons are of little use when earnings evaporate or accumulate as quickly as they do in the Maritime Industry. A more practical stock valuation methodology is to weigh the share price against Net Asset Value (NAV) per share. NAV is the market value of a carrier's assets, minus net debt, plus equity interests. Generally, a stock is undervalued when it trades below NAV/share. Investors are paying a premium when the share price is above NAV/share. Private equity interests are tough to value, as are ships, in many cases, making NAV difficult to calculate at times. That said, a vessel's value is closely correlated to its income-generating potential. Alternatively, investors may use a company's recent share-earnings momentum and analysts' near-term estimates as a guide.