GE Shipping: Cycle turning favourable?

This is how Mr K M Sheth, Chairman of GE Shipping describes running shipping business successfully in the FY17 Annual Report:

  • Shipping is a truly global business in every respect as well as a cyclical and volatile one in which many moving parts across the world have a bearing on earnings as well as asset values. It is not unusual to see swings of 50% or more in earnings and swings of 30% or more in values within a period of twelve months.
  • At its core, success in the commodity shipping business can come by doing two basic things well: buying and selling the right ships at the right price and time, and running the ships well in the interim.
  • Interest and depreciation, which are directly affected by the capital cost of the asset,constitute almost half of our operating cost base. This shows the key role that the acquisition price of ships plays in our profitability.
  • We have done a lot of work trying to identify the right price for different types of assets. In most cases, this coincides with very weak freight markets, which means that charter rates are not remunerative if not loss making, i.e., earning a very low or negative current yield.
  • It is not possible to time troughs and peaks perfectly. However, we expect that investing with such a ‘value based’ rather than a ‘momentum-based’ approach will deliver US dollar returns on capital in excess of 10% over an investment horizon of 3 to 5 years. With some leverage thrown in, this can translate to an even higher return on equity.
  • Company attempts to manage volatility risk in various ways. If the Company believes that the freight market could weaken, it may enter into time charter contracts ranging from 6 months to 3 years. Another method of managing risk is by adjusting the mix of assets in the fleet through sale or purchase of ships.

Sub-sectors/Asset classes of GE Shipping:

  1.  Crude Oil Tankers

Two types of Tankers and their usage as explained below:

Where do crude tankers sit in the value chain?

Click here for basics of the Tanker segment

Currently, GE Shipping owns 7 Suezmax of 10,76,376 dwt and 5 Aframax of 532,307 dwt. They owned 4 Suezmax crude carriers of 610,797 dwt and 4 Aframax carriers of 426,314 dwt as at March end 2016 resulting into 76% and 25% increase in Suezmax and Aframax tonnage capacity respectively over last two and half years. 

In FY16, crude tankers, inclusive of ‘spot’ and‘period’, earned an average TCY of $ 31,913 /day (FY15: $21,650/day). The strong earnings were, principally due to the following factors:

  • All oil producing nations upped their production levels and then continued their record high production even as oil prices fell.
  • The surplus in crude availability translated directly into higher volumes shipped around the world, as refinery margins soared, demand spiked at lower prices, refinery maintenance was postponed and plants ran at historically high rates across the board.
  • The lower oil prices spurred large scale stock-building (Commercial and Strategic).
  • The crude fleet growth was modest in FY 2016 coming in at about 2.8 %.
  • The earnings were also helped by the drop in the price of bunkers in tandem with oil prices from more than $300/tonne at the start of FY16 to less than $ 200/tonne by the end of FY 2016.

Similar factors can probably play out again in 2019

In FY 17, crude tankers, inclusive of ‘spot’and ‘period’, earned an average TCY of $ 21,853 /day. In FY18, average spot earnings fell 42% YoY. 

In Q2FY19, avg TCY was $10,373/day vs $15,975/day YoY. In H1FY19, avg TCY was $10,692/day vs $15,779/day. As can be seen, TCY has fallen from the peak of $32k to $10.4k recently. There is light at the end of the tunnel. In October, Suezmax rates have shot up significantly to around $30k/day and Aframax to around $25k. In November, spot rates for Suezmax hit as high as $50,638 while Aframax has been stable around $25k/day as per Clarkson data. Certainly, the worst in terms of freight rates is behind us. Marginal new fleet supply in 2019 should ensure that rates average around $25k/day going forward which along with capacity addition over last two years should lead to significant increase in cash flow generation. 

Risks to high freight rates are fleet growth of 7% in CY2019 and probable OPEC production cuts though the biggest listed crude tanker operator Euronav believes the additional fleet supply can be absorbed by the market as the chart below shows

2. Product Tankers

GE owned 4 Long Range One (LR1) carriers and 9 Medium Range (MR) carriers as at March’16. Over the last two and half years, GE has added one Long Range Two (LR2) and 3 MRs. 

Similar to the trend in Crude tankers, Product freight rates have almost halved from the peak and at the lowest level in Q2. MR Rates have since then strengthened by around 20%. 

PeriodTCY/day
FY16$20,155
Q3FY17$16,285
Q4FY17$15,868
Q1FY18$15,432
Q2FY18$13,833
Q3FY18$15,259
Q4FY18$14,598
Q1FY19$14,697
Q2FY19$10,323

Factors influencing freight rates:

  • Inventory build-up and arbitrage opportunities
  • New refinery capacity away from oil consuming countries, end oil consumer demand, seasonal refinery maintenance shutdown
  • Net fleet growth/orderbook. BIMCO estimates net fleet to grow by 2.4% (lowest since 2012) next calendar year.
  • Crude oil tankers cannibalise when their earnings are lower leading to oversupply of vessels
  • IMO 2020 regulations require cleaner fuel for seaborne trade leading to higher demand in 2020. 

3. Gas Carriers

GE owns 6 Gas carriers now of which 3 added in the current FY from just one Very Large Gas Carrier (VLGC) as on March’16. 

Q2CY18 saw average VLGC spot rates going down to below $10,000 a day and now they are more in the region of $20,000 per day. Timing of carriers purchase and sell track record remains. 

Factors influencing freight rates:

  • Increase in shale production in US, internal consumption and hence LPG Exports from US
  • New fleet growth. VLGC orderbook as a % of current fleet stands at 7.1% for 2019 and 8.6% for 2020 which shows supply would be high over next two years.  

4. Dry Bulk Carriers

GE own one Capesize carrier (pic below), 8 Kansarmax vessels out of which it has contracted to sell one Kansarmax to be delivered in Q3FY19 and 6 Supramax carriers out of which one was sold in July.  

Freight rates have been relatively strong and are expected to remain around current levels or lower. 

PeriodTCY/day
FY15$9,860
FY16$6,638
Q3FY17$6,972
Q4FY17$8,345
Q1FY18$9,166
Q2FY18$8,940
Q3FY18$12,231
Q4FY18$11,852
Q1FY19$13,597
Q2FY19$12,447

Factors influencing freight rates:

  • Coal, iron ore (long haul i.e Brazil or short haul i.e Australia) and bauxite imports by China
  • Fleet growth and scrapping. BIMCO expects net fleet growth (
    after considering scrapping) of 3% in 2019  which seems manageable if the Chinese imports continues to grow. 

5. Offshore Business

As the Exploration and Production (E&P) spending remain subdued, this part of the business is expected to be depressed going forward from growth perspective. Currently, all four rigs are working. Two rigs have been contracted till early 2021 at lower rates. Utilization of vessels is to improve from last year. Of the old contracts, one is going to get over at this time next year and fourth rig contract will get over in early 2020. Higher utilisation and lower rates will likely result in moderate fall in cash flows going forward. 

Financials:

Significant Operating Leverage: As most of the fleets are on spot rates compared to 40-50% spot earlier, every $1000 increase in rates flows to the bottomline.

Debt repayment: GE did a capex of $400mn over last two and half years for purchasing tankers and vessels for which they raised debt. Debt currently is Rs 2850crs. As the earnings cycle improve, asset value of tankers and vessels usually picks up, sale of which along with operational cash flows will be used to trim down debt. No major capex except $18-20mn scrubber installation as GE doesn’t intend to add more vessels in the near future. 

P&L Statement: Due to the new accounting standard, liability side of balance sheet gets marked to market while the asset side isn’t due to rupee depreciation while in reality GE is a net beneficiary of weaker rupee as both assets and liabilities are in dollar and hence it makes no sense to look at the Quarterly Profit figures. H1 Consolidated reported loss was Rs 468crs while operating cash flows was Rs 485crs. 

NAV: Shipping businesses globally are valued on NAV basis where assets are valued on the basis of valuation by shipbrokers adjusted for balance sheet items. Standalone NAV as on Q2FY19 was Rs 352/share and consolidated NAV was Rs 397-420/share. Asset values of crude tankers and product tankers should improve as freight rates move up. Consequently standalone NAV should improve. Globally, ship owners are trading at a discount to NAV. 

https://www.screener.in/company/GESHIP/consolidated/

Reference: BIMCO, ShippingWatch, Lloyd’s list

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1 thought on “GE Shipping: Cycle turning favourable?

  1. Pingback: Read, Learn, Improve – 8-Dec-18 – Random Thoughts of Analyst

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