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How to Invest in Shipping

If you ask me how to invest in shipping stocks, I have to reply: Why?

Seriously, folks. There's a reason we call the shipping sector the place "where money goes to die," and it's not because shipping is a great place for investment. To cite one (extreme) example, shipping is where investors in DryShips (NASDAQ: DRYS), run by noted scallywag George Economou, watched their stock fall from a split-adjusted valuation of $55.3 million per share to prices below $5 a share over the past four years.

That's a loss of 99.999998%.

Not all shipping companies have lost as much, of course. Container shipper Danaos Corporation's stock is down "only" 77% since its highs of early 2014. Seaspan (NYSE: SSW) has fallen just 75% from its 5-year high, Costamere (NYSE: CMRE) 74%. But still, the damage is significant and widespread.

Big red cargo ship
Big red cargo ship

Today's low shipping rates could use a tug (or three) in the right direction. Image source: Getty Images.

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The occasional pirate CEO is only part of the problem. You see, historically, the economics of the shipping business have been suboptimal. When shipping rates are high and profits are flush, shipping companies often overbuild their fleets in order to capture as much market share as possible. The problem is that the laws of supply and demand dictate that when capacity surges, it drives prices back down -- zeroing out the profits at the worst possible time. Last year, for example, shipping executives estimated total losses among the 20 largest container shipping companies at $10 billion. And these surges in excess shipping capacity can take years, if not decades, to work through before the cycle ramps back up.

Putting a pin in the cycle

That's where we are in the shipping cycle right now. Times are tough for shippers this year, with rates in the dumps and trending downward. The Baltic Dry Index, which tracks lease rates for ships carrying cargo such as grain, iron ore, and similar dry cargo, had inched back up until about mid-last month, but has since begun slumping again. The situation with oil shippers looks similar, with the Baltic Dirty Index trending down since late October and the Baltic Clean Index basically flatlined.

But what about container shipping, you ask? Didn't The Wall Street Journal just say the container shipping industry is "emerging from a painful six-year slump?"

You can't "emerge" from a high point

Well, yes and no. In 2015, global shipping consultancy Drewry noted that container lease rates (the cost to rent 20- or 40-foot shipping containers) had fallen to a "record low" -- but then rates fell another 24% in 2016. And now, Drewry says rates are "under pressure" again this year.

The good news is that cheap container lease rates encourage customers to ship goods, and this, combined with a healthier global economy, has been increasing demand for shipping services in 2017. Shipping analyst Alphaliner predicts about a 5% annual growth rate for shipping volumes through 2020, at which point it's possible that demand and supply will roughly equalize.

Shipment rates have already recovered off their lows of early last year. In Q1 2016, shipping containers on the Asia-Europe route cost as little as $300 per container. Today, rates are more than twice that. But even so, citing information from Braemar ACM Shipbroking, the Journal notes that the $783 cost of shipping a 20-foot container from Asia to Europe in September was barely half the $1,400 that most shipping companies need to charge to cover their fuel and other operating costs. Shipping 40-foot containers from Asia to the U.S. West Coast is similarly dicey. Rates average $1,490 per container today, versus the $2,800 needed for shippers to break even.

While off their lows, rates this year have still fallen below where they were a year ago. So while it may be true that demand for shipping services is "emerging from a painful six-year slump," the prices shippers can charge for these services remain in a trough.

What it means for investors

It gets worse. The Wall Street Journal reports that in an effort to cut costs, the 11 largest container shipping lines in the world are now moving to build as many as 60 new "megaships" to add to their fleets. On the one hand, with each megaship carrying up to 20,000 20-foot trailers, costs per container should fall. On the other hand, though, by expanding shipping capacity so much, there's a real risk that prices will fall alongside the container liners' cost to ship.

So what's an investor to do in such a situation? Personally, I'd avoid the sector entirely. It seems to me that the shipping business is caught in a Catch-22, where even moves to cut costs end up costing shippers money. That being said, if you feel you absolutely must invest in this industry, I'd at least suggest investing in companies that have shown their ability to keep earning profits even in a nasty rate environment.

Two of the container ship charterers named above -- Seaspan and Costamere -- have remained profitable all through the downturn, for example (according to data from S&P Global Market Intelligence). Seaspan and Costamare also earn far higher operating profit margins than do the large shipping lines such as Cosco and Evergreen, Maersk, and CMA CGM. Moreover, at P/E ratios of 6.5 and 11.0, respectively -- and with powerful dividend yields of 7.7% and 6.5% -- Seaspan and Costamare stocks both look affordable, and pay you a dividend while you wait for the shipping industry to cycle back up.

I think they're the best ways to invest in shipping today.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Seaspan. The Motley Fool has a disclosure policy.